What Is Accounts Receivable?
Accounts Receivable

Every unpaid invoice is money your business has earned but not yet received. Added together, those invoices are your accounts receivable. For a small business, it is often the single biggest thing standing between being profitable on paper and having cash in the bank. Knowing the figure, and who it is owed by, is the first step to shrinking it, and a weekly look at it is one of the most valuable habits a small business can build.

Accounts receivable at a glance

Ageing your receivables

An aged report splits what you are owed by how long it has been outstanding past its due date. It turns a single worrying number into a clear, ordered to-do list. Invoices not yet due need nothing but a reminder before their date. Those 1 to 30 days overdue need a friendly chase. Those 31 to 60 days overdue need a firm reminder and, for business customers, a look at statutory interest. Those over 60 days need a phone call without delay, and possibly a letter before action. The late payment interest calculator shows what each overdue business invoice has accrued.

What drives receivables up

Receivables and cash flow

A business invoicing £6,000 a month on 30-day terms that are paid on time has about £6,000 outstanding at any moment. If customers slip to 60 days, that becomes about £12,000: £6,000 of cash the business no longer has, with nothing having changed except customers' habits. Shorter payment terms, prompt invoicing and consistent chasing each pull receivables down. Where long terms cannot be avoided, invoice finance can release cash against unpaid invoices, at a cost.

Receivables, the cash basis and accruals

How receivables affect your tax depends on your accounting basis. Under the cash basis, which most sole traders now use, income counts when it is received, so unpaid invoices are not yet taxable income; your receivables list is a management tool rather than a tax figure. Under accruals, income counts when it is earned, so invoiced but unpaid work is already part of your profit, and your receivables appear in your accounts as an asset. If an invoice under accruals later proves unrecoverable, it can generally be written off as a bad debt.

Receivables and VAT

For a VAT-registered business using standard VAT accounting, VAT on a sales invoice is normally due at its tax point, whether or not the customer has paid. That is why large unpaid invoices can leave a business paying VAT it has not collected. The cash accounting scheme, for eligible smaller businesses, accounts for VAT when payment is received instead. If an invoice remains unpaid for 6 months after the later of its due date and the date of supply, and is written off, VAT bad debt relief may return the VAT paid on it.

Measuring how fast you are paid

A simple measure tells you whether receivables are under control: how many days of sales are waiting to be paid. Divide what you are owed by your sales over a recent period, and multiply by the number of days in that period. If you invoiced £18,000 over the last 90 days and are owed £9,000 today, you are carrying about 45 days of sales. If your terms are 30 days, customers are paying, on average, about two weeks late. Work it out monthly and keep a note of the result. A rising figure is an early warning, long before cash runs short.

Credit control for a small business

Credit control is simply the habit of managing who you let owe you money, how much and for how long. For a sole trader it can be light touch:

1. Decide terms before the work, not when invoicing.
2. Check new customers, especially businesses; a company's filed accounts and status are free to view on Companies House.
3. Set limits. Do not let one customer owe more than you could afford to lose.
4. Invoice promptly and accurately, with the due date as a date.
5. Chase on a fixed schedule, starting the day after the due date.
6. Stop new work for customers who are seriously overdue, where your contract allows.

Receivables in your records

Your invoices are part of the business records you must keep, and your receivables list is built from them: every sales invoice issued, less every payment received and credit note issued. Keeping those records complete and in one place, as Making Tax Digital requires for the businesses it covers, means your receivables figure is always accurate and always to hand. Keep them for at least 5 years after the 31 January filing deadline for a sole trader, and 6 years for VAT records.

Tools for managing receivables

• A list of open invoices. Most invoicing software shows it; a spreadsheet works for a handful of customers.
• An aged report, reviewed weekly or monthly.
• Statements of account sent monthly to customers with several open invoices; see statement of account.
• Remittance advices matched to payments; see remittance advice.
• A chasing routine with fixed steps; see how to chase an unpaid invoice.

A worked example

A sole trader electrician reviews his aged report at the start of the month: £9,800 outstanding. £4,200 is not yet due. £2,900 is up to 30 days late, mostly one letting agency; he emails their accounts team with the invoices attached. £1,800 is 31 to 60 days late, from a café that has gone quiet; he phones, and they agree to pay half now and half next week. £900 is over 60 days late from a customer who has stopped replying; he sends a letter before action including statutory interest and £40 compensation. By the end of the month, £5,300 has come in and the oldest debt has a deadline.

When a receivable will not be paid

Some debts will never be recovered: a customer goes out of business, disappears or genuinely cannot pay. Recognise it rather than carrying the debt forever. Under accruals, write it off as a bad debt, which reduces your profit. Under the cash basis, it was never counted as income, so there is nothing to reverse, though you should still record that it was written off. If you are VAT registered and paid VAT on the invoice, check whether VAT bad debt relief applies. If the customer is insolvent, you may be able to register a claim with the insolvency practitioner, though unsecured creditors often recover little.

Receivables and business finance

Lenders look closely at receivables. A business with a healthy list of creditworthy customers paying on time is a better credit risk than one whose receivables are old and concentrated. Invoice finance products use receivables directly as security. Even if you never borrow, keeping receivables clean makes your accounts easier to read for anyone who needs to, from a mortgage lender assessing your self-employed income to a buyer valuing your business.

Common mistakes

• Not knowing the total. If you cannot say what you are owed today, start there.
• Treating overdue as normal. Every day overdue is a day of free credit to your customer.
• Chasing the newest invoices first. Start with the oldest; they are the hardest to recover.
• Letting one customer dominate. A large share owed by one customer is a concentration risk.
• Forgetting the VAT timing if you use standard VAT accounting.
• Never writing anything off. Carrying a debt that will never be paid overstates what you are owed and hides the real picture.
• Offering generous terms to new customers. Earn trust first: short terms or a deposit until a customer has shown they pay on time.

Related terms

The opposite side of the books is accounts payable: what you owe suppliers. Receivables are made of invoices, each identified by an invoice number and due under your payment terms. For turning them into cash sooner, see invoice finance and invoice factoring.

The short version

Accounts receivable is your earned but unpaid income. Know the total, age it, chase the oldest first, keep terms short and invoices prompt, and write off what will never come. A business that manages its receivables well, week in and week out, has more cash, fewer surprises and a clearer view of how its customers really behave.