SMALL BUSINESS RESOURCES

What is accounts receivable?

3 min read

As someone who’s just set up their business in New Zealand and fresh to admin tasks, at some point you’ll find yourself wondering ‘what is accounts receivable’? 

If you‘re in the early stages of a fledgling business, such accounting terminology – and how it relates to the administrative and compliance aspects of running a business – is often assumed knowledge. Yet we can’t know it all, can we?

But it’s vital to have a thorough understanding of accounts receivable, accounts receivable reports, accounts receivable turnover and trade debtors, as well as how these apply to your business.

Accounts receivable in a nutshell

What is accounts receivable? Accounts receivable is essentially the outstanding debts your business is owed. It means you have a debtor.

This outstanding business debt comes primarily in the guise of unpaid invoices. 

So, if your business has issued an invoice to a client for work your business has done, yet you’re still unpaid for that work, you have accounts receivable.

It’s also important to understand that your accounts receivable is defined as an asset for accounting purposes.

Accounts receivable report

Your ‘accounts receivable report’ is a way of documenting and understanding the weight and scale of your accounts receivable. 

This is also often referred to as an ‘accounts receivable ageing report’.

Start by listing the individual debtors who owe you unpaid invoices (past the due date on the invoice), alongside a column listing the debt figure and then a column for the age of the debt. You now have an important report on your hands. 

By referring to this accounts receivable report, you’ll be able to see:

  • Which debts are late, by how much, and which debtors you should be chasing for payment.  
  • Who are the repeat offenders in terms of late or unpaid invoices (react appropriately).
  • Which debtors should be receiving late payment penalties as per your terms and conditions.
  • What your overall cashflow looks like.
  • Which outstanding debts may become ‘bad debt’ for accounting and compliance purposes.

Accounts receivable turnover

If your business activity and cashflow is based on issuing invoices for work completed, understanding your accounts receivable turnover is key to quantifying your business’s health.

The accounts receivable turnover ratio is a way of understanding how many people owe you money in the form of unpaid invoices vs. those who paid on time. It can also tell you how long on average you wait to get paid. It’s an important metric to get to grips with when analysing your business’s cashflow and health.

The lower your ratio, the better you are at collecting debt and you’ll have more cash and less debt owed, equating to better cashflow.

If you want to figure out your accounts receivable turnover, the formula goes like this:

  • Net annual credit sales ÷ ((beginning accounts receivable + ending accounts receivable) / 2)
  • ‘Beginning’ and ‘ending’ refers to the time period you’re calculating.

By monitoring this and checking year-on-year (YOY) you can understand how good you are at extending credit and chasing outstanding debt, which talks directly to your ability to maintain cashflow. It will also tell you when you should restrict payment policies or re-evaluate extending credit.

What are trade debtors?

In the course of running your business you may have heard the term ‘trade debtors’ uttered. What are they? 

A trade debtor is basically just another term for a debtor. 

A trade debtor is either the individual or business who hasn’t paid their invoice on time and still owes your business money.

While ‘accounts receivable’ refers to the actual debt or figure which is sitting on your ledger or report, the trade debtor refers to the entity which owes that accounts receivable sum.