Definition:
Accounts receivable is the amount customers owe the company. Since revenue is a promise to pay (typically customers don’t pay when they receive the product or service; they wait 30 days, or longer, to pay the bill), accounts receivable is the place where those promises are tracked. Accounts receivable is a current asset (what the company owns) on the balance sheet because all (or most) of those promises will soon convert to cash. It is like a loan from the company to the customers, and the company owns the customers’ obligations.
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Example:
Let’s say that your company just sold $2,000 worth of product to a customer. If you have no other Accounts Receivables, your balance sheet would add $2,000 to the Accounts Receivable line. When the customer actually pays the $2,000, the $2,000 will move to the cash line.
Book Excerpt:
(Excerpts from Financial Intelligence, Chapter 11 – Assets)
Sometimes a balance sheet includes an item labeled “allowance for bad debt” that is subtracted from accounts receivable. This is the accountants’ estimate—usually based on past experience—of the dollars owed by customers who don’t pay their bills. In many companies, subtracting a bad-debt allowance provides a more accurate reflection of the value of those accounts receivable. But note well: estimates are already creeping in. In fact, many companies use the bad-debt reserve as a tool to “smooth” their earnings.
