Accounts Receivable
Credit sales, collection, and managing cash flow gaps
Why This Matters
A retail store has two customers:
Customer A
Walks in, buys $1,000 of merchandise, pays cash immediately.
- Cash goes into the register
- Revenue is $1,000
- Profit is immediate
- Risk: None
Customer B
Walks in, buys $1,000 of merchandise, says "Bill me, I'll pay next month."
- No cash in the register today
- Revenue is $1,000
- Profit is $1,000
- Risk: Might not pay
Which sale is better? Most people say Customer A. But from an accounting perspective, both are the same revenue. From a business perspective, Customer B is riskier.
Accounts receivable is the gap between earning revenue and collecting cash. Understanding that gap—and managing the risk—is critical.
What Is Accounts Receivable?
Accounts Receivable is money that customers owe you for products or services you've already delivered.
Key Characteristics
- Revenue is already earned – Work is done or product delivered.
- Cash hasn't been collected – Customer pays later.
- It's a current asset – Expect to collect within one year.
- It's a legal claim – The customer owes you money.
NOT Receivable
- • Money customer owes but hasn't ordered yet (no sale)
- • Loans to employees (notes receivable)
- • Deposits held for customers (liability)
- • Money owed for future services (advance payment liability)
Recording Receivables: The Journal Entry
Step 1: The Sale on Credit
Scenario: Sell $5,000 of products to Customer X on credit.
Step 2: Collection of Receivable
Scenario: Customer X pays the $5,000 owed.
Key insight: Revenue was recorded when we sold, not when we collected. This is accrual accounting.
The Receivables Aging Schedule
Companies track how old receivables are because older = riskier.
| Customer | Total Owed | Current (0-30) | 30-60 days | 60-90 days | 90+ days |
|---|---|---|---|---|---|
| ABC Corp | $10,000 | $10,000 | - | - | - |
| Widget Co | $6,000 | $2,000 | $4,000 | - | - |
| Tech Startup | $15,000 | - | - | $8,000 | $7,000 |
| TOTAL | $51,000 | $20,000 (39%) | $12,000 (24%) | $12,000 (24%) | $7,000 (14%) |
Interpretation & Action:
39% is healthy (current), but a massive 38% is past 60 days overdue (24% + 14%). Immediate action is required to follow up with customers in the 60+ day buckets.
Credit Policy: Who You Sell To
Not all customers are equally creditworthy. Before extending credit, evaluate:
1. Customer History
- Good: Ordered 10x, always paid on time
- Bad: Missed payments in the past
2. Financial Condition
- Good: Large company, strong financials
- Bad: Company near bankruptcy
3. Industry Risk
- Good: Stable, growing industry
- Bad: Industry with high failure rate
4. Loan Amount
- Good: Request is small relative to size
- Bad: Request is huge relative to size
Terms of Sale
Net 30 (N/30)
Payment due 30 days later. Most common for B2B sales.
Net 60 (N/60)
Payment due 60 days later. Used for longer-supply relationships.
2/10 Net 30 (2/10, N/30)
2% discount if paid within 10 days, otherwise full amount in 30 days. Encourages early cash collection.
Collection Timeline
Day 1-30: Normal
No action needed. Within terms.
Day 31-45: Recent Overdue
Send friendly reminder. "Did you receive the invoice?"
Day 46-60: Clearly Overdue
Send formal notice. "Payment is now 30 days overdue. Remit immediately."
Day 61+: Significantly Overdue
Personal phone call, management involved. Consider legal action/write-off.
Receivables Fraud Schemes
1. Recording False Sales
Salesperson records sales that haven't happened to hit targets. Revenue and AR increase, but no product ships.
2. Recording Sales Twice
Customer pays cash, sale is recorded. Fraudster records it again as a credit sale to inflate revenue.
3. Channel Stuffing
Company pressures salespeople to "make the quarter". They force excess inventory onto distributors who can't possibly sell it all.
Accounts Receivable Turnover
Example: $1,000,000 sales ÷ $100,000 avg AR = 10 times/year.
This means you collect receivables roughly every 36.5 days (365 ÷ 10). Higher turnover = collecting faster (Better).
Profit ≠ Cash
A company can be profitable but cash-poor if it doesn't collect receivables.
- Sales: $100k (Credit)
- Expenses: $60k (Cash paid)
- Profit: $40k ✓
- Cash Flow: -$60k ✗
If the company needs cash immediately to pay bills, it has a major problem despite showing a profit.
Internal Controls for Receivables
1. Credit Approval
Credit department evaluates creditworthiness before sales can proceed. Prevents selling to uncreditworthy customers.
2. Aging Analysis
Monthly review of all receivables. Follow up on 60+ day overdue. Prevents balances growing unchecked.
3. Customer Confirmations
Send statement to customer asking "Does this match your records?" Exposes false sales.
4. Segregation of Duties
Different people approve credit, record sales, ship product, and collect payments. Prevents manipulation.
Key Takeaway
Accounts receivable represents credit sales that haven't been collected yet. Recording revenue on the sale (not collection) is accrual accounting, but it creates risk.
Aging analysis helps identify collection problems. Fraud risks include false sales, duplicate recording, and channel stuffing. Controls like credit approval and customer confirmations prevent fraud. Managing receivables directly impacts cash flow, since profit doesn't equal cash until customers pay.
Test Your Understanding
See if you've got the basics down. Click each option and check your answer.
Question 1: A company sells $50,000 of products to a customer on credit (N/30 terms). When should the company record revenue?
Question 2: An accounts receivable aging report shows 50% Current (0-30 days), 25% 30-60 days, 15% 60-90 days, and 10% 90+ days. What does this indicate?
Question 3: A company has sales of $1,000,000 and average accounts receivable of $150,000. What is the accounts receivable turnover?
Question 4: Which scenario best indicates potential receivables fraud?
Question 5: True or False: A company can be profitable while having cash flow problems due to accounts receivable.
Ready to Practice?
You now understand accounts receivable and credit sales. The Practice Lab challenges you to record credit sales, analyze aging reports, detect fraud, and calculate receivables metrics.
Try the Practice LabWhat's Next?
Now that you understand receivables, the next module explores Allowance for Doubtful Accounts—accounting for receivables that probably won't be collected.