Accounts Receivable
/əˈkaʊnts rɪˈsiːvəbl/
Accounts receivable is the money owed to your business by customers for goods or services delivered but not yet paid for, representing short-term assets that impact cash flow and financial health.
Accounts receivable is the money owed to your business by customers for goods or services delivered but not yet paid for, representing short-term assets that impact cash flow and financial health.
Accounts receivable represents the money that customers owe your company for goods or services you've already delivered but haven't yet been paid for. In accounting terms, it's classified as a current asset on your balance sheet because you expect to convert these amounts into cash within the next 12 months. For founders and business owners, managing accounts receivable effectively is crucial for maintaining healthy cash flow and ensuring your business has the working capital needed to operate.
When you issue an invoice to a customer with payment terms (like "net 30 days"), that amount becomes accounts receivable until the payment is received. This is different from upfront payments or cash sales, where you receive money immediately. Accounts receivable represents your company's extension of credit to customers, which is why monitoring this figure closely helps you understand your cash conversion cycle and identify potential liquidity issues before they become critical.
The value of your accounts receivable tells investors and lenders how much of your revenue is still "in the air" rather than in your bank account. A high accounts receivable balance relative to your sales might indicate that customers are taking too long to pay, which can strain your finances. Conversely, a well-managed accounts receivable process demonstrates financial discipline and contributes to the overall health shown in your financial statements.
While accounts receivable represents money coming into your business from customers, accounts payable is the opposite—it's money your company owes to suppliers, vendors, or service providers for goods and services you've received but haven't paid for yet. Both appear on your balance sheet, but accounts receivable is an asset (money owed to you), whilst accounts payable is a liability (money you owe to others).
Managing both sides effectively creates a balanced cash flow system. If your accounts receivable collection period is longer than your accounts payable payment terms, you might find yourself in a cash crunch where you need to pay suppliers before customers pay you. This timing mismatch is one of the most common reasons small businesses face liquidity problems, even when they appear profitable on paper.
For founders, understanding the relationship between accounts receivable and accounts payable helps you negotiate better payment terms with suppliers. If you can extend your payment terms with vendors while speeding up collections from customers, you improve your working capital position without needing external equity financing.
Effective accounts receivable management directly impacts your cash flow statement and determines whether your business has the liquidity to pay bills, invest in growth, or handle unexpected expenses. When customers delay payment, your cash inflows slow down, which can force you to dip into reserves or seek expensive short-term financing options.
A key metric to watch is Days Sales Outstanding (DSO), which calculates the average number of days it takes to collect payment after a sale is made. A rising DSO indicates that customers are taking longer to pay, which could signal financial distress among your client base or inefficiencies in your own collections process. Many businesses set up automated reminders and implement early payment discounts to encourage faster settlement.
For startups and small businesses, poor accounts receivable management can be particularly damaging. Without the financial cushion of larger corporations, delayed payments can quickly lead to missed payroll or inability to pay critical suppliers. This is why establishing clear credit policies and diligent follow-up procedures from day one is essential for business survival.
When you make a sale on credit, you record two entries in your accounting system. First, you debit accounts receivable (increasing this asset account) and credit your revenue account (recognising the income). This reflects that you've earned revenue but haven't yet received cash. When the customer eventually pays, you then debit your cash account and credit accounts receivable, clearing the balance.
This double-entry system ensures your books accurately reflect both the revenue earned and the cash position. At your financial year end, your accountant will review the accounts receivable balance and may create an "allowance for doubtful accounts" if there are invoices unlikely to be collected. This allowance reduces the reported accounts receivable to a more realistic "net realisable value" on your balance sheet.
When customers fail to pay invoices within the agreed terms, those amounts become overdue receivables. Initially, you should send reminder emails or make follow-up calls. If payment is still not received, you may need to consider more formal actions like engaging a debt collection agency or, in extreme cases, pursuing legal action through small claims court.
From an accounting perspective, uncollectible accounts receivable must eventually be written off as bad debt expenses. This reduces both your accounts receivable balance and your profit for the period. To prevent this situation, many businesses perform credit checks on new customers before extending credit terms, especially for significant orders where the risk of non-payment could materially impact your finances.
When potential buyers or investors evaluate your company, they closely examine your accounts receivable balance as part of their due diligence process. A high proportion of old or overdue receivables can significantly reduce your business's perceived value because it suggests poor credit management and increases the risk of future bad debt write-offs.
Conversely, a well-managed accounts receivable portfolio with prompt collections and low DSO demonstrates financial discipline and operational efficiency. Investors view this as a positive indicator of management capability and may assign a higher valuation multiple to your earnings. This is particularly important when seeking equity financing or preparing for an exit event.
For tax purposes, accounts receivable generally follows the accrual accounting method—you recognise revenue when you earn it (when you deliver goods or services), not when you receive payment. This means you may need to pay corporation tax on income you haven't yet collected in cash, which creates timing differences between your accounting profit and your cash position.
When you eventually write off a bad debt, you can typically claim this as a tax-deductible expense, reducing your taxable profit. However, the specific rules around bad debt deductions vary, and you'll need proper documentation to support the write-off. It's worth consulting with a tax professional to ensure you're correctly accounting for benefit in kind situations that might involve non-cash transactions.
Effective accounts receivable management starts with clear credit policies communicated to customers upfront. Set reasonable payment terms, offer early payment discounts where appropriate, and implement automated invoice reminders. Consider requiring deposits or milestone payments for large projects to reduce your exposure.
Regularly review your accounts receivable aging report, which categorises invoices by how long they've been outstanding. Focus your collection efforts on the oldest invoices first, as the likelihood of collection decreases significantly after 90 days. For repeat customers with consistently slow payment, consider tightening their credit terms or requiring upfront payments for future orders.
Technology can significantly improve your process. Accounting software with integrated invoicing and automated follow-up features can reduce administrative burden while ensuring timely collections. Many platforms also offer credit checking services that help you assess new customers' payment reliability before extending credit terms.
