What are Trade Receivables?

Trade receivables are the sum of money owed to a company by its customers when the company delivers goods or services to them. Trade receivables are also called account receivables and they are classified as current assets on the balance sheet of a company.

Now let us understand what are current assets? Current assets are the assets which are expected to be converted into cash in the near future, say within one year. Some examples of current assets are cash, cash equivalents, stock inventory, marketable securities, pre- paid liabilities, etc.

A company may also have some non- trade receivables, which do not arise as a result of business sales, such as tax refunds or insurance payouts. Non- trade receivables are also classified as current assets in the company’s balance sheet.

There is a term called ‘accounts payable’, which is opposite to the account receivables. When a company owes money to its suppliers or other parties, then it is called account payables.

Example of Trade Receivables

Let us understand the trade receivable with an example. Suppose a company has delivered goods worth $500 to a customer and invoiced the same to the customer. Under double entry accounting principle, the company will credit the sales account by $500 and debit the trade receivables account by the same amount. Once the customer has paid the bill, the company will credit the trade receivables account and debit the cash account.

Importance of Trade Receivables

Trade receivables represent a part of money inflow into the business within a short period and they indicate the company’s income and profitability. Trade receivables are convertible into cash and hence the company has capacity to pay its debts, other liabilities, etc.

If a company has increased trade receivable days, it means that the company is not able to collect its debt timely. It may eventually lead to bad debt and the consequences may be bankruptcy or liquidation.

How to Calculate Trade Receivables?

Trade Receivables = Debtors Receivables + Bills Receivables

Both debtor’s receivables as well as bills receivables can be found in the company’s balance sheet.

There is another formula by which you can calculate the time by which the debtors will pay back their bills. This term is known as trade receivable day formula, or debtor days’ ratio.

Trade Receivable Days= (Trade Debtors x 365/ Revenue)

Example

Suppose your company has a total amount of $15000 debtor receivables as shown in the balance sheet, $12000 as bills receivables and revenue of the company is $75000. If the credit terms and payment terms are 60 and 30 days respectively, then trade receivables and trade receivable days can be calculated as follows:

Trade Receivables = $15000 + $ 12000 = $ 27000

Trade Receivable Days = (27000 x 365/75000) = 98.55 days i.e. 99 days.

It means that the company takes approximately 99 days to collect the payment against a typical invoice.

How to Reduce Your Trade Receivables?

Adopt Early Payment Discount and Late Payment Fee Policies

Money is a great incentive. If you provide discount for early payments, then it encourages the clients to pay quickly to avail the discount. In the similar manner, the late payment should attract fee and penalties. It is a human psychology that however small is the late fee, we want to avoid it. So it will help the company to recover the trade receivables within the payment term.

Send a Sales Invoice Immediately after the Customer Receives Goods or Services

Raising the sales invoice and sending it quickly to the client or customer is crucial. The longer you will deliver the invoice, the longer you will have to wait for the payments.

Email Payment Reminders in Advance

Sending email payment reminders a few days before the payment due date is very helpful in reminding the client about the payment and enhanced the chances of getting payments within time.

Keep the Payment Terms Shorter

It is always better to keep the payment terms as short as possible because sooner you will get the payment better will be the cash flow of the company.

Call the Client

If the clients become non- responsive, call them or have a small chat with them in such cases to know what is the real issue with them?

Request for a Partial Advance Deposit

If you are working on a long project or delivering costly product or service, then you can always ask for partial advance deposit. This will reduce the risk of not getting paid at all.

Provide as many Payment Options as You Can

Keeping many payment options open for the client is always helpful. Some customers prefer by paying checks or demand drafts and some want to pay online. Now a day payment through wallets or UPI ID is becoming very popular through which you can get the amount quickly.

Conclusion

Trade receivables are liquid assets which represent cash inflow of the company in the short term i.e., within a year. If a company has increased trade receivables, it means it has more liquidity and company is capable to pay its liabilities and operation expanses. It is important to recover the trade receivables timely because increased trade receivable period means the company has difficulty in getting its debt and it may eventually convert to bed debt resulting in bankruptcy or liquidation. Therefore, the organizations should always keep track of its trade receivables and adopt the methods to recover them in earliest possible time.

Also read: How to Evaluate Financial Position of a Supplier?