Accounts Receivable (AR)

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Accounts Receivable (AR): Definition, Uses, and Examples

What is accounts receivable?

Accounts receivable (AR) are amounts owed to a business for goods or services that have been delivered but not yet paid for. AR is recorded on the balance sheet as a current asset because payment is generally expected within one year.

How AR works

  • When a sale is made on credit, the seller records an invoice as accounts receivable until the customer pays.
  • AR effectively represents short-term credit extended to customers, with terms that might be due in a few days, 30, 60, 90 days, or sometimes longer.
  • Because customers have a legal obligation to pay, AR is treated as a liquid asset and can be used as collateral for short-term financing.
  • AR is part of working capital; efficient AR collection improves a company’s liquidity and cash flow.

Classification

  • Current asset: expected collection within 12 months (alongside cash, inventory, marketable securities).
  • Distinct from noncurrent assets, which include long-term investments, property, and intangible assets.

Accounts receivable vs. accounts payable

  • Accounts receivable: amounts a company is owed (asset).
  • Accounts payable: amounts a company owes to suppliers or creditors (liability).
    Example: If Company A bills Company B for services, Company A records AR while Company B records the same amount as AP.

Key metrics for analyzing AR

  • Accounts Receivable Turnover = Net Credit Sales ÷ Average Accounts Receivable
  • Measures how many times receivables are collected during a period; higher is generally better.
  • Days Sales Outstanding (DSO) = (Average Accounts Receivable ÷ Net Credit Sales) × Number of Days (commonly 365)
  • Shows the average number of days to collect payment; lower DSO indicates faster collection.
  • Net Receivables = Gross Accounts Receivable − Allowance for Doubtful Accounts
  • Reflects the receivables a company reasonably expects to collect.

Handling uncollectible receivables

  • Bad debt expense/write-off: when a receivable is clearly uncollectible, it’s removed from AR and recorded as an expense.
  • Allowance method: companies estimate uncollectible accounts and record an allowance against gross AR to present net receivables.
  • Factoring or selling receivables: companies may sell outstanding invoices to third parties (factoring) for immediate cash at a discount.

Example

An electric utility bills customers after service is delivered. Until customers pay their bills, the utility records those unpaid amounts as accounts receivable. Many businesses similarly extend short-term credit, issuing invoices that create AR balances until collected.

Why AR matters

  • Indicates expected future cash inflows and contributes to liquidity.
  • Impacts working capital and the company’s ability to meet short-term obligations.
  • Efficiency of AR collection affects cash flow, credit risk exposure, and overall financial health.

Bottom line

Accounts receivable represent money due from customers for delivered goods or services. Proper measurement, monitoring (turnover, DSO, allowances), and management of AR are essential for maintaining liquidity, reducing credit risk, and ensuring steady cash flow.