Trade receivables are the sum of money your customers owe you for buying goods and services on credit. These amounts are a significant component to maintaining your business’ good financial health and profitability.
When you sell on credit to a big number of customers, having to deal with unreliable buyers who refuse to pay you back on time is common. That’s why it’s crucial that every trade receivable is accurately recorded into your accounting books and sought after, in case of a payment delay.
In this guide, we’ll be going in-depth on what trade receivables represent, their importance, calculation, and how to reduce them by getting paid on time.
Read along to learn about:
- What Are Trade Receivables?
- Why Are Trade Receivables Important?
- How to Calculate Trade Receivables
- Trade Receivables Example
- 7+ Tips on Reducing Trade Receivables
- Frequently Asked Questions
- Automate Your Receivables with Accounting Software
What Are Trade Receivables?
Trade receivables also referred to as accounts receivable, are the total amounts of money earned from the sale of goods and services which have been billed but haven’t been sent by the buyer yet. Or, in simpler terms, trade receivables represent profit yet to be received, earned from selling goods and services on credit.
Although this cash is yet to be received, trade receivables are treated as an asset account, or as part of the balance sheet of a business. They count as an asset because the amount owed to the company will be eventually converted to cash, as the customer is legally obliged to pay off their debt.
The period that trade receivables are paid is usually less than a one-year period, which is why trade receivables are also considered as current assets - they’re liquid and easily convertible into cash.
Now you may be wondering: what happens if a customer doesn’t pay their invoice on time or refuses to settle their trade receivables altogether?
There are several approaches you can take to handle a past due invoice, such as sending email reminders, making provisions for bad debt expenses, or taking legal actions against the customer. It all depends on the value of the sales invoice, the relationship with the client, how much the payment has been delayed, and the overall severity of the situation.
If you want to learn how to take precautionary measures and make provisions for overdue payments, check out our complete guide to provisions in accounting.
Why Are Trade Receivables Important?
As we’ve mentioned, trade receivables represent a portion of the money that flows into the business, and thus, they are one of the clearest indicators of your company’s income and profitability. And that’s only one of the many advantages that come from recording trade receivables.
Many loyal customers pay within the specified payment terms, but unfortunately, some don’t, resulting in potential cash flow issues. So, if you forget to record a receivable, you may end up providing your product for free and thus negatively impacting your ability to earn profits. This is one other reason why it’s crucial that you carefully monitor your trade receivables and take action immediately if you notice a missing or overdue payment.
Keeping track of trade receivables on a daily basis is also necessary to create accurate accounting reports at the end of the year. These reports are analyzed by investors, creditors, and other stakeholders to evaluate your financial situation and your credibility as a business. So, in the long run, recording your trade receivables makes your business appear more reliable and attractive to third parties interested in your business.
How to Calculate Trade Receivables
There’s a very straightforward and easy formula you can use to calculate your trade receivables:
Trade Receivables = Debtors Receivables + Bills Receivables
Both your debtors and bills receivables can be found by looking at your business’s balance sheet.
If you want to estimate how long it will take debtors to pay back their bills, you can use another formula, known as the trade receivable days formula, or your debtor days ratio, which goes as follows:
Trade Receivable Days = (Trade Debtors / Revenue) x 365 days
Trade Receivables Example
Let’s check out an example to see how these formulas work in practice.
Assume Company ABC has a total amount of $20,000 debtor receivables on the balance sheet, along with $15,000 in bills receivables. Revenue amounts to $100,000.
You can easily calculate your trade receivables as follows:
$20,000 + $15,000 = $35,000
To estimate how quickly Company ABC will receive these payments for trade receivables, we need to use the trade receivable days formula, which is:
Trade Receivable Days = ($35,000 / $100,000) x 365 days = 127,75
As you can see, it takes around 127 days for Company ABC to collect a typical invoice.
