Receivables: Overview, definition, and example
What are receivables?
Receivables refer to amounts of money that a company or individual is owed by its customers or clients for goods or services that have been provided but not yet paid for. Receivables represent a legal right to collect payment in the future and are considered an asset on the balance sheet. There are two main types of receivables: accounts receivable (money owed for goods or services delivered on credit) and notes receivable (amounts owed based on formal agreements or promissory notes).
Receivables are a critical part of a company’s cash flow management, as they represent future cash inflows that are essential for maintaining day-to-day operations and funding business activities.
Why are receivables important?
Receivables are important because they represent a significant portion of a company’s working capital and can directly impact cash flow. If receivables are not collected in a timely manner, it can lead to liquidity issues, even if the company is otherwise profitable. Effectively managing receivables ensures that a company can continue to operate smoothly, pay expenses, and invest in growth opportunities.
For businesses, understanding and managing receivables is crucial for maintaining a healthy financial position. It allows businesses to track outstanding payments, forecast future cash flows, and implement strategies to improve collections and reduce the risk of bad debts. For individuals, receivables may reflect amounts owed by clients or customers for services rendered or products sold on credit.
Understanding receivables through an example
Imagine a retail business sells goods to a customer on credit. The customer agrees to pay within 30 days, and the business records the amount owed as accounts receivable. Over the next 30 days, the business expects to receive payment, which will increase its cash flow. If the customer fails to pay within the agreed period, the business may need to take steps to collect the debt, such as sending reminders or involving a collections agency.
In another example, a consulting firm provides services to a client and issues a formal contract with payment due within 60 days. The consulting firm records the outstanding payment as notes receivable. Upon receipt of payment, the firm will convert the notes receivable into cash, improving its liquidity.
An example of a receivables clause
Here’s how a receivables clause might appear in a contract:
“The Buyer agrees to pay the full amount of the Invoice within [X] days of receipt of goods or services. Any amounts outstanding after this period will be considered overdue, and the Seller reserves the right to charge a late fee of [X]% per month on overdue receivables. The Seller may assign the receivables to a third party for collection if payment is not received within [Y] days of the due date.”
Conclusion
Receivables are a key element of a company’s financial health, representing amounts owed by customers for goods or services provided on credit. Proper management of receivables ensures timely cash flow and reduces the risk of non-payment or bad debts. For businesses, understanding and managing receivables effectively is essential to maintaining liquidity, operational efficiency, and profitability. Clear receivables clauses in contracts help outline payment terms and ensure that both parties understand their financial obligations, minimizing potential disputes.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.