Is accounts receivable an asset? Companies provide goods and services to customers sometimes on credit. When a seller company does this, the customers owe the company a certain amount of cash for the goods and services provided. This money owed is referred to as accounts receivable. Is accounts receivable an asset?; being that it is the money that the customers owe the company.
In this article, we will discuss account receivables and assets to decipher if accounts receivable should be considered an asset and why.
What are accounts receivable?
Accounts receivable (AR) is the balance of money that is due to a company/business for goods delivered or services rendered but not yet paid for by the customers. It is any amount of money owed by customers for purchases made or services gotten on credit.
AR amounts to the outstanding invoices that a company has; it is simply the money that clients or customers owe the company. The term ‘accounts receivable’ or ‘receivable’ reports the amounts that a business has the right to receive because it has delivered a product or service. It typically represents a line of credit extended by a company and usually has terms that require payments due within a relatively short period. These terms of payment usually range from a few days to a fiscal or calendar year.
A typical example of Accounts Receivable includes an electric company that bills its clients after the clients have received and used the electricity. The unpaid invoices are recorded by the electric company as accounts receivable as the company waits for its customers to pay their bills. The majority of companies operate by allowing a portion of their sales to be on credit. They sometimes offer sales on credit to frequent or special customers that receive periodic invoices. This practice allows customers to avoid the stress of physically making payments as each transaction occurs.
Now, having known what accounts receivable are; is accounts receivable an asset?
Let’s look at what an asset is to know if accounts receivable can be considered an asset.
What is an asset?
An asset is a resource with economic value owned by an individual, corporation, or country with the expectation that it will provide an economic benefit in the future. Assets add value to a business and are used to generate cash flow and reduce expenses. That is, an asset will help a business increase its equity and meet its financial commitments.
Assets contain economic value and can increase the value of a business, benefit a company’s operations, or raise an individual’s net worth. An asset can be used for the daily operation of a business, it can be currently available to sell or available for long-term sale. A high proportion of a company’s assets compared to its liabilities is an indicator of a successful business. This is because it indicates a sign of a higher degree of liquidity.
Assets can be grouped into different types based on physicality, liquidity or operational activities. Based on physicality, assets can be divided into tangible and intangible assets. They can also be grouped into current and fixed assets based on liquidity. Moreso, based on operational activities, assets are grouped into operating and non-operating assets.
Therefore, assets can vary from things of value or resources owned by the company, to prepaid expenses that haven’t expired or been used up yet, to costs with a measurable future value. Typical examples of assets include cash, inventory, real estate, vehicles, long-term investments, accounts receivable (unpaid invoices from customers), properties, patents or trademarks. etc.
Is accounts receivable an asset?
Yes, accounts receivable is considered an asset. This is because it is defined as cash owed to a company by a customer. Accounts receivable are found on a company’s balance sheet booked as an asset because they represent money owed to the company. It is the amount owed to a business by a customer and as such, it is an asset. AR is considered an asset because it is convertible to cash on a future date.
On the balance sheet, accounts receivable is listed as a current asset, since it is usually convertible into cash in less than one year. Companies confidently record accounts receivable as an asset in their balance sheets because the customer is bound by a legal obligation to pay the debt. Since accounts receivable can be used as collateral to secure a loan to help meet short-term obligations, they are considered to be liquid assets. They are therefore part of a company’s working capital.
In a situation whereby the receivable amount only converts to cash in more than one year, it is recorded on the balance sheet as a long-term asset instead (possibly as a note receivable). Moreso, due to the fact that there is a possibility that some receivables will never be collected, the account is offset (under the accrual basis of accounting) by an allowance for doubtful accounts. This allowance is an estimate of the total amount of bad debts related to the receivable asset. Then the net reported amount of the allowance and the gross receivable is the number of receivables outstanding that the company actually expects to collect.
