The terms “Accounts Receivable” and “Collections” are often used in the context of managing a company’s finances, particularly in relation to money owed by customers. Here’s a detailed explanation of the differences between the two:
- Accounts Receivable (A/R): This refers to the money that is owed to a company for goods or services that have been delivered or used but not yet paid for by customers. Accounts receivable is listed as a current asset on the company’s balance sheet since it represents funds that are expected to be received within a year.
- Collections: This term relates to the process of pursuing payment on the accounts receivable that are past due. Collections involve following up with customers who have not paid their invoices within the agreed-upon payment term.
- Accounts Receivable: This function involves billing customers for sales on credit, recording and tracking such sales, and recognizing revenue. It’s about managing and maintaining the records of what customers owe.
- Collections: This function is more about action – it’s the proactive steps taken to collect the outstanding debts. This can involve sending reminders, making phone calls, negotiating payment plans, and sometimes taking legal action.
- Financial Statement Impact:
- Accounts Receivable: A/R impacts both the balance sheet and income statement. It appears as an asset on the balance sheet and affects revenue on the income statement when the sale is made, regardless of whether cash has been received.
- Collections: While collections don’t directly appear as a line item on financial statements, the effectiveness of the collections process can impact the cash flow statement and the allowance for doubtful accounts, which is a contra-asset account on the balance sheet that reduces the net amount of accounts receivable.
- Risk Management:
- Accounts Receivable: Managing A/R involves assessing the creditworthiness of customers, setting credit limits, and terms, and continuously monitoring credit risk.
- Collections: The focus here is on managing the risk of non-payment. This includes identifying problematic accounts and deciding on the appropriate course of action for delinquent accounts.
- Accounts Receivable: This process begins immediately after a sale is made on credit terms.
- Collections: This process starts when an account receivable becomes overdue. The timeline for this can vary based on the company’s payment terms (e.g., Net 30, Net 60 days).
- Accounts Receivable: The primary objective is to accurately track and manage credit sales.
- Collections: The goal here is to minimize the amount of outstanding receivables and reduce the days sales outstanding (DSO) – a measure of the average number of days that it takes to collect payment after a sale has been made.
In summary, while accounts receivable and collections are closely related and both crucial for the management of a company’s cash flow and credit risk, they represent different aspects of the process of managing and collecting money owed by customers. Accounts receivable is about recording and tracking credit sales, while collections focus on the actual recovery of funds from overdue accounts.