Is Accounts Receivable an Asset? | Financing Explained
As a business owner or contingent worker, you may have come across the topics of accounts receivable and been wondering: what exactly is accounts receivable? Is accounts receivable an asset? A liability? Or equity?
Let’s get into the details of accounts receivable and how it’s treated in accounting and everyday business.
Is Accounts Receivable an Asset? Receivables Defined and Explained
Yes. Accounts receivable is an asset, specifically a current asset, that lives on the balance sheet.
What is an Asset? A Quick Balance Sheet Primer
An asset is an accounting term used to describe something that is intended to be converted into cash for a company, or adds value. For example, if a company sells t-shirts to make money and has them in stock, we treat those t-shirts as an inventory asset and its value is “held” on the balance sheet. This is because those t-shirts are intended to be sold and generate a profit.
Assets are further categorized into current assets and non-current assets. This delineation simply breaks assets into things of value that are likely to be converted to cash within one year (current assets), versus things of value that are likely to be converted to cash in a longer timeframe, longer than a year (non-current assets).
What is Accounts Receivable? Are Receivables Revenue?
Accounts receivable can be a confusing topic to understand, but it is simply money that you expect to receive from your clients or customers. In business, it’s common for transactions to not occur instantaneously. For example, you may invoice a client and they could take 30 days to pay that invoice. During those 30 days, the outstanding balance is considered an accounts receivable!
When an invoice has been issued, but cash is not yet received, that’s what creates an accounts receivable balance. At the same time, revenue is recognized (and booked) even before the invoice has been paid. So technically—yes accounts receivable is revenue. We won’t go into details of journal entries and credits vs debits in this article, however, the proper journal entry is:
Credit (increase) Revenues (or Sales, or Income) on Income Statement (or P&L)
Debit (increase) Accounts Receivable on Balance Sheet
When you actually get paid on the invoice, the journal entry is then:
Debit (increase) Cash on Balance Sheet
Credit (decrease) Accounts Receivable on Balance Sheet
Examples of Accounts Receivable:
You are a freelance writer and have completed a copywriting gig for a client and invoice them for $500. Your client pays you in 30 days—during those 30 days, that balance is an Accounts Receivable.
You sell 2x4 wooden planks as a mill to retailers like Home Depot. The payment terms are pre-agreed upon and Home Depot has 60 days to pay your invoices. During those 60 day periods, the outstanding balances are considered accounts receivable.
You are a freelance illustrator and have completed 3 different brand asset catalogs. You’ve invoiced a client and they have 45 days to pay. Another client you’ve invoiced pays immediately, and the last client you invoice has 30 days to pay. This will create two accounts receivable entries, since one of three clients paid immediately and there are no receivables.
Benefits of Having Accounts Receivable
You may be wondering why accounts receivable even exists or how it benefits businesses. To put it simply, accounts receivable exists because every business needs to manage cash flow. The main beneficiaries when accounts receivable is incurred, is mainly the payer, or vendor. This is because accounts receivable is a “delay” in payment, which allows vendors to have temporary cash that’s available to use for purchasing materials, pay for labor, etc.
How to use Accounts Receivable in Analysis
In analysis, accounts receivable is often considered as a metric used in calculations to determine how “liquid” a particular business or practice is. If a business is unable to collect on its accounts receivable balance, then it may run into liquidity issues, meaning, the business has to pay out cash sooner, or in larger amounts, than it can receive cash.
For example, you own a design agency and have sub-contractors whom you delegate work to. You’ve promised your subcontractors that you would pay them upon completion of work, however, the client doesn’t need to pay for 30 days. That means that as soon as the work is complete, you would be out cash first, before being paid by the client.
This brings up an important point—accounts receivable balances are not a singular balance. Usually, accounts receivable balances consist of many invoices from many clients, and they may all have different payment terms. Some clients have agreed to pay sooner, others may have more leverage and can pay later. This general concept is referred to as “accounts receivable aging”. An accounts receivable aging report is a very commonly used analysis tool to determine the health of feasibility of repayment for accounts receivables. Here’s an example of what an accounts receivable aging report could look like:
| Client: | Current | 30-60 Days | 61-90 Days |
|---|---|---|---|
| ABC Company | $1,234 | $5,678 | $190 |
| 123 Company | $4,321 | $6,789 | $215 |
| 456 Incorporated | $3,456 | $2,345 | $400 |
accounts receivable aging report example
That brings up an interesting question…
What Happens if Accounts Receivables are Never Paid?
This shouldn’t be a common occurrence, but if accounts receivables are left unpaid, they are written off and considered an expense. Specifically, we call accounts receivable that are uncollectible, Bad Debt Expense. In larger businesses, uncollected accounts receivables are often sold to collection agencies that specialize in collecting bad debt. In small businesses, it’s basically considered a loss.
So What’s Accounts Payable? What’s the Difference between Receivables and Payables?
Payables are just what they sound like—the opposite of accounts receivable. Accounts payable is a liability and is money that you owe vendors/suppliers and have yet to pay. Like receivables, payables can be a source of financing but for the buyer (you). This is because you will have cash available today to use, since you don’t have to pay immediately.
An efficient method of financing for businesses is if owners are able to negotiate longer accounts payable terms than their accounts receivable payment terms. For example, you have 45 days to pay vendors, but get paid by customers in 30 days. This creates a 15-day window where you have cash available.
FAQs:
Is accounts receivable an asset yes or no?
Yes. Accounts receivable is a tangible, current asset, because a business expects to convert accounts receivable to cash in the short term.
Is accounts payable an asset?
No—accounts payable is a liability. Payables are money that is owed to vendors and suppliers that has not yet been paid, but will be paid in the short term.
What is accounts receivable classified as?
Accounts receivable is classified as a tangible, current asset. It represents money not yet received from customers/clients, but is expected to be received in the short term.
