Assets can come in many forms. One in particular worth considering is accounts receivable. Your accounts receivable represent money owed to your small business from customers who have bought products or services on credit.
While offering credit can be risky—as one in 10 invoices are often paid late—it also can help grow your assets. These assets can then be used to improve your small business’s operation.
Why Is an Accounts Receivable an Asset?
You may feel reluctant to offer credit to your customers, but there is a bright side that’s worth considering. As you know, your accounts receivable represent money coming into your business. This makes each receivable an asset for your small business.
Assets for your small business include anything of value or use. This means that the more receivables you get from customers, the more value your small business gains. This will help you grow over time.
How does this growth directly occur? Assets, like your accounts receivable, help you:
- Run your small business easier. Assets can be sold, transferred, or even used to lower your taxes. All of these can help you improve your small business operation.
- Generate more revenue. Assets can be invested into your small business operation in countless ways that can help you become even more profitable.
That being said, your accounts receivable are not considered revenue if you’re using the cash basis of accounting. This accounting method considers revenue to be revenue when cash is received. Therefore, you wouldn’t consider your receivables as revenue because they will be converted into cash at a future date. If you counted them as revenue right away, you’d be claiming revenue that you haven’t received yet.
However, if you use the accrual basis of accounting, receivables are considered revenue. This is because, under accrual basis accounting, revenue is considered revenue when a sale is incurred.
Typically, your accounts receivable are converted into cash in less than one year. If they are converted into cash after a year’s time, they are considered a long-term asset or fixed asset. Either way, your accounts receivable will be recorded on your small business’s balance sheet. Also, as you consider your accounts receivable, keep in mind that they play a role in determining your overall net income.
Are Accounts Receivable Tangible Assets?
So, you know that your accounts receivable are assets, but what kind of assets are they? They’re considered tangible assets. This may seem surprising because tangible assets are usually physically present and include:
However, tangible assets also include securities like stocks or cash. This means that your accounts receivable are considered tangible assets because they have clear cash value and can be measured easily.
This cash value is represented in the transaction that takes place between you and your customer. Your customer agrees to a payment period before they make a purchase. You then send them an invoice with a due date that they need to legally commit to. This commitment to pay you back makes the cash you expect to receive a tangible asset.
Also, keep in mind that tangible assets differ significantly from intangible assets. These assets differ from tangible assets because they do not always represent physical value. Intangible assets include:
- Internet domain names
- Noncompetition agreements
- Customer relationships
- Licensing agreements
- Computer software
- Patented technology
Recording Accounts Receivable on the Balance Sheet
Recording your accounts receivables is just as important as collecting them. Your accounts receivable are typically recorded as current assets on your balance sheet. This section of your balance sheet is found under the assets header, which is listed first. Under this assets header, you’ll find current assets listed with an accounts receivable section. You may also see sections for:
- Cash and cash equivalents
- Marketable securities
- Trade accounts receivable
- Employee accounts receivable
- Prepaid insurance
What Is the Difference Between Accrued Revenue and Accounts Receivable?
Your accrued revenue and accounts receivable may both be considered assets, but they have key differences. To better understand these differences, let’s break them down side by side:
- Accrued revenue. This includes the revenue that your small business has earned but has not yet billed the customer for. This type of revenue is common in service industries. This is because invoices are not sent until you’ve finished delivering the services, which can last months, depending on the job. For instance, say you get hired to install a pool for a customer. You won’t send the invoice until after the project is complete, even though you earn — or accrue — revenue as you work through the stages of the installation.
- Accounts receivable. In comparison, accounts receivable include revenue that your small business has earned and billed but not yet received. For example, say you deliver a load of inventory to a local business. You then send them an invoice right away. This invoice includes a 30-day payment period. This transaction would be documented as an accounts receivable for your small business.
Does Collecting Accounts Receivable Affect Net Income?
One of the most fundamental goals of any small business is to make a profit. This is what your net income represents. Your net income is your small business’s income after subtracting the costs associated with goods sold, expenses, and taxes. It’s often referred to as “the bottom line” for your small business. This means it’s an accurate representation of how profitable your business actually is.
Each time you record an accounts receivable, you want to debit your accounts receivable account. You then want to credit your revenue account. Once you receive the cash, you credit your accounts receivable account and then debit the cash account. This means that your accounts receivable have an effect on your overall net income. Your net income is then represented on your small business’s income statement.
Now that you understand why your accounts receivable are assets, you don’t have to feel as cautious about offering credit to your customers. The more receivables that flow in, the more value will be generated for your business in the long run. However, be sure that you are collecting your receivables efficiently and in a timely manner. If not, you may delaying or missing out on payments you’ve earned fair and square.
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