What is accounts receivable? A guide for small businesses

Published Wednesday 27 May 2026

Table of contents

• What is accounts receivable?
• Accounts receivable example
• Why is accounts receivable important?
• Accounts receivable vs. accounts payable
• How to record accounts receivable
• What is the accounts receivable turnover ratio?
• What is ageing of accounts receivable?
• How to manage and collect accounts receivable
• What is a bad debt?
• When should you write off a bad debt?
• What is accounts receivable financing?
• Simplify your accounts receivable with Xero
• FAQs on accounts receivable

Key takeaways

• Accounts receivable (AR) is the money your customers owe you for goods or services you've already delivered, and it appears as a current asset on your balance sheet.
• Tracking AR closely helps you forecast cash flow, spot late payers early, and make smarter decisions about extending credit to customers.
• Ageing reports sort outstanding invoices into time buckets so you can prioritize collections and reduce the risk of bad debts.
• Automating your AR process with tools like invoice reminders and payment tracking saves time and helps you get paid faster.

What is accounts receivable?

Accounts receivable (AR) is the money customers owe your business for goods or services you've already provided. It's sometimes called "bills receivable" and sits on your balance sheet as a current asset.

When you sell something on credit rather than collecting payment upfront, you create an accounts receivable entry. The AR process covers invoicing, tracking what's owed, following up on late payments, and reconciling payments once they arrive.

For most small businesses, AR is one of the largest current assets on the books. Managing it well means you'll have a clearer picture of how much cash is actually coming in and when you can expect it.

Accounts receivable example

A worked example helps show how AR moves through your books.

Suppose your consulting firm delivers $5,000 worth of services to a client on credit. At the time of delivery, you record a debit of $5,000 to accounts receivable and a credit of $5,000 to revenue. Your balance sheet now shows that the client owes you $5,000, and your income statement reflects the earned revenue.

Two weeks later, the client pays the full $5,000. You then record a debit of $5,000 to your cash account and a credit of $5,000 to accounts receivable. This brings your AR balance for that client back to zero and puts the cash where it belongs.

Why is accounts receivable important?

Keeping a close eye on AR gives you real insight into the financial health of your business.

AR directly affects how much cash you have available to cover expenses, pay suppliers, and invest in growth. If customers are slow to pay, your cash flow tightens, even when your sales look strong on paper.

The total value of your AR, and how quickly it converts to cash, tells you whether your business is collecting revenue at a healthy pace. Lenders and investors often look at AR metrics when assessing your financial position.

Monitoring who pays on time and who doesn't helps you decide which customers deserve flexible terms and which ones need closer attention. It also helps you spot patterns before small issues become big problems.

AR data helps you set payment terms that balance customer convenience with your own cash needs. You can adjust credit limits and terms based on actual payment behaviour rather than guesswork.

Accounts receivable vs. accounts payable

Understanding how AR and accounts payable (AP) differ helps you manage both sides of your cash flow.

• Accounts receivable: money owed to you by customers. It's a current asset on your balance sheet.
• Accounts payable: money you owe to suppliers and vendors. It's a current liability on your balance sheet.
• Balance sheet placement: AR appears under current assets; AP appears under current liabilities.
• Cash flow effect: collecting AR brings cash in; paying AP sends cash out.
• Goal: collecting AR quickly and paying AP on time without paying too early.

How to record accounts receivable

Recording AR correctly depends on understanding debits and credits under accrual accounting.

Under accrual accounting, you recognize revenue when it's earned, not when cash changes hands. When you deliver goods or services on credit, you debit accounts receivable (increasing the asset) and credit revenue (recognizing the income). When the customer pays, you debit cash and credit accounts receivable to close the balance.

If a customer only makes a partial payment, you record the cash received and reduce AR by that amount. The remaining balance stays in AR until it's paid or written off. For a deeper look at how debits and credits work, see Xero's guide on debits and credits.

What is the accounts receivable turnover ratio?

The AR turnover ratio measures how efficiently your business collects payments from customers over a given period.

The formula is straightforward: divide your net credit sales by your average accounts receivable. Net credit sales are total credit sales minus returns and allowances. Average AR is the sum of your opening and closing AR balances divided by two.

For example, say your business had $240,000 in net credit sales over the year. Your AR was $30,000 at the start of the year and $50,000 at the end. Your average AR is $40,000.

Dividing $240,000 by $40,000 gives you a turnover ratio of six. That means you collected your average receivables six times during the year.

You can also calculate days sales outstanding (DSO) by dividing 365 by your turnover ratio. In this example, 365 divided by six gives you roughly 61 days. That's the average number of days it takes your customers to pay. A lower DSO generally means faster collections and healthier cash flow.

What is ageing of accounts receivable?

An ageing report sorts your outstanding invoices into time buckets based on how long they've been unpaid. It's one of the most useful tools for managing collections.