Accounts receivable as a current asset
Accounts receivable are reported on the balance sheet as a current asset. Current assets are highly liquid assets that can be sold and converted into cash easily. Financial assets such as mutual funds, cash, bonds, stocks, and other marketable securities are considered the most liquid current assets because these assets can be sold easily and quickly without their price being affected.
Accounts receivable are current assets, being that the account balance is due from the debtor in one year or less. A company having accounts receivable means that the company has made a sale on credit but is yet to collect the money from the customer/clients. Basically, the company has accepted a short-term IOU from its customer/client. Accounts receivable are an example of a current asset as well as cash, inventory, and prepaid expenses.
Accounts receivable as a tangible asset
Can accounts receivable count as a tangible asset? Yes. Tangible assets are physical and real properties that have a clear value that can be easily measured. Stocks, real estate, inventory, cash, machinery, equipment, bonds, furniture, etc are all classified as tangible assets. They are physically tangible and the majority of them are considered current assets because they can be converted to cash easily.
Surprisingly, accounts receivable can count as a tangible asset because when the company invoice a customer, the amount and terms of payment are set, and the customer has legally committed to paying the money. Therefore, accounts receivable is a tangible asset.
Why is accounts receivable an asset?
Now that it is clear that accounts receivable is an asset, one may be asking ‘why is accounts receivable an asset?’. The reason why accounts receivable is an asset is relatively straightforward. It is considered an asset because the amount that is owed to the company will be converted to cash eventually when paid later. That is, more receivables equate to more cash, which leads to the growth of the business, over time.
Also, companies can use accounts receivable to raise short-term credit just like any other assets. This is another reason why accounts receivable is considered an asset. Like any other asset, accounts receivable can be put as collateral to raise short-term funds from banks or other non-banking financial institutions. The practice of using a company’s unpaid accounts receivable as collateral for a loan is called invoice discounting.
An example of accounts receivable as an asset
Let’s take an example to explain why accounts receivable is an asset.
Assume a manufacturing company, Company ABC Ltd., has Company XYZ as a regular client. Say Company XYZ gives Company ABC order of 100 tire sets at the rate of $15 for each tire set and Company ABC delivers the product to Company XYZ.
Company ABC generates an invoice of $1500 with the condition of 30 days credit period. This means that Company XYZ has to clear its debt to Company ABC within 30 days. In this instance, as Company ABC delivers the product with the terms of 30 days credit period to company XYZ, company ABC records the sale made in the books as an account receivable.
The $1500 is recorded as account receivable until when the amount is transferred to the bank account of company ABC. When Company XYZ eventually pays, the amount gets credited to company ABC. The cash or bank balance will increase by $1500, and the same $1500 would decrease the account receivable. Therefore, once the money gets credited into the bank account of the seller of goods or service providers, the account receivable would be transferred into cash or bank account.
Risk of accounts receivable
What could possibly be the risk associated with accounts receivable when counted as an asset? The major drawback would be a situation whereby customers don’t pay their debts when due. Companies have to be careful before giving credit to the customers because some customers can sometimes default to the debtor and never pay back for the products or services received from the company.
What happens is that when a company discovers that an account receivable won’t get paid by a customer, it is written off as a bad debt expense or one-time charge. Hence, it will be reported in the profit and loss account. Therefore, having a huge amount of accounts receivable is always a potential risk. It is a crucial responsibility for the company to follow up with outstanding invoices or payments. At least within one year, account receivable is supposed to be collected by the company. But if the seller company fails to collect the money within one year, the money owed would become a fixed asset.
In conclusion, accounts receivable are an asset and not a liability. It cant be a liability because it is not a debt that the business owes rather it is a debt that is owed to the business. Therefore, when one is examining his/her company’s books, they should always remember to include accounts receivable as an asset, if not their calculations may end up going off track. The bottom line is that accounts receivable are tangible, current assets. Also, depending on the accounting method used by a company, they may also be counted as revenue.