Accounts Receivables​

Customers often purchase goods on credit. This asset represents the amounts due from these purchases.

What are Accounts Receivables?​

Accounts Receivable (A/R) represents the credit sales of a business, which have not yet fully been paid by its customers. Companies allow their clients to pay at a reasonable, extended period of time, provided that the terms are agreed upon. For certain transactions, a customer may receive a discount for paying the receivable back to the company early.

The average AR days assumption is an important part of forecasting changes in non-cash working capital in financial modeling.

Why use Accounts Receivables instead of Cash?

Some businesses allow selling on credit to make the payment process easier. Take for example, a phone provider. This provider may find it hard to collect payment perpetually every time someone makes a call. Instead, the provider will be periodically at the end of the month for the total amount of service used by the customer. Until this monthly invoice has been paid, the amount will be recorded in account receivables.

Allowing purchase on credit also encourages more sales. Customers tend to hold on to cash, but are more inclined to purchase on credit if possible.

For someone working in FP&A, equity research, or investment banking it’s important to understand the cash conversion cycle.

Risks:

  1. Uncollected debt – high A/R that goes uncollected for a long time is written off as bad debt. This situation occurs when customers who purchase on credit go bankrupt, or otherwise shirk the invoice with no reasoning.
  2. Cash flow deficiencies – a business needs cash flow for its operations. Selling on credit may boost revenue and income, but present no actual cash inflow. In the short-term this is acceptable, but in the long run can cause the company to run short on cash and have to take on other liabilities to fund operations.