Definition: Accounts Receivable (AR) is the proceeds or payment which the company will receive from its customers who have purchased its goods & services on credit. Usually the credit period is short ranging from few days to months or in some cases maybe a year. Description: The word receivable refers to the payment not being realised. This means that the company must have extended a credit line to its customers. Usually, the company sells its goods and services both in cash as well as on credit. Show ADVERTISEMENT Account Receivables (AR) are treated as current assets on the balance sheet. Let's understand AR with the help of an example. Suppose you are a manufacturer M/S XYZ Pvt Ltd and you manufacture tyres. A customer gives you an order of Rs 1,00,000 for 100 tyres. Now, when the invoice is generated for that amount, sale is recorded, but to make the payment the company extends the credit period of 30-days to the customer. Till that time the amount of Rs 1,00,000 becomes your account receivable because the customer will pay that amount before the period expires. If not, the company can charge a late fee or hand over the account to a collections department.ADVERTISEMENT Once the payment is made, the cash segment in the balance sheet will increase by Rs 1,00,000, and the account receivable will be decreased by the same amount, because the customer has made the payment.The amount of account receivable depends on the line of credit which the customer enjoys from the company. Usually, this is offered to customers who are frequent buyers. A credit sale is a type of transaction where the buyer delays payment to a later date. The seller usually decides on this date when they make a sale. Even if the buyer pays in cash at a later date, it is still not a cash sale. A cash sale is when a buyer pays for goods and services at the time of purchase. For example, if I go to a computer shop on July 1st and purchase a laptop with a promise to pay for the computer on July 31st, then it is a credit sale. In a credit sale, the buyer can pay at a later time using any acceptable form of currency: bills, credit cards, checks, etc. As a seller, you have to trust that the customer will pay for the item at the agreed time. Terms Used In Credit SalesImagine you are selling a game to a friend who does not have the cash to pay for it at the moment. There is also no agreement on when he will pay you for the game — you just gave it to him assuming he’ll give you the money eventually. If your friend is unreliable, you might as well call the game a gift. He may never pay you! The same thing happens in business. If a company sells on credit to customers and there are no terms for the credit sale, it means that the customers can pay the debt anytime they choose — which may be never. To minimize such unwanted situations, sellers usually have credit sales terms that include the time when the debt will be due for payment, a discount duration, and a discount. Credit terms are written as: a/b net c Where a is the discount a customer can receive if the buyer pays the debt within the discount duration. b is the discount duration, c is the time when the credit will mature, and the customer will pay for the sale. At this point, the customer receives no discount. For example, a credit term of 2/10 net 30 means that the buyer will get a discount of 2% if they make payment within the first ten days. The total time to pay for the item is 30 days. Recording Credit SalesA business records credit sales using journal entries. Journal entries are one of the most widely used account recording formats for sales. For credit sales, the recording involves creating account receivables for the company. Take a look at the general format below. Amount is the total amount that can be received for a credit sale. Sales is the name of the item or items that are sold on credit. If, during payment, the customer receives a discount for paying within the discount time, the discount is also included in the journal entry. ExampleOn December 1st, a computer retailing company, Com A, made a credit sale of 42 computers to a software company, Com B. The total credit sale was $63,000. The terms of the credit sale were 2.5/10 net 30. Com B paid $20,000 to Com A on December 5th to take advantage of the 2.5% discount. On December 31st, Com B paid another $36,000 to Com A. Let’s break this down by first creating journal entries for credit sales in December. The first step is to record the credit sale before the payments were made. The next step is to record the next part payment that was made by Com B. Com B paid $20,000 during the first ten days, which attracts a discount of 2.5%. 2.5% of $20,000 0.025 * $20,000 = $500 So the actual amount Com B paid was $20,000 – $500 = $19,500. It will be recorded as: Note that the cash discount is also recorded as part of account receivable from Com B. Com B also made another part payment on December 31st, a sum of $36,000. However, this time, there is no discount because it is outside the discount duration. This second payment is recorded below. I guess you are saying in your mind that Com B did not finish paying their debt to Com A within the terms of the credit sale, and you are correct. The total amount paid by Com B is $20,000 + $36,000 = $56,000 which is $7000 less than the $63,000 debt. This debt is recorded below. Com A has recorded a loss of $7,000, which will most likely be written off as a bad debt and deducted as an expense from the income statement. Advantages of Credit SalesIf you have a business and want to sell on credit, here are some ways you may benefit.
Disadvantages of Credit SalesSelling on credit is not all rosy. You should be mindful of the pitfalls below!
ConclusionSo, should you sell on credit? The best approach is to consider the advantages, the risks, and how much it will cost you to keep track of your debtors. Companies that sell capital intensive equipment are more likely to sell on credit, while companies that sell inexpensive items such as pencils are most unlikely to sell on credit. FAQs1. What is a Credit Sale?A Credit Sale is when a company sells an item to its customer on the condition that they will pay for it later. The company gives the customer their product on credit, and the customer promises to pay the company later on. 2. How do you calculate Credit Sales?You calculate Credit Sales by multiplying the cost of goods sold (COGS) with the percentage of adding on credit. For example, if your COGS is $10 and you add on 20% for Credit Sales, then your Credit Sale will be $12. 3. Is Credit Sales an asset?Credit Sales are not an asset. They are a liability since they are money that you have received from your customers, but do not belong to you until the customer pays up. 4. What are the basis for Credit Sales?The basis for Credit Sales are normally the competition's price, the competitor's terms of payment, and your company's cash position. You should also consider the customer's credit history, which you can find from their bank or credit checks. 5. Is a Credit Sale a loan?No, a Credit Sale is not a loan. A Credit Sale is an agreement made between the seller and the buyer that enables the buyer to pay for the agreed amount in installments. |