In the regular course of business, a trade receivable is the amount billed to a customer for the sale and delivery of goods or services. In business, trade receivables constitute one of the larger assets of the company carried on its books, apart from inventory. Trade receivables are current assets because they refer to monetary amounts owed to the business by customers that are collectable within two to three months from the sale date.
Also known as an account receivable, a trade receivable is the amount you bill to your customers when you deliver goods or services to them in the ordinary course of business.
What Are Trade Receivables?
A trade receivable represents the dollar value the company does not have to invest in inventory, pay its debts or market its goods or services. Many businesses operate by allowing customers to benefit from a credit period of 30, 60 or in some cases 90 days. Meaning, the company sells goods or services but does not receive an immediate monetary value for the sale. Companies that do not carry trade receivables on their books operate by collecting cash at the time of a sale being made. These companies have money to reinvest back into the business.
Trade Receivables Are Unsecured Claims
An unsecured claim is a claim or debt for which the seller has no assurance of payment because there is no security. A trade receivable, unlike automobile loans or equipment leases, is an unsecured claim on another business. When a business sells goods or services to a customer, usually another business, there is no hard asset securing the sale, which can be repossessed in the event of non-payment. Trade receivables are an extension of credit based on the creditor’s belief that the debtor has the future ability to pay.
Variability of Asset Characteristics
A trade receivable is a type of asset for a business, but there is no similarity across transactions. Products or services, sales practices, buyers, accounting procedures, payment terms and collection policies vary from industry to industry and seller to seller. Trade receivables are assets with short term credit periods; as such there is constant exposure to the changing financial status of the buyer’s business. The performance of a trade receivable is a variable factor. It is influenced by the seller’s underwriting practices, seller’s relationship with the buyer, market position of the buyer’s business and current financial condition of the buyer’s business.
Understanding the Risk Factors
Trade receivables are assets that have a rapid turnover. Depending on business collection policies and payment structuring, a trade receivable may become due in as little as 10 days. There is some level of risk attached to trade receivables. Business fortunes can turn in as little as 30 days, and the seller could end up losing the money due on the trade receivable if the buyer’s business fails. If the seller of the goods or services fails to perform a credit evaluation of the buyer’s ability to make good on the trade receivable, the risk of an asset becoming a bad debt is possible. If the buyer declares bankruptcy, the trade receivables of the seller could become part of the bankruptcy proceedings.