Accounts Receivable and Cash Flow

Accounts receivable represent sales that have not yet been collected as cash. You sell your merchandise or services in exchange for a customer's promise to pay you at a certain time in the future. If your business normally extends credit to its customers, then the payment of accounts receivable is likely to be the single most important source of cash inflows. In the worst case scenario, unpaid accounts receivable will leave your business without the necessary cash to pay its own bills. More commonly, late-paying or slow-paying customers will create cash shortages, leaving your business without the cash necessary to cover its own cash outflow obligations.

Accounts receivable also represent an investment. That is, the money tied up in accounts receivable is not available for paying bills, paying back loans, or expanding your business. The payoff from an investment in accounts receivable doesn't occur until your customers pay their bills. The idea of accounts receivable as an investment is an important concept to understand if you wish to consider the impact of accounts receivable on your cash flow.

The following analysis tools can be used to help determine the effect your business's accounts receivable is having on your cash flow:

• average collection period measurement
• using the average collection period
• accounts receivable to sales ratio
• accounts receivable aging schedule
• using the accounts receivable aging schedule