Accounts receivable is a business term used to describe the account that the business uses for money that it has made through transactions but has not received. This is very common with credit. A business wants to increase sales by offering credit but also needs a way to keep track of how much money it is owed and how on-time customers are when it comes to payment. A company can analyze the effectiveness and efficiency of accounts receivable by examining the investment in it over different financial periods.
Investment in Accounts Receivable
When it comes to investment in accounts receivable, the analysis does not actually study how much money the business puts into starting and running accounts receivable. The phrase actually refers to a specific type of analysis. Businesses look at how much money they actually hold, on average, in accounts receivable, money earned but not yet collected. The number is reached by taking the average number of days it takes to collect, dividing them by the number of days in the period, then multiplying the result by credit sales for that period. The answer shows how much money businesses trust to their accounts receivable.
Because businesses collect accounts receivable in different ways and have a wide variety of collection techniques and standards, it is very difficult to come up with an average investment number, even for a single industry. A business that has credit sales of around $10,000 per month and a long collection period like 60 days has around $18,000 of investment in accounts receivable. A business that has $100,000 of credit sales in a year and a more typical 30-day period may have around $11,000 in investment.
The collection period remains a key determinant of the averages for accounts receivable and is one reason that average investments can vary so frequently. One business can choose to have a lengthy collection period, such as 60 to 90 days. This gives customers more time to pay back their debts but does not necessarily decrease losses and means that the company has to rely more heavily on money held "within" accounts receivable, so its investment is higher. A high investment can be dangerous for a business, since it shows money that has not actually come into the organization yet.
Methods of Improvement
Businesses can improve their investment in accounts receivable (lower the investment number) in a variety of ways. They can institute lower collection periods to make debts get paid faster and have a higher turnover, a sure method of decreasing investment. Many companies form a partnership with debt-collection agencies, outsourcing the work to save on time and money while also increasing the likelihood of getting paid on time.