What is accounts receivable? Definition, examples, and tips

You've just delivered an amazing product or service to a client, they're thrilled with the results, and you've sent over the invoice. That outstanding invoice represents money your business is owed but hasn't collected yet. That's what accounts receivable (AR) is.

Think of AR as the bridge between making a sale and getting paid. It's the formal way businesses track who owes them money and when those payments are due. Accounts receivable directly impacts your company's cash flow, which means it affects everything from paying your team to investing in growth opportunities.

In this article, we'll cover what accounts receivable is, where it appears in financial documents, its process, and tips for automation.

What is accounts receivable (AR)?

Accounts receivable is the money a business's customers owe for goods or services they've received but have yet to pay for.

For example, when Company A sells products to Company B on credit, Company B owes money. Company A would record the amount owed as accounts receivable. Because AR represents money expected to come in, Company A considers it an asset.

Company B records the amount owed as accounts payable (AP), and they'd record it as a liability until they pay it.

Is accounts receivable an asset?

Yes, accounts receivable is considered an asset. You'd list AR under the current assets section of your balance sheet, as you’d typically anticipate receiving the amount owed within a year.

What are net receivables?

Net receivables represent the amount of money your company expects to collect from customers who owe you money. You calculate it by taking gross accounts receivable (the total amount customers owe) and subtracting an allowance for doubtful accounts (an estimate of what you won't collect due to bad debts).

For example, if a company has $100,000 in total receivables but estimates it won’t collect $5,000, the net receivables would be $95,000. This gives a more realistic picture of the cash the company can expect to receive and is the figure typically reported on the balance sheet.

Accounts receivable vs. accounts payable

Accounts receivable represents money customers owe your business for goods or services already delivered. Accounts payable is the opposite: It's money your company owes to suppliers and vendors for purchases made on credit. Think of AR as incoming money and AP as outgoing money.

Similarities and differences

While both AP and AR deal with credit transactions, they sit on opposite sides of your financial ledger.

The key difference lies in direction: AR brings money into your business while AP takes money out. AR affects how quickly you convert sales into cash, while AP determines when you pay for the resources that fuel your operations. Both directly influence your working capital and day-to-day cash availability.

Impact on cash flow

Both AR and AP play vital roles in your company's liquidity management. Your accounts receivable balance represents cash that's technically yours but isn’t yet available for operations. The longer customers take to pay, the longer you wait for that cash to materialize. High AR balances can create cash crunches even when your business appears profitable on paper.

Accounts payable provides the opposite effect. It's a form of free financing from your suppliers. When vendors give you 30-day payment terms, you essentially get an interest-free loan for that period. This float can improve your cash position by allowing you to use goods or services before paying for them.

The balance between these two creates your cash conversion cycle (CCC). Companies with fast-paying customers and generous supplier terms enjoy better cash flow than those dealing with slow-paying customers while facing immediate payment demands from vendors.

Cash flow example

Let's say Sarah runs a small marketing agency. She just completed a $50,000 project for a client and sent the invoice with standard 30-day payment terms. Meanwhile, she needs to pay her freelance designers $15,000 this week and her $3,000 office rent by month's end.

Sarah's books show she's profitable: The $50,000 revenue minus $18,000 in expenses gives her a healthy $32,000 profit. But her bank account only has $5,000 right now. The client hasn't paid yet, and she's facing immediate bills.

This situation perfectly illustrates how accounts receivable affects cash flow. Sarah technically owns that $50,000, but it's tied up until her client pays. She might need to delay paying her freelancers or draw funds from a credit line to cover expenses.

You must actively manage both AR and AP to optimize your working capital and maintain healthy cash reserves for expenses and growth.

Accounts receivable examples

Let’s look at some simple accounts receivable examples to see how it works in practice:

Example 1: Law firm providing legal services

A law firm completes $10,000 worth of legal work for a new client in September. Instead of asking for immediate payment, the firm sends an invoice with net 30 payment terms, meaning the client has 30 days to pay the total amount.

On October 1, the firm records the $10,000 the client owes as an accounts receivable asset on its balance sheet, where it stays until the client pays the amount owed. The journal entries look like this:

This entry shows the value owed for the services. Until the client pays, the amount remains as accounts receivable on the firm’s books. Once the firm receives the amount owed, it makes the following journal entries:

Here’s how this accounts receivable transaction would appear on a balance sheet, where cash and accounts receivable under assets are affected:

Example 2: Marketing agency redesigning a website

ABC Marketing Services completed a website design project for Client XYZ on March 15. The total invoice amount is $3,000, with net 30 payment terms. When ABC Marketing Services completes the project and sends the invoice, they record the sale even though they haven't received payment yet:

This entry increases both the company's assets and its revenue for the period. Next, Client XYZ pays the full invoice amount on April 10, well within the 30-day payment terms. ABC records the payment as:

This entry converts the receivable into actual cash. The company's total assets stay the same, but the composition changes from "money owed" to "money in hand."

