Average accounts receivable definition
What are the average accounts receivable?
Every sale a company makes is recorded as revenue on the income statement and is recorded accordingly in the balance sheet at the end of a period (month, quarter, year). A sale can be recorded under one of two basic items on the balance sheet: cash and accounts receivable. Cash means every sale which the clients pay in cash increases the cash amount on the balance sheet. The company could also make a sale in which the buyer is expected to pay some time in the future, which would be recorded as accounts receivable. So, average accounts receivable provides an overview of the average outstanding amount a business should collect from its clients within a given period.
It is fairly easy to calculate average accounts receivable because the process is rather straightforward. In addition, the needed information is readily available in a balance sheet or company reports. Two or more time periods can be considered for the purpose of calculating the average accounts receivable. In some circumstances, it may be advisable for more periods to be included in the calculations.
One drawback when using two periods is that the calculations may not include the seasonality changes. For instance, previous year-end balance and this year-end balance of accounts receivable are taken into consideration. In this calculation, it is expected that there are no major fluctuations in the level of accounts receivable throughout the year. But if the company has seasonality in its activities, they will not be accounted for in this calculation.
Using data for more periods, such as ending monthly balance, will provide a more accurate representation of the average accounts receivable. The seasonality in business activities could be accounted for when taking the information for the last 12 months. Average accounts receivable can be calculated when the values of accounts receivable for each period under consideration are added, and the sum then divided by the number of periods.
When are average accounts receivable used?
When selling on credit, every business should try to collect the money within the agreed period and eliminate the risk of not getting paid by the client. The efficiency in the collection of accounts receivables can be analyzed through accounts receivable turnover ratio.
Accounts receivable turnover ratio = Sales on credit / Average accounts receivable
This ratio shows the number of times a company converts its sales on credit into cash. The ratio is estimated on the basis of two main items: the accounts receivable or credit sales made by the company, and the average accounts receivable.