Definition
Trade receivables, also known as accounts receivable, are amounts that a company is owed by its customers for goods or services provided on credit. This amount is recorded as an asset on the company’s balance sheet because it represents money that is owed to the company. They are typically due within a short period and are considered part of a company’s working capital.
Key Takeaways
- Trade Receivables are amounts which are owed to a company by its customers who have bought its goods or services on credit. They are treated as an asset for the company.
- The level of Trade Receivables is directly related to sales levels. Increased sales on credit terms typically lead to an increase in the volume of trade receivables.
- Trade Receivables require efficient management as they impact a business’s cash flow. Businesses therefore must have a good collection policy to prevent bad debts and ensure prompt payment.
Importance
Trade Receivables, as a crucial part of business finance, reflect the amount owed to a company by its customers who have bought its products or services on credit.
The management and analysis of such receivables are vital as they are closely tied to a company’s cash flow and profitability.
They represent future cash inflow and hence, are listed as assets on the balance sheet.
Efficient management of trade receivables can improve a firm’s liquidity while also providing valuable insights into customers’ creditworthiness.
Therefore, trade receivables are crucial in understanding the cycles of cash flow, determining business liquidity, and devising suitable credit policies.
Explanation
Trade receivables play a crucial role in a company’s cash flow and finance management process. They are primarily used as a financial asset which reflects the credit sales of goods or services that a company has made to its customers, but for which payment has not yet been received.
This implies that the company has provided its product or service, generating an extension of credit with the understanding that payment will be obtained in the future. In essence, trade receivables represent the amount of money owed to the business by its customers.
They are a significant element in managing a company’s liquidity and are often used as collateral to secure short-term loans. Trade receivables can be converted into cash when required, thereby enhancing the firm’s cash flow status.
By accurately predicting payment times and taking active measures to ensure prompt collection, companies can efficiently manage their working capital and verify their short-term financial health. Furthermore, trade receivables can be sold to third parties, known as factoring, which allows companies to immediately recover some of their potential income, consequently improving the company’s liquidity further.
Examples of Trade Receivables
Retail Store – A major department store that sells products to customers might also have business clients that purchase a larger volume of products for their own needs. In this case, instead of asking them to pay upfront, the store can provide the goods first and give them a period of time (like 30 or 60 days) to pay. The money owed by these business clients will be recorded as trade receivables in the store’s balance sheet.
Construction Contractor – A construction contractor who completes a project won’t typically expect immediate payment upon completion. Instead, they’ll issue an invoice outlining the work completed and the total cost, payable within a certain time frame. The money that’s due from the client is considered a trade receivable.
Manufacturing Company – A manufacturing company that produces parts for other businesses may supply products on credit, especially to their regular and trusted customers. The company will book this amount as a trade receivable until the invoice is fully paid.
FAQs on Trade Receivables
What are Trade Receivables?
Trade receivables are amounts billed by a business for goods sold or services provided to customers, whom the company allows to pay at a later date. These are typically one of the largest current assets on a company’s balance sheet.
How are Trade Receivables recorded on the balance sheet?
Trade receivables are recorded as a current asset on the balance sheet, under accounts receivable. When a receivable is collected, it is removed from accounts receivable and cash is recorded of an equal amount.
What is the difference between Trade Receivables and Accounts Receivable?
While both terms refer to debts owed by customers, there’s technically a difference. Trade receivables refer to the debt originated due to sales through the business operations, whereas Accounts Receivables include all the money owed to the business from outside sources, which includes the trade receivables and non-trade receivables.
How can a company recover Trade Receivables?
A company may use different strategies to recover trade receivables, including outstanding payment follow-ups, debt collection agencies, and legal procedures. Additionally, companies often offer discounts to encourage quick payment.
How Trade Receivables impact cash flow?
Trade receivables have a significant impact on a company’s cash flow. High levels of receivables can tie up funds that could otherwise be used for operations, potentially creating a cash flow squeeze. Therefore, efficient receivable management is critical to maintain robust cash flows.
Related Entrepreneurship Terms
- Accounts Receivable
- Credit Sales
- Debtor Collection Period
- Bad Debt
- Invoice Factoring
Sources for More Information
- Investopedia – A comprehensive financial website that explains finance terms like Trade Receivables in-depth.
- Accounting Tools – A resourceful website that offers a wide variety of explanations for finance and accounting terms.
- Corporate Finance Institute – An organization that provides online courses and free resources about finance including the subject of Trade Receivables.
- My Accounting Course – A website that provides accounting courses and informative content about various financial topics.
