What is accounts receivable? Definition and how it works

Published Monday 15 June 2026

Table of contents

• What is accounts receivable?
• Why is accounts receivable important?
• How does accounts receivable work?
• How to calculate accounts receivable
• Is accounts receivable an asset?
• Accounts receivable vs accounts payable
• What is ageing of accounts receivable?
• What is accounts receivable financing?
• What is a bad debt?
• When should I write off a bad debt?
• Managing your accounts receivable effectively
• Simplify your accounts receivable with Xero
• FAQs on accounts receivable

Key takeaways

• Accounts receivable (AR) is the money customers owe your business for goods or services delivered on credit, and it sits on your balance sheet as a current asset until paid.
• Tracking AR closely helps you maintain healthy cash flow, spot late payment trends early, and make confident decisions about spending, hiring, and growth.
• A clear AR process covers everything from setting payment terms and sending invoices to following up on overdue accounts and recording payments.
• Tools like accounting software, automated invoice reminders, and online payment options can reduce the time you spend chasing payments and help you stay on top of your finances.

What is accounts receivable?

If you sell goods or services on credit, you'll have accounts receivable on your books. Understanding what it is and how it works gives you a clearer picture of your business finances.

Accounts receivable (AR) is the money that customers owe your business for goods or services you've already delivered. It appears on your balance sheet as a current asset until your customers pay their invoices.

AR is sometimes also called trade debtors. In practice, it covers the full cycle of credit-based sales. That includes creating invoices for completed work, tracking which invoices have been paid, following up on overdue payments, and matching customer payments to specific invoices.

Most small businesses deal with accounts receivable regularly, whether they're invoicing clients for consulting work, billing customers for products, or collecting payment for ongoing services.

Why is accounts receivable important?

Accounts receivable isn't just an accounting term; it directly affects your ability to pay bills, invest in your business, and plan for the future.

When your AR is well managed, cash flows into your business predictably. You can cover supplier payments, meet payroll, and handle day-to-day expenses without scrambling for funds. When it's not, even a profitable business can run into serious cash flow problems.

Keeping a close eye on accounts receivable also helps you spot potential issues early. If a particular customer regularly pays late, you can adjust their credit terms or follow up sooner. If your overall AR balance is growing faster than your sales, it could signal that your collection process needs attention.

Beyond cash flow, your accounts receivable balance is a key indicator of financial health. Lenders, investors, and accountants all look at it to assess how efficiently your business collects what it's owed.

How does accounts receivable work?

The accounts receivable process follows a clear sequence from the moment you agree to sell on credit to the point where payment lands in your account. Here's how it typically works.

1. Agree on credit terms

Before you start work or ship goods, set clear payment terms with your customer. This includes the payment deadline (for example, 14 or 30 days from the invoice date), accepted payment methods, and any penalties for late payment.

2. Deliver goods or services

Once you've completed the work or delivered the product, you've earned the right to be paid. At this point, the amount your customer owes becomes part of your accounts receivable.

3. Send the invoice

Issue an invoice promptly after delivery. Invoicing software can speed this up and reduce errors. Your invoice should include the amount due, payment terms, due date, and clear instructions on how to pay. Sending invoices quickly helps set expectations and reduces delays.

4. Track and follow up

Monitor which invoices are outstanding and which are approaching their due date. If a payment is late, follow up with a reminder. Automated invoice reminders can save you time and keep the process consistent.

5. Record the payment

When your customer pays, match the payment to the correct invoice and update your records. This removes the amount from your accounts receivable and increases your cash balance. Bank reconciliation helps you confirm that the payment in your accounting records matches the deposit in your bank account.

How to calculate accounts receivable

Calculating your accounts receivable helps you understand how much cash is tied up in unpaid invoices. While accounting software does this for you, knowing the basic formula is useful.

Start with your total accounts receivable from the previous period. Add the value of all sales made on credit during the current period. Then subtract any cash payments you've received from customers. The result is your new accounts receivable balance.

The formula looks like this: opening AR + credit sales - payments received = closing AR.

Accounts receivable turnover ratio

The accounts receivable turnover ratio measures how efficiently your business collects payments. A higher ratio means you're collecting more quickly; a lower ratio may suggest your collection process needs improvement.

