What are trade receivables?

Trade receivables are defined as the funds owed to a business by its customers following the sale of goods and services on credit. Also known as accounts receivables, it is also classified as current assets on a company’s balance sheet. Most companies extend credit to customers for purchases, making trade receivables a key line item. Sometimes, it can represent a significant portion of total current assets.

Current assets are short term assets which are expected to be converted to cash in the coming year. Trade receivables fit into this category because most companies use standard invoice payment terms of between 30 and 90 days. That means businesses can expect to receive the payments their trade receivables represent within a short time frame.

In addition to trade receivables, current assets also include items such as cash, cash equivalents, stock inventory and pre-paid liabilities.

A company’s receivables may include both trade and non-trade receivables, with the latter including receivables which do not arise as a result of business sales, such as tax refunds or insurance payouts. Non-trade receivables are also typically recorded on the balance sheet and other financial statements as current assets.

Accounts payable is the opposite of accounts receivable or trade receivables. Accounts payable refers to the total amount of money a business owes to its suppliers for goods or services delivered. In any buyer-supplier transaction, both accounts receivable and accounts payable are created. Accounts payable is recorded by the buyer, and accounts receivable by the seller.

How to calculate trade receivables

Calculating trade receivables is simple when you understand what they’re made up of. You can use the following formula to figure out your trade receivables:

Trade receivables = Bills Receivables + Debtors

Bills receivables are invoices that haven’t yet reached their due date and are still outstanding. Debtors, on the other hand, are invoices that are past their due date and still outstanding.

Trade receivables example

To give an example of trade receivables, a company might invoice its customer $475 for the sale of materials. Under double-entry accounting principles, the company will credit the sales account by $475 while also debiting the trade receivables account by the same amount. Once the customer has paid the bill, the company will credit the trade receivables account by $475 and debit the cash account.

Trade receivables and working capital

A company’s trade receivables or accounts receivable are an important consideration when it comes to calculating working capital. Working capital is calculated as current assets minus current liabilities, with current assets including accounts receivable and inventory as well as cash and equivalents, and current liabilities including accounts payable.

Where working capital is concerned, one significant metric is Days Sales Outstanding (DSO), which is defined as the time taken for a company to receive payment from customers after selling goods or services. A lower DSO is preferable, as the faster an invoice is paid, the sooner the seller can make use of cash.

However, the other side of this equation is the buyer, who may wish to extend payment terms in order to increase their Days Payable Outstanding (DPO). This can result in a higher DSO for suppliers, which may not receive payment for 30 days, 60, days, or even 90 days in some cases.

Financing trade receivables

When a company sells goods on credit, it has to pay for raw materials weeks or even months before receiving payment for the sale from its customers. This can lead to cash flow problems and make it difficult to fulfil customer orders or invest in business growth and research and development (R&D). As such, companies may choose to finance their trade receivables – in other words, seek early payment in exchange for a discount.

Companies can achieve this in a number of different ways, including the use of AR finance and receivables finance solutions. Invoice factoring, for example, enables a company to sell its invoices to a factor at a discount, thereby receiving a percentage of the value of an invoice straight away. The factor will then be paid by the company’s customers at maturity. However, this can be an expensive funding option.

Similar to factoring is invoice discounting, in which an invoice discounter advances a percentage of the value of an invoice. Unlike factoring, invoice discounting allows the seller to retain control over its sales ledger while remaining responsible for collecting payments from customers.

Another option is asset-based lending (ABL), in which companies can access a line of credit with funding secured against assets such as accounts receivable. ABL can also be structured around other assets, such as commercial property, equipment, or inventory.

Early payment programs

Companies can also receive early payment if their customers give them access to early payment programs such as supply chain finance or dynamic discounting. These are initiated by the buyer rather than the seller and tend to provide funding at a lower interest rate than methods such as factoring.

Early payment programs can provide considerable flexibility when choosing which invoices to finance. This type of solution also gives sellers more certainty about the timings of future payments, making it easier to forecast cash flows effectively.

Accounts receivable department

Trade receivables are also known as accounts receivable. But that term, accounts receivable, also refers to the department within an organization that’s responsible for tracking and collecting trade receivables.

The accounts receivable (or AR) department carry out activities like generating and sending invoices, monitoring invoice due dates, and chasing overdue customer payments. Accounts receivable may also carry out receivables analysis to understand the payment behavior of the whole customer base, and of specific debtors.

In cases where customers do not pay their invoices by the maturity date, accounts receivable will be responsible for chasing customers, with actions ranging from letters and phone calls to initiating legal action and engaging external debt collection agencies.

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