When you make a sale for a good or service but don’t immediately take full payment, you create a receivable. Receivables are assets that represent monetary value to your business in the form of payment owed to you, and best practices requires you to account for them in your books. Very small business sometimes operate on a cash basis, but this system can’t handle receivables so you must use the more common accrual basis instead. This involves making entries in several account ledgers for each transaction.
Create an accounts payable account and ledger. Because they are assets, you technically could record receivables in your main assets account, but business assets are diverse and this account can become unwieldy over time. For cleaner recordkeeping, create an entirely separate daughter account specifically for receivables. Then you can do all your data entry in that ledger, and simply compile it into the main assets account when you prepare financial reports.
Record each sale that creates a receivable in your revenues account ledger first, as you would do in general. The sale goes in the right-hand column as a credit, since crediting increases a revenue account.
Record the creation of the receivable, for the same dollar amount as the sale price, in your accounts receivable ledger, except here mark it in the left-hand column as a debit. This entry establishes that you are owed money and have not yet been paid.
Update the entry in your accounts receivable ledger when you actually receive payment. Record payments as credits; full payment should perfectly cancel out the value of the receivable. Use invoice or tracking numbers to properly map payments to the correct receivables.
Debit your cash account ledger for the payment amount. This indicates that the reduced value of your assets has been offset by an increase in cash.
Create a new segment in your accounts receivable ledger with a title like “Allowances for Bad Receivables.” This serves as a counterpart to your receivables account; its purpose is to estimate “bad,” “unrealizable” or “uncollectible” debts that you expect not to be able to collect.
Estimate the value of the bad receivables you expect to accrue over the coming period. To make a good estimate, use industry statistics when available, or rely on your past experience, the experience of colleagues in the industry or an assessment of current economic conditions in your market. Enter your estimated bad receivables as a credit in the allowances ledger, and enter the same amount as a debit in your expenses account ledger.
Adjust the value of your accounts receivable downward at least once each accounting period by taking the value of doubtful or uncollectible receivables that you estimated in your allowances ledger and subtracting that from your total in the receivables ledger. The new total creates a figure called the “net realizable value” or “net receivable,” and represents the receivables money owed to you that you realistically expect to collect.
Sum your accounts receivable at any time to see the total value of your company’s accounts receivable. Use this information as a reference to avoid spending too much money in the short term that you haven’t yet collected.
As an alternative to the allowance method for estimating bad receivables, you could use a much simpler method called the direct write-off. In this method you simply credit bad receivables for their full value once you deem them to be uncollectible, and create a corresponding debit entry in your expenses account. This is easier for tax purposes than using the allowance method, and involves less data entry, but is less powerful and less flexible. The allowance method is usually preferred.
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