To calculate it, divide your net credit sales by your average accounts receivable for the period.

For example, if your net credit sales over a quarter are £60,000 and your average AR balance is £15,000, your turnover ratio is 4. That means you're collecting your average receivables 4 times during the quarter.

Tracking this ratio over time helps you spot trends. If it's falling, it could be a sign that customers are taking longer to pay or that your follow-up process needs tightening.

Is accounts receivable an asset?

Yes, accounts receivable is a current asset because it represents money customers owe your business. These outstanding invoices have real value and appear on your balance sheet.

The accounts receivable lifecycle shows how an invoice moves through your books:

• Outstanding invoice: listed as a current asset on your balance sheet
• Paid invoice: converted into cash and removed from accounts receivable
• Unpaid invoice: may eventually be written off as a bad debt expense
• Written-off debt: no longer treated as an asset in your accounts

As a current asset, AR is expected to be converted into cash within 12 months. That makes it an important part of your working capital and a factor in how lenders and investors assess your business.

Accounts receivable vs accounts payable

These 2 terms are easy to mix up, but they sit on opposite sides of your balance sheet. Understanding the difference helps you manage your cash flow more effectively.

Accounts receivable is the money your customers owe you. Accounts payable is the money you owe to your suppliers or vendors. In other words, AR is money coming in, and AP is money going out.

Here's a practical example. Say you're a graphic designer who completes a £2,000 project for a client with 30-day payment terms. That £2,000 is your accounts receivable. At the same time, you receive a £500 invoice from a stock image supplier with 14-day terms. That £500 is your accounts payable.

The balance between AR and AP affects your cash flow directly. If your customers take 45 days to pay you but your suppliers expect payment in 14 days, you'll need enough cash on hand to cover the gap.

What is ageing of accounts receivable?

Late payments are a fact of life for most small businesses. Ageing of accounts receivable helps you see exactly how overdue your invoices are so you can take action before small delays become bigger problems.

Ageing is the process of tracking how many days an invoice is past its due date. You calculate the age by counting days from the due date to today. For example:

• Invoice due 10 days ago = 10 days aged
• Invoice due 30 days ago = 30 days aged
• Invoice due 90 days ago = 90 days aged

According to Xero Small Business Insights data from 440,000 UK small businesses, invoices were paid an average of 8.2 days late in the March quarter of 2026. That shows late payments remain a persistent challenge for small businesses across the UK.

What does an ageing report do?

An ageing report organises all your overdue invoices by how long they've been outstanding. This makes it simple to prioritise your collection efforts and spot payment trends.

Ageing reports are useful because they help you focus on the invoices that need the most attention. Here's why they matter:

• Older invoices are less likely to be paid
• Early action improves collection rates
• Clear visibility prevents invoices from being forgotten

Best practice collection timeline

A consistent follow-up schedule keeps your collections on track. Here's a simple timeline you can adapt to your business:

1. Day 1 overdue: send an automated email reminder
2. Day 7 overdue: call the customer
3. Day 30 overdue: send a formal collection letter
4. Day 60 or more overdue: consider using debt collection services

Get more tips from the Xero guide on how to treat overdue invoices.

What is accounts receivable financing?

Sometimes you need cash now but your customers won't pay for weeks. Accounts receivable financing lets you sell outstanding invoices to a finance company for immediate cash, converting unpaid invoices into working capital.

Here's how invoice financing usually works:

1. Initial payment: the finance company pays 70%–90% of the invoice value upfront
2. Customer pays: your customer pays the finance company directly
3. Final payment: the finance company pays you the remaining balance, minus its fees
4. Total cost: you receive about 85%–95% of the original invoice value

There are some limits on when you can use invoice financing:

• It only works with recent, high-quality invoices
• It isn't suitable for old or disputed debts
• Fees typically range from 1%–5% of the invoice value

Speak to your accountant or financial adviser before using these types of services.

What is a bad debt?

Not every invoice gets paid. A bad debt is an outstanding invoice that you don't expect to collect from a customer.