Other AR examples

These are just two examples of outstanding invoices, but AR can also look like:

• Credit to customers: Amount owed for goods or services provided on credit
• Rental income: Amount owed by tenants for property rentals
• Interest: Amount owed on loans for interest charges
• Fees: Amount owed for services rendered
• Licensing fees: Amount owed for use of licensed property
• Insurance claims: Amount owed from approved insurance claims

Accounts receivable encompasses all amounts owed to a business, ranging from traditional credit sales to diverse income streams.

Tracking AR turnover

The accounts receivable turnover ratio measures how efficiently your business collects outstanding debts by comparing your net credit sales to your average accounts receivable balance. This metric tells you how many times per year you're able to collect your entire receivables balance. It's calculated as:

Accounts receivable turnover ratio = Net credit sales / Average accounts receivable

A high turnover ratio signals that your company collects payments quickly and maintains tight control over credit policies. This means cash flows into your business faster, giving you more working capital to reinvest in operations and growth. Companies with high ratios typically have shorter payment terms, effective collection processes, or customers who pay promptly.

A low turnover ratio indicates that money sits tied up in unpaid invoices for longer periods. While this might suggest collection challenges or overly generous credit terms, it could also reflect your industry norms or a strategic decision to extend credit to valuable long-term customers. The key lies in comparing your ratio to industry benchmarks and monitoring trends over time rather than focusing solely on the absolute number.

This ratio serves as an early warning system for potential cash flow issues. When you notice the ratio declining, you can investigate whether specific customers are having payment difficulties, your credit policies need adjustment, or your collection efforts require strengthening. Regular monitoring helps you maintain the delicate balance between growing sales through credit offerings and protecting your cash position.

Where to find AR on financial statements

Accounts receivable appears on your company's balance sheet under the current assets section, typically listed right after cash and cash equivalents. The placement among current assets reflects its liquid nature. These are amounts you expect to convert to cash within 1 year, alongside cash, short-term investments, and inventory in your working capital cycle.

Accurate AR tracking directly affects your financial health because receivables represent a significant portion of working capital for most businesses. Investors, lenders, and creditors closely examine your receivables balance to evaluate liquidity and collection efficiency.

When your AR grows faster than sales, it can signal collection problems, while receivables that shrink relative to sales might indicate improved collections or potentially restrictive credit terms.

What is the accounts receivable process?

The accounts receivable process involves several steps to create smooth payment collection and cash flow.

The typical accounts receivable billing process follows these steps:

1. Agree on payment terms: Establish clear payment terms (e.g., net 30, net 60) with customers in advance and create an accounts receivable policy outlining when invoices are overdue and when to recognize bad debt. Most companies recognize bad debts after 90 days of delinquency.
2. Send invoices after a sale or service is provided: Record the invoice in the accounts receivable system or ledger. This establishes the amount owed by the customer.
3. Track payments: Accounts receivable staff track what’s owed and follow up with pending payments. This can also be automated through your billing process with accounting and AP software.
4. Record payments: When available, record payments to clear the balance on paid invoices. You can also apply partial payments.
5. Manage collections of overdue invoices: If an invoice is past due, accounts receivable will begin collection efforts, including calls and letters to request payment
6. Record invoices after receiving payment: After receiving payment on invoices or deciding they’re uncollectable, close those invoices out of accounts receivable

Improving your AR team's process can significantly impact your business's financial health. The first step to improvement is understanding how to measure performance. Critical metrics for assessing AR performance include:

• AR turnover ratio: Measures the frequency at which you convert outstanding receivables into cash over a defined period, offering insight into the efficiency of credit and collections processes
• Days sales outstanding (DSO): This number reflects the average number of days it takes to collect receivables, providing a key indicator of liquidity and customer payment behavior
• Cash conversion cycle: This measures the entire cycle of converting cash into inventory, sales, and ultimately back into money, highlighting the operational efficiency of working capital management

By observing the receivables balance over time, you can improve the accounts receivable process, improve cash flow, and identify trends in customer payments.

