What is accounts receivable?

How does accounts receivable work in practice?

The moment you raise an invoice, the sale is recorded and the customer becomes a debtor. Accounts receivable is the running total of those unpaid invoices. When a customer pays, the receivable is cleared and the bank goes up.

It is an asset because it is money you are entitled to. It is also the least useful kind of asset, because you cannot pay wages with it. A business with £20,000 of receivables and £500 in the bank is rich on paper and broke in practice.

The figure is only as good as the invoices behind it. An invoice that will never be paid is not really an asset, which is why receivables are reviewed by age and written off when they go bad.

A worked example

An electrician has three invoices outstanding on 30 June: £850 to a landlord for a rewire, dated 2 June; £1,200 to a builder for first fix, dated 15 June; and £430 to a homeowner for a consumer unit, dated 27 June. Accounts receivable is £2,480.

On 4 July the builder pays in full. Receivables fall to £1,630 and the bank rises by £1,200. The sale itself was recorded on 15 June, so July's profit is unaffected — the payment simply turns one asset into another.

If the electrician is VAT registered, the invoices include VAT and so does the receivable. The £1,200 is £1,000 of sales and £200 of VAT owed to HMRC once it is collected or, on the standard VAT scheme, once it is invoiced.

Why do profitable businesses run out of cash?

Because profit is measured when the invoice is raised and cash arrives when the customer decides to pay. The gap between the two is accounts receivable, and it has to be funded by someone — usually you.

The fix is dull and effective: invoice the day the job finishes, state payment terms clearly, chase on the due date rather than a month later, and make paying easy. Automated chasing removes the part most people avoid, which is asking.