The standard buckets are current (not yet due), 1–30 days overdue, 31–60 days overdue, 61–90 days overdue, and 90+ days overdue. Each bucket shows you the total dollar amount outstanding, so you can see at a glance where your collection efforts should focus.

Invoices that have been overdue for 60 or 90+ days are the ones most at risk of becoming bad debts. By reviewing your ageing report regularly, you can follow up with late-paying customers before small delays turn into serious losses.

How to manage and collect accounts receivable

Good AR management starts with clear processes and consistent follow-up. Here are practical steps to help you collect what you're owed.

• Set clear payment terms upfront. Common options include net-30 and net-60. State your terms on every invoice so there's no confusion about when payment is due.
• Offer early payment discounts. A small discount (for example, 2% off if paid within 10 days) can encourage customers to pay sooner and improve your cash flow.
• Send automated reminders. Set up reminders that go out before and after the due date. Automated reminders save you time and keep collection consistent without awkward conversations.
• Follow up personally on overdue invoices. When automated reminders don't get results, a direct phone call or email often does. Be polite but firm about your expectations.
• Escalate when needed. If a customer still hasn't paid after repeated follow-ups, consider pausing their credit, sending a formal demand letter, or engaging a collection agency as a last resort.

For more tips on getting paid, see Xero's guide on chasing outstanding invoices.

What is a bad debt?

A bad debt is money owed to you that you no longer expect to collect. It happens when a customer can't or won't pay, and your efforts to recover the amount have been exhausted.

Most businesses set up an allowance for doubtful accounts to plan for this. The allowance is an estimate of how much of your current AR you expect to go uncollected. You record it as a contra-asset on your balance sheet, which reduces the total value of your AR to a more realistic figure.

Bad debt rates vary by industry and the credit terms you offer. Tracking your own bad debt rate over time helps you refine your credit policies and set aside appropriate reserves.

When should you write off a bad debt?

Writing off a bad debt is a last step, not a first one. Before you give up on collecting, make sure you've exhausted your follow-up process.

You should consider a write-off when the customer has gone out of business, declared bankruptcy, or become completely unresponsive after multiple collection attempts. At that point, keeping the amount on your books overstates your assets and distorts your financial picture.

In Canada, the Canada Revenue Agency (CRA) allows you to deduct bad debts from your income for tax purposes. You'll need to show that the debt was previously included in your income and that you made reasonable efforts to collect it. Keep records of your invoices, payment reminders, and any correspondence to support your claim.

Even if a debt seems unlikely to be paid, it's worth making one final attempt before writing it off. Customers sometimes pay old debts when their own financial situation improves.

What is accounts receivable financing?

AR financing lets you access cash tied up in unpaid invoices without waiting for customers to pay. There are two common forms to be aware of.

Invoice factoring involves selling your unpaid invoices to a third party (called a factor) at a discount. The factor advances you a percentage of the invoice value, typically up to 90%, and then collects payment directly from your customer. Once the customer pays, the factor sends you the remaining balance minus their fee.

Invoice discounting works differently. You use your unpaid invoices as collateral to borrow from a lender, but you keep control of your sales ledger and collect payments yourself. Your customers don't need to know you're using this type of financing.

Both options can help bridge cash flow gaps when you have large outstanding invoices and bills to pay. However, fees and terms vary widely. It's a good idea to speak with your accountant before choosing a financing option. For more detail, see Xero's guide on invoice financing.

Simplify your accounts receivable with Xero

Managing AR manually takes time you could spend on your business. Xero automates the repetitive parts of the process so you can focus on what matters most.

With Xero, you can set up automatic invoice reminders, track payments in real time, and run ageing reports to see exactly who owes you and how overdue they are. Bank feeds match incoming payments to open invoices, cutting down on manual reconciliation. Sign up today and get one month free.

FAQs on accounts receivable

Here are answers to frequently asked questions about accounts receivable.

What is the difference between accounts receivable and accounts payable?

AR is money customers owe you (a current asset); AP is money you owe suppliers (a current liability). Together, they shape your working capital, so keeping AR turnover faster than AP cycles helps you stay cash-positive.

Does accounts receivable count as revenue?

AR itself isn't revenue. It's the record that payment for already-earned income hasn't arrived yet.

When does a debt become a receivable?

A debt becomes a receivable the moment you deliver goods or services on credit and issue an invoice. At that point, your customer has an obligation to pay, and you have an asset on your books.

What happens if customers never pay what's due?

If collection efforts fail, the unpaid amount becomes a bad debt. You can write it off and, in Canada, claim a tax deduction through the CRA, provided you've documented your collection attempts.

Is accounts receivable a debit or credit?

AR carries a normal debit balance, so you debit it when you invoice a customer. When payment arrives, you credit AR to reduce the balance.