7+ Tips on Reducing Trade Receivables
- Try to provide as many payment options as you can. Some clients prefer to pay by cash or checks, while others favor credit cards and online payment transfers. By offering various payment methods, you encourage them and give them more reasons to pay back on time.
- Provide early payment discounts and implement late payment fee policies. There’s no incentive like money. Encourage customers to pay you back early with early discounts, and small late payment fees, so that they don’t take advantage of any free credit.
- Send a sales invoice as soon as you complete the project or provide the service you’ve been contracted for. The longer you wait, the longer it is likely for the payment to be delayed.
- Email them a payment reminder in advance. Some clients can be neglectful, and a short email reminder a few days before payment is due can encourage them to pay back their trade receivables on time.
- Consider requesting a partial advance deposit. If you’re working on a long-term project, for instance, or selling a very costly product, requesting an advance partial payment can help reduce the risk of not getting paid back.
- The shorter the payment term, the better. Although invoice terms vary from industry to industry, it’s in your best interest to keep payment terms as short as possible - the sooner you get paid, the sooner cash is flowing into your business.
- Give the client a call. If the client is completely unresponsive to your emails, you can always give them a call to have a short chat and figure out what’s going on, and why they’re delaying their payments.
Frequently Asked Questions
#1: What Is an Accounts Receivable Aging Schedule?
An aging schedule is a table that outlines a company's trade receivables, according to their due dates. It’s essentially a breakdown of receivables by the duration of the outstanding invoice, along with the corresponding customer name and amount due.
Although the table can be created manually, it’s more commonly generated automatically by accounting software, to help a business see which customers aren’t paying on time, which payments are long-overdue, and which ones rank the highest in value and priority.
#2: What’s the Difference Between Trade Receivables and Accounts Payable?
Accounts payable is the exact opposite account of trade receivables. While trade receivables represent cash that your customers owe you for goods and services sold on credit, accounts payable are what you owe your vendors and suppliers for purchasing inventory, and other products or services.
Additionally, trade receivable is an asset account, whereas accounts payable represent current liabilities. Both records are included in the balance sheet.
Want to learn how to manage your accounts payable and make bill payments on time? Then, you can head over to our complete guide on invoice payments.
#3: What Is an Allowance for Doubtful Accounts?
The allowance for doubtful accounts is considered a contra-asset account that directly decreases trade receivables. More specifically, it estimates the percentage of trade receivables that a business expects to be uncollectible. Then, in case there’s a bad debt expense that a client refuses to pay, cash is taken out of this allowance.
If your clients all pay you back in time, you’ll probably never need to use the allowance, however, it’s still a good business practice to set money aside for such future payments.
Automate Your Receivables with Accounting Software
Journalizing each trade receivable by hand and manually sending reminders every time a payment runs late can fast become an exhaustive and time-consuming process.
That’s why most businesses choose to automate their receivables with accounting software like Deskera, as an easier, faster, and overall more convenient tool.
Deskera is an intuitive platform, with a user-friendly interface, specifically designed so small business owners can manage their finances through one integrated software, in just a few clicks.
Deskera comes with an entire Sell dashboard dedicated to managing your trade receivables, where you can keep tabs on every detail of your issued invoices. Through this dashboard, you can also set up recurring invoices, request advance deposits, send late payment reminders, and include any extra fees & expenses.
The best part: you can access the platform anytime, anywhere, just by downloading the Deskera mobile app on your phone, or tablet.
So, what are you waiting for? Try the software right now, with our completely free trial!
And that’s a wrap! We hope this guide helped you understand how do trade receivables work and what are some of the main steps you can take to reduce them and increase your business’s profitability.
For a quick recap, let’s go through some of the main points we’ve covered:
- Trade receivables represent the total amounts from billed, but unpaid goods and services.
- Keeping track of trade receivables is important because they indicate your company’s income and profitability, allow you to track missing payments, and make you appear more reliable to stakeholders.
- You can calculate trade receivables by adding up debtors and bills receivables.