What are Trade Receivables?
In the ordinary course of business, it is often customary for business enterprises to fulfill customer orders for goods or services on credit instead of demanding upfront payment. This practice is intended to facilitate streamlined, convenient transactions and is extremely common across a wide range of industries. Trade receivables represent the amounts owed to a supplier of goods or services as a result of such activity, and are evidenced by the issuance of invoices that must be paid according to the stated terms of the initial credit extension. Trade receivables are frequently used by businesses to leverage immediate access to cash, so balance sheets generally show them as current assets.
The process of establishing trade receivables begins with the provision of goods or services on credit terms. The amount owed as a result of the order fulfillment is then evidenced in writing by an invoice that is submitted to the customer. The trade receivable is considered to exist from the time the customer purchases the goods or services until the time payment has been remitted. Accounting journal entries for this type of transaction require debiting of a receivable and crediting of revenue amounts; at the time payment is received, cash will be debited and the receivable will be credited. Customer payments are always to be made in conformity with the specific credit terms promulgated by the seller.
Typical credit terms may call for payment within 10, 30, or 45 days of invoicing date or shipping date. Prepayments of amounts due often entitle customers to a discount, the details of which are clearly outlined in the payment terms. It is not uncommon for businesses in various industry sectors to accept payments on outstanding accounts receivable up to two weeks late.
Trade receivable turnover refers to a firm's success in fulfilling orders on credit terms and subsequently securing full payment. High turnover is evidence of careful credit-granting practices combined with diligent collection efforts. Low turnover is evidence that multiple, seriously delinquent receivables remain outstanding. Particularly high rates of turnover can serve as a signal that a business may be employing unnecessarily harsh credit standards that may result in the loss of potential sales.
A particularly valuable function of trade receivables for many businesses is their ability to be used as a means of generating quick cash in collaboration with a factoring agent. Through this process, receivables are sold to a third-party factor for pursuit of payment of outstanding invoices from customers. Additionally, it is possible for business enterprises to offer their receivables as security to increase the likelihood of obtaining a loan. For these reasons, trade receivables are vital elements in the operation of any business that routinely provides goods and services on credit.
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