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Account receivable

Account receivable, any amount owed to a business by a customer as a result of a purchase of goods or services from it on a credit basis. The company making the sale does not receive an acceptance or promissory note (i.e., written orders or promises to pay) from the purchaser but merely enters the amount due as a current asset in its books. Accounts receivable constitute a major portion of the assets of many companies and tend to vary directly with sales.

Accounts receivable may be sold to finance companies or pledged as collateral to obtain loans from commercial banks or finance companies. This kind of financing differs from factoring (q.v.) in that the company’s customers are not notified that their accounts have been sold or pledged as collateral, and the company remains responsible for credit losses.

This type of financing is frequently employed by smaller companies that cannot obtain additional credit from commercial banks and have no other highly liquid assets to offer as security.

Accounts receivable are the credit a firm gives its customers. The volume and terms of such credit vary among businesses and among nations; for manufacturing firms in the United States, for example, the ratio of receivables to sales ranges between 8 and 12 percent, representing an average collection period of approximately one month.

The basis of a firm’s credit policy is the practice in its industry; generally, a firm must meet the terms offered by competitors. Much depends, of course, on the individual customer’s credit standing.

To evaluate a customer as a credit risk, the credit manager considers what may be called the five Cs of credit: character, capacity, capital, collateral, and conditions. Information on these items is obtained from the firm’s previous experience with the customer, supplemented by information from various credit associations and credit-reporting agencies. (See credit bureau.) In reviewing a credit program, the financial manager should regard losses from bad debts as part of the cost of doing business.

Accounts receivable represent an investment in the expansion of sales. The return on this investment can be calculated as in any capital budgeting problem.