Accounts Receivable as a Balance Sheet AssetReceivables are also sometimes known as accounts receivables and represents money that is owed to a company by its customers.
How Accounts Receivable Are Recorded on the Balance SheetHere's how it works: Let's say Wal-Mart wants to order a new DVD which is being released by Warner Brothers. Wal-Mart orders 500,000 copies for its stores. Warner Brothers receives the order, and within a week, ships the DVDs to one of Wal-Mart's warehouses. Included in the shipment is a bill (let's say WB charged Wal-Mart $5 per DVD for half a million copies - that's $2.5 million). Warner Brothers has already sent the movies to Wal-Mart, even though Wal-Mart hasn't paid a penny. In essence, Wal-Mart is buying on credit and promising to pay WB's the $2.5 million.
The $2.5 million would go on Warner Brother's balance sheet as accounts receivables.
Accounts Receivable TermsGenerally a company that sells a product on credit sets a term for its accounts receivable. The term is the number of days customers must pay their bill before they are charged a late fee or turned over to a collection agency (most terms are, 30, 60 or 90 days). If Warner Brothers sold the DVDs to Wal-Mart on a 30 day term, Wal-Mart must pay its bill during that time.
While accounts receivable are good, they can bring serious problems to a business if they aren't handled properly. What if Wal-Mart went bankrupt or simply didn't pay Warner Brothers? WB would then be forced to write down its receivables on the balance sheet by $2.5 million. This is what is called a delinquent account. Normally, companies build up something called a reserve to prepare for situations such as this. Reserves are set amounts of money that are taken out of the profits each year and put into an account specifically designed to act as a buffer against possible loses the company may incur. (Reserves are touched on in Part 29). When customers don't pay their bills, companies can take money out of the reserve they had built up to pay back suppliers. Most companies, however, don't actually set aside the money they charge to reserves, but instead just write it off the income statement. In other words, you can't "dip into the reserves" in the traditional sense unless you were dealing with an extremely conservative management that actually believed a set percentage of sales should be put aside in safe cash equivalents.
This page is part of Investing Lesson 3 - Understanding the Balance Sheet. To go back to the beginning, see the Table of Contents. If you have already read this lesson, you can skip directly to the Balance Sheet Quiz.