Accounts Receivables

Meaning of Accounts Receivables

Accounts receivable is the monetary amount due from the business customers to whom the goods and services are supplied/provided by the business entity in the routine course of its operations and it includes business current debtors, bills receivable where generally the payment is done by the customer within a year.

In simple words, it is money that is owed to the company by the customers (credit to the customers). The company has provided services / delivered the product to the customer but it has not collected the cash yet (that goes into cash and cash equivalents).

What are Gross and Net Accounts Receivables?

• Gross receivables are the total receivables (open invoices) that are due to the company. This does not take into account a scenario where the customer may default.
• Net Receivables, on the other hand, takes into account the probability of default from the customers. To prepare for some nonpayments, the company estimates that a proportion of its credit sales will go bad. This term is usually called “allowance for doubtful accounts“.
• The estimate shows up on the income statement as a bad debt expense. This expense is usually charged to SG&A in the income statement.

Colgate Example

In Colgate, we note the following –

• 2014 – Net receivables is $1,552 mn, allowance is $54 mn; This implies Gross Receivables are $1,552 + $54 = $1,606 mn
• 2013 – Net receivables is $1,636 mn, allowance is $67 mn; This implies Gross Receivables are $1,636 + $67 = $1,703 mn

Below is the Colgate receivables policy suggests a shorter credit policy of less than 60 days

 

Accounts Receivables Accounting

Let us take one case study and see how it works. ToysforU sales and receipts from customers are shown below.

• All customers buy on credit and pay cash the following year if they are not bankrupt. Any uncollected receivables are then written off
• Based on its experience, ToysforU books 10% of its receivables outstanding at the end of the period as an allowance for bad debts
• There are no other costs, i.e. the cost of goods sold (COGS) is $0
• The actual write-offs differ from expectations as shown in the table below.

Please create the Income Statement, Balance Sheet and Cash Flows at the end of Year 1 and Year 2

Year 1

Income Statement for the 1^st Year

• $100 sales will be booked due to the “Accrual Accounting” concept (introduced in 1^st chapter Kartik’s case study)
• COGS is $0 as given in the case study
• Bad Debt Expense is 10% of the Sales = 10% of $100 = $10
• Net Income Reported in 1^st Year is $90

Balance Sheet for the 1st Year

• Receivables is an asset and is reported as $100
• After accounting for the allowance for bad debt, Net Receivables becomes $90

Cash flow for Year 1

There is no cash received in Year 1, Cash Flow = $0

Year 2

Income Statement for the 2^nd Year

• Sales will be booked due to the “Accrual Accounting” concept (introduced in 1^st chapter Kartik’s case study)
• COGS is $0 as given in the case study
• Bad Debt Expense is 10% of the Sales = 10% of $150 = $50
• Net Income Reported in 2^nd Year is $135

Balance Sheet for the 2nd Year

• Receivables is an asset and is reported as $150
• After accounting for the allowance for bad debt, Net Receivables becomes $135

Cash flow for Year 2

The actual cash collection during the year was $90. Cash Flow = $90

Industry Examples

Let us now have a look at the industry average receivables

Rank	Industry	Receivables (Days)
1	Banks	331.9
2	Machinery	109.93
3	Construction	107.88
4	Metal Products	103.36
5	Chemicals	98.27
6	Glass & Ceramics Products	97.9
7	Precision Instruments	97.8
8	Electric Appliances	96.46
9	Rubber Products	92.09
10	Other Services	89.74
11	Pulp & Paper	85.73
12	Nonferrous Metals Products	85.13
13	Other Products	83.87
14	Iron & Steel	81.3
15	Wood & Wood products	75.7
16	Communication	74.19
17	Wholesale Trade	73.78
18	Transportation Equipment	70.65
19	Textiles & Apparels	69.34
20	Leather Products	69.23
21	Air Transportation	68.22
22	Publishing & Printing	67.31
23	Agriculture	61.59
24	Oil & Gas Mining	60.29
25	Other Transportation	58.85
26	Insurance	56.89
27	Foods	55.44
28	Oil & Coal Products	54.99
29	Forestry	54.38
30	Coal Mining	48.24
31	Fishery	42.81
32	Metal Mining	41.66
33	Gas	36.26
34	Movie	33.49
35	Road Transportation	32.41
36	Retail Trade	28.23
37	Hotel	27.47
38	Electric Power	27.28
39	Railway	24.68
40	Warehousing	23.81
41	Marine Transportation	23.72
42	Amusement	18.78
43	Real Estate	10.64
44	Securities	6.86

source: ediunet

As you can see from above, industries like Banks have a very long receivables period (in excess of 300 days), however, for capital goods and heavy asset industries like machinery, construction, metals, etc, it is around 100 days.

How to generate cash from Receivables?

Since Receivables is an asset, the company can approach a bank to provide them with a loan against these receivables as security. This is a fairly common practice adopted by companies for liquidity.

Credit Card Payments and Receivables

Credit card sales from customers are technically receivables for the company, but only for 1-2 days. This one to two days’ time is what it takes for the bank to reconcile and deposit the amount in the company’s account.

Conclusion

Accounts receivables are the amount that is due to the company by its customers. It is important to consider the default probability of the customer and therefore look at the Net Receivables numbers. Each industry has a different set of credit policy and hence, account receivable days differ by wide measures.

Accounts Receivables Video

This has been a guide to the meaning of Accounts Receivables and its definition. Here we also discuss Accounts Receivables Accounting along with Industry examples.  You may also have a look at these following articles to learn more about accounting.