Why accounts receivable management is important

With an effective accounts receivable team, AR management not only keeps cash flow steady, but also improves financial forecasting by giving you a clearer view of expected payments. But mismanaging your receivables can create issues:

• Delayed collections can strain cash flow and disrupt financial planning
• Operational inefficiencies drain resources and hinder productivity
• Risk of customer defaults grows, increasing the likelihood of bad debt write-offs

The right strategies can help you stay on top of what customers owe, reduce the risk of uncollected debts, and keep your operations running smoothly. Here are some AR best practices to help you stay in control:

• Create a clear AR policy: From the start, make sure your customers understand your payment terms and outline when invoices are considered overdue. This sets the stage for timely payments and gives you a way to recognize delinquencies, bad debt provisions, and losses.
• Send timely and accurate invoices: Send invoices promptly after a sale and include all relevant order and billing details
• Offer payment options: To make paying convenient, give customers flexibility by accepting various payment methods, such as credit cards, checks, and electronic fund transfers (EFTs)
• Track payments closely: Watch due dates to quickly identify late payments and understand your customers' payment patterns. Automated billing software can help by sending reminders to customers before and after the due date, making follow-up easier and more efficient.
• Follow up on outstanding invoices: Quickly address billing issues or customer inquiries manually or through invoice automation software. Doing so will help you get paid faster and strengthen your client relationships.

What if customers don't pay?

When invoices go unpaid, the effect ripples through your entire business. Your cash flow takes an immediate hit, making it harder to pay your own bills, invest in growth opportunities, or handle unexpected expenses.

Unpaid invoices eventually become bad debts—money that you've earned but will likely never collect. In severe cases, you may need to write off these receivables entirely, which directly reduces your profit margins.

You can minimize these losses. Start with gentle payment reminders. A friendly email or phone call often does the trick when customers have simply forgotten an invoice. For customers facing financial difficulties, consider offering payment plans that break down large balances into manageable installments.

When informal efforts don't work, you may need to escalate to formal collections through an agency or legal action. The key is to act quickly. The longer an invoice remains unpaid, the less likely you are to collect it.

Tips for streamlining and automating accounts receivable

Managing accounts receivable doesn't have to feel like an endless uphill battle. With the right approach and tools, you can turn this often tedious process into a well-oiled machine that practically runs itself.

Start with the right software

Investing in dedicated AR software pays dividends quickly. Look for platforms that integrate with your existing accounting system and offer features such as automated invoice generation, payment tracking, and customer communication tools. Cloud-based solutions work particularly well since your team can access information from anywhere, and updates happen automatically.

Set up automated payment reminders

Gone are the days of manually tracking due dates and sending individual follow-up emails. Configure your system to send gentle payment reminders at predetermined intervals: 7 days before the due date, on the due date, and then 15 and 30 days after. These automated touchpoints keep payments flowing without constant manual intervention.

Make online payments a priority

The easier you make it for customers to pay, the faster they'll actually do it. Implement online payment portals that accept credit cards, ACH transfers, and digital wallets. Include direct payment links in your invoices and reminder emails. This simple step often reduces payment cycles by weeks.

Batch similar tasks together

Instead of handling AR activities sporadically throughout the day, designate specific time blocks for similar tasks. Batch invoice creation, payment posting, and follow-up calls. This focused approach increases efficiency and reduces the mental energy spent switching between different types of work.

Use automation tools for data entry

Optical character recognition (OCR) technology can automatically capture and input payment information from checks and remittances. Bank feed integrations can match incoming payments to outstanding invoices without manual intervention. These tools eliminate hours of data entry while reducing human error.

Create different workflows for different customers

Not all customers need the same treatment. Set up different automation rules based on payment history, invoice amounts, or customer relationships. VIP clients might get more personal attention, while smaller accounts can follow standard automated sequences. This targeted approach maximizes efficiency while maintaining important relationships.

Use analytics to spot patterns

Most AR software includes reporting features that highlight trends in your receivables. Pay attention to which customers consistently pay late, which payment methods work best, or which invoice formats generate faster payments. Use these insights to refine your processes continuously.

Automate credit decisions

Establish clear credit approval criteria and let your system handle routine decisions automatically. For amounts below certain thresholds or for established customers with good payment history, automated approvals keep sales moving while protecting your cash flow.

The goal is to create processes that work efficiently in the background, freeing up your team to focus on exceptions and relationship management rather than routine administrative tasks. Start with one or two automation initiatives and gradually build from there. You'll be amazed at how much time and frustration these improvements can save.

How Ramp automates bookkeeping

Accounting automation is just one part of finance automation. It can do away with tedious, repetitive accounting tasks and allow your staff to prioritize communication, management, accounting, and strategizing.

Ramp is a solution for finance and accounting teams that does just that. Ramp’s expense management software can help you handle your business finances and bookkeeping with best-in-class integrations for today's most popular accounting tools, including QuickBooks, Xero, NetSuite, and Sage Intacct.

Try Ramp to see for yourself how much time and money you can save.