Last updated by
June 10, 2022
Accounts receivable is located in the asset section of the balance sheet usually right underneath cash or bank accounts and is the next best thing to cash.
Accounts receivable is located in the asset section of the balance sheet usually right underneath cash or bank accounts. Accounts receivable is the next best thing to cash so it is highly important by being near the top of the balance sheet.
Here is a snapshot of a sample balance sheet with accounts receivable highlighted.
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Table of contents
The Balance Sheet is one of the two most important statements of a business. It goes hand in hand with the Income Statement sometimes called the Profit and Loss Statement in small business.
The balance sheet documents the assets, liabilities and equity of a company. It is a snapshot of a point in time and typically is dated with the words and dates similar too: “as of 12/31/20”. It tells the value of everything you own and owe and the accumulated value since the beginning of the company.
The balance sheet is based on a formula: ASSETS = LIABILITIES + EQUITY
In simple terms, assets are things that you own or have rights too such as cash, accounts receivables, inventory and fixed assets.
Liabilities are things that you owe to someone else or to a company. Liabilities typically include things like accounts payable, sales tax payable, or long-term loans.
Equity is what you might call the book value of the company. It isn’t necessarily what someone would pay to purchase the company; rather it documents all contributions and distributions by owners to the company and the accumulation of profits and losses since the beginning of the company.
Accounts receivable is an asset because it is money that is owed to you. As mentioned previously it is located just under cash on the balance sheet, as it is the next asset to easily convert into cash.
Accounts receivable is an important number to understand. It is a credit sale to a customer, meaning the customer will pay their bill in the future. So, you have a claim on that money from the customer. It takes money to operate a business so obviously cash in hand is better than cash that is owed to you. So, the challenge for a business is to collect accounts receivable as quickly as they can.
Typical of small businesses do not have on staff accountants and the owner is often so involved with selling and growing the business accounts receivables can be overlooked. This can cause cash flow problems in the future. The longer a receivable goes uncollected the harder it is to collect.
The solution is to make sure you have an accounts receivable ledger that tracks all unpaid invoices. At least weekly you should review the ledger and identify invoices that are close to the due date or past due. Often all it takes is a simple email, phone call or letter to remind customers of their pending due or past due invoice. By weekly reviewing the report you can prevent problems and keep your cash flow moving through the company.
The answer to how do accounts receivables impact the income statement is more of a technical question, but let’s make it simple. As previously mentioned, there are two primary statements important to a business, the balance sheet and the income statement.
The reason they are important is not just because they are important. The two statements actually have a relationship – one affects the other. You may have heard accounting is a double entry system. What this means is every transaction affects two accounts. Typically, one account on the balance sheet and one account on the income statement.
The balance sheet tracks what you own and what you owe. The income statement tracks what you sell and what you spend. With that simple explanation you begin to understand the relationship.
Consider selling a widget for $100 on credit. That transaction results in a Sale for $100 which is an income statement account. And results in a $100 in accounts receivable balance because the customer will owe you in the future. You see the double entry system – sales are on the income statement; accounts receivable is on the balance sheet.
So, to answer the question how do accounts receivables impact the income statement – they are tied to sales. Anytime you create a credit sale, you create an accounts receivable.
If you notice the sample balance sheet listed above, you will see another term called “current assets”. So, why is accounts receivable classified as a current asset?
A current asset is one that is expected to be converted to cash in less than 1 year or a shorter period of time. Every asset is ranked based on how it converts to cash.
When you sell on credit you might offer 30 days for the customer to pay. In some situations, you might offer 45-90 days to pay, but this isn’t a preferred option but might be demanded by a particular customer. The main objective is to collect quickly because of this accounts receivables are “current” or short-term assets.
Moving down the balance sheet above you see some other current assets like inventory. Inventory is a physical product. Maybe you sell lapel pins that you have purchased or made. Inventory is an asset that remains on your shelf until you sell it. Because it is a physical asset and you have to sell it, it typically does take longer to convert it to cash so it comes underneath accounts receivables. But it is still anticipated that you will convert the inventory into a sale within a one-year period so it is classified as current.
The next category is called “fixed assets”. Fixed assets are things you use to operate your business-like desks, computers, equipment, etc. These types of assets are not for sale and therefore will not be converted into cash. Because of this they are classified as long-term assets. They will help you make money but have a longer life than 1 year before they wear out and are disposed of.