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Accounts Receivable

What is Accounts Receivable?

Accounts receivable are the monies owed to a business for goods sold or services provided. It is a record of the date of sale, to whom, the amount and when payment is due. Credit terms may vary from a couple days, to a week or up to one year.

Business Operation with Accounts Receivable

When a business makes a sale it receives the payment at the time from cash or credit card. Alternatively, it may agree credit terms with the purchaser and enter the sale in accounts receivable. A hardware store, for example, may sell to the public and have a construction company run sales on credit via accounts receivable. This makes purchasing easier for the construction company, as authorized employees may collect stock without the need for carrying cash. At the end of the week, month or year the construction company will clear the total amount, clearing their entry in accounts receivable and start again for the next period.

Benefits and Drawbacks

The benefits of accounts receivable to the hardware store is that they keep a regular customer, as the construction firm is unlikely to change to another supplier once agreeing credit terms. The store will have a regular flow of income and may stock a supply of a product knowing that they have a buyer for it.

One drawback of the system is that the store may need to pay for the product in full at time of purchase, leaving it out of pocket until payment of the bill on accounts receivable. A bigger problem may be that the construction company defaults on the credit terms due to insolvency or bad payments. The store may not get a full repayment, which will impact on the cash flow of the business. With this in mind, it is vital that the store only runs accounts receivable for firms with a good credit record and can pay their bills in full.

Keeping a Tight Rein on Accounts Receivable

Due to the fear of default, a business should only give short credit terms for accounts receivable where possible. This will also shorten the time the store will need to repay its suppliers. Ownership of the goods should remain with the store until receiving payment in full, allowing the store to recover them in the case of default.  By keeping a close eye on the accounts receivable, the storeowner will note payments missed, raising a red flag and a warning of any possible difficulties in the future.

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