Accounts Receivable Basics

In most businesses, what drives the balance sheet are sales and expenses. In other words, they cause the assets and liabilities in a business. One of the more complicated accounting items is the accounts receivable. As a hypothetical situation, imagine a landlord that offers all its tenants a 10-day credit period for receiving rent. The rent is due on the first of the month but isn’t paid until the 10th. That creates accounts receivable for the rent balance owing.

Accounts receivable asset shows how much money customers who bought products on credit still owe the business. It’s a promise of a payment that the business will receive. Accounts receivable is the amount of uncollected sales revenue at the end of the accounting period. Cash does not increase until the business collects this money from its customers. However, the company includes the amount of money in accounts receivable in the total sales revenue for that same period. The business did make the sales, even if it hasn’t acquired all the money from the sales yet. Sales revenue then isn’t equal to the cash the business accumulated.

To get actual cash flow, the accountant must subtract the actual credit sales not collected from the sales revenue in cash. Then add in the amount of cash collected for the credit sales that the company made in the preceding reporting period. The accounts receivable account increased if the business made more in credit sales than it collected from customers.

If the amount they collected during the reporting period is more significant than the credit sales made, then the accounts receivable decreased over the reporting period.

This will often be one of the main reasons the cash flow doesn’t equal the net income. There are timing differences in the collection of accounts receivable and revenue recognition for GAAP purposes.