If you are a business owner that handles some or all the accounting functions of your business, you’re probably familiar with the term “Accounts Receivable”.
Defined as money that is owed to your business from customers who purchased your product or service, Accounts Receivable is typically considered an asset.
Even though the possibility of default and other unexpected issues makes it important to never fully rely on expected future income, Accounts Receivable is usually safe to include in the assets column of your balance sheet.
While there is never a guarantee of receiving money owed, Accounts Receivable can help your business in a few important ways.
Accounts Receivable is a liquid asset.
Defined as “an asset that can be converted to cash in a short time with little or no loss in value”, liquid assets can help you scale, cover unexpected losses, and decrease your operating cost by lowering your reliance on financing/allowing you to safely increase your deductible.
Accounts Receivable increases balance sheet revenue.
High revenue can make you more attractive to lenders, investors, or potential partners at the negotiating table. Businesses with high revenue typically qualify for lower interest rates and have an easier time raising capital.
Accounts Receivable can help you grow your business.
In the words of Sol Luckman: “It takes money to make money.” Payments owed to your business can give you the peace of mind of knowing you can safely make an investment in new technology or another competitive advantage.
Accrual Basis of Accounting vs. Cash Basis
Before going into more detail, it’s important to note that only the accrual basis of accounting considers Accounts Receivable as an asset. If you are using the cash basis of accounting, accounts receivable is only considered an asset after cash is received.
Because accounts receivable is typically converted into cash within the fiscal year, the accrual basis of accounting views AR the same way it would any other type of short-term liquid.
That said, if you don’t plan on collecting within the fiscal year, AR should be considered a long-term asset.
While long-term accounts receivable is still considered an asset through the lens of accrual base accounting, they should typically not be included on a net-income calculation for a fiscal year in which they will not be collected.
Are Accounts Receivable Tangible Assets?
Now that we know Accounts Receivable is an asset, it’s important to clarify whether or not these accounts are considered tangible assets.
Defined as assets with clear cash value that can be easily measured, a list of tangible assets typically includes land, inventory, buildings, equipment, furniture, cash, stocks and anything else that can be converted to cash in a hurry.
Accrued Revenue vs. Accounts Receivable
Under the accrual basis of accounting, both accrued revenue and accounts receivable are considered assets.
That said, there is an important difference between the two that all business owners need to be aware of.
The difference between accounts receivable and accrued revenue basically boils down to invoicing and billing. While both items can be similarly defined as revenue that a business has earned, accrued revenue is revenue that has not yet been billed or invoiced to the customer.
Accrued revenue assets are particularly common in the service industry, especially with businesses selling subscription-based services (ex: software).
To clarify, a service company with a customer committed to a year of service billed monthly should consider revenue billed for the current month as Accounts Receivable, and revenue that will be billed over the remainder of the contract as Accrued revenue.
Accounts Receivable Payment Terms
The best way to leverage Accounts Receivable as a liquid asset is with the help of A/R terms. As a business owner, you’ve probably received an invoice that specified the time period after which payment would be considered late.
Accounts Receivable payment terms are typically expressed as “Net X”, with x being the number of days allowed before payment becomes late. Common A/R terms include:
- Net 10
- Net 15
- Net 30
- Net 45
- Net 60
- Net 90
The length of time allowed for timely payment typically depends on the cost of the invoice, average liquidity of customers served and other factors such as whether or not customers need to vend the product you sold them to recoup the money they spent buying it from you.
At Tomins, we design custom business insurance that’s hand-crafted to the unique needs of each business we serve. You deserve an insurance partner who works as hard as you do.
Give us a call today.