Writing off bad debts removes uncollectable amounts from your accounts receivable and can reduce your taxable income. UK tax law says you can only claim a deduction for a debt that is bad, or for a doubtful debt that's likely to become bad.

Writing off bad debts helps your business in several ways:

• Accurate reporting: shows the true value of your receivables
• Tax benefits: reduces taxable income for money you won't receive
• Clean records: removes old, uncollectable invoices from your books

When should I write off a bad debt?

Knowing when to write off a bad debt can save you time and help you keep accurate records. The decision comes down to whether there's any realistic chance of getting paid.

Write off bad debts when there's no reasonable expectation of payment. For tax purposes, you must assess each debt on a case-by-case basis. You can only claim a deduction for specific debts when the circumstances of the particular debtors show that the amounts are bad or doubtful.

Common situations include customer bankruptcy, unresolved disputes, or complete non-response to collection efforts. For broader guidance on handling what your business owes and is owed, see the Xero guide on how to manage debt. You might decide to write off an invoice in situations like these:

• Customer bankruptcy: a business has closed or declared insolvency. In the case of the bankruptcy or insolvency of a debtor, the debt can be written off, except for any amount that might still be reasonably recovered.
• Ongoing disputes: legal disagreements are unlikely to be resolved
• No response: the customer ignores all collection attempts for more than 6 months
• Cost vs benefit: collection costs exceed the invoice value

After you write off a bad debt, you still have a few actions to take:

• Continue sending periodic reminders
• If the customer eventually pays, record the amount as income on your next tax return
• Keep written-off invoices in a separate file for reference

Managing your accounts receivable effectively

Even profitable businesses can run into trouble if cash isn't flowing in on time. Strong accounts receivable management helps you stay on top of what you're owed and keep your finances predictable.

When customers pay late, you may struggle to pay suppliers, staff, and other essential expenses. Xero Small Business Insights data shows that UK small businesses wait an average of 29 days to be paid, underscoring why consistent follow-up on outstanding invoices is so important.

Here are practical steps you can take to improve your collections:

1. Set clear payment terms before starting work, including due dates and accepted payment methods
2. Send invoices immediately after you complete the work
3. Use automated invoice reminders so overdue accounts don't slip through the cracks
4. Offer multiple payment options, including online payments, to make it easy for customers to pay
5. Review your ageing report regularly to prioritise follow-up on the oldest invoices
6. Consider requesting deposits upfront for larger projects to reduce your exposure

A smooth accounts receivable process gives you more time to focus on running your business. Online accounting software can help you manage invoices, track payments, and see your cash flow in real time. Keeping accurate digital records of your invoices and payments also supports your Making Tax Digital (MTD) obligations.

Simplify your accounts receivable with Xero

Managing accounts receivable doesn't have to be a manual, time-consuming task. With the right tools, you can automate invoicing, set up payment reminders, and track what's owed to you in one place.

Xero's online accounting software helps you create and send invoices, accept online payments, reconcile your bank transactions, and monitor your cash flow. You can connect payment services like GoCardless and Stripe through Xero to give your customers more ways to pay. Get one month free.

FAQs on accounts receivable

Here are answers to some frequently asked questions about accounts receivable.

What is the difference between accounts receivable and accounts payable?

Accounts receivable is the money customers owe your business for goods or services. Accounts payable is the money your business owes to its suppliers or vendors.

Is accounts receivable a debit or a credit?

Accounts receivable is an asset, so it's recorded as a debit. When a customer pays their invoice, the AR balance decreases (a credit) and your cash balance increases (a debit).

What is an example of accounts receivable?

A marketing consultant completes a project and sends a £3,000 invoice to their client with 30-day payment terms. That £3,000 is part of the consultant's accounts receivable until the client pays.

What is the accounts receivable turnover ratio?

It's a measure of how efficiently your business collects payments, calculated by dividing net credit sales by average accounts receivable. A higher ratio means you're collecting what you're owed more quickly.

Does accounts receivable count as revenue?

Under accrual accounting, revenue is recognised when you earn it, not when cash arrives. So yes, a sale recorded in accounts receivable counts as revenue on your income statement, even though the cash hasn't been received yet.