finance
Accounts Receivable (AR)
Money customers owe you for goods or services already delivered.
Definition
Accounts receivable (AR) is money customers owe for invoices issued but not yet paid. It sits as a current asset on the balance sheet. AR is real value but it isn't cash - and the gap between booking AR and collecting cash is where service businesses get into trouble. Days Sales Outstanding (DSO) measures how long AR takes to collect; under 30 days is healthy, over 60 is a problem. Aggressive collections, clear payment terms, and incentives for early payment all reduce AR.
AR aging buckets and what they signal
AR is grouped into aging buckets: current (not yet due), 1 to 30 days past due, 31 to 60 days, 61 to 90 days, and 90+ days. Healthy US service businesses have 80 to 90 percent of AR in current or 1 to 30 days. Anything over 60 days has a 50 to 70 percent probability of becoming bad debt unless actively collected. Over 90 days, the probability drops below 30 percent. Run an aging report weekly in QuickBooks or Xero, and assign personal ownership to every invoice over 30 days. The aging curve is the single best leading indicator of cash flow stress.
Setting payment terms that get paid
Default payment terms in the US are net 30, but enterprise buyers commonly push to net 60 or net 90. Three tactics. One, require deposits (25 to 50 percent upfront for service work). Two, offer early-pay discounts: 2/10 net 30 means 2 percent off if paid within 10 days, full balance otherwise. The implicit annual cost of not taking the discount is roughly 36 percent, so any buyer with cash takes it. Three, charge late fees (typically 1.5 percent per month) and enforce them. Stating fees on every invoice signals you are serious. Software like Bill.com, FreshBooks, and Stripe Invoicing automate reminders.
When AR becomes bad debt
US GAAP requires recognizing an allowance for doubtful accounts based on aging and historical collection rates. For a typical US service business, write off invoices 120 to 180 days past due unless there is an active payment plan. Bad debt is tax-deductible if you previously recognized the revenue (accrual basis). On cash basis, you cannot deduct bad debt because you never recognized the revenue in the first place. Use the specific charge-off method or the reserve method (most US small businesses use specific charge-off). Document collection attempts before writing off so the deduction holds up under IRS audit.
Speeding up AR collection
Five practical levers, in approximate order of impact. One, invoice immediately upon delivery or milestone; every day of delay before invoicing adds to DSO. Two, offer multiple payment methods (ACH, credit card, wire, Stripe Link) - friction kills collections. Three, automate reminders at 7, 14, and 30 days past due before human intervention. Four, call (do not email) anything over 45 days; humans pay humans they have spoken to. Five, factor receivables for chronically slow payers - factoring fees of 1 to 5 percent are often cheaper than the working capital cost of 90-day AR.
FAQ
Should I use cash basis or accrual basis accounting for AR?
US small businesses under 25M average gross receipts can choose either. Cash basis is simpler: you recognize revenue when paid, so AR does not exist on your books. Accrual basis recognizes revenue when invoiced, creating AR. Accrual is required if you carry inventory or if a lender or investor demands it. For most service businesses, accrual gives a truer picture of business performance but cash basis simplifies tax. Many founders run accrual for management reporting and cash for taxes via a Schedule M reconciliation.
What is a healthy DSO for a US service business?
Under 30 days is excellent. 30 to 45 days is healthy. 45 to 60 days is workable but pressuring cash flow. Over 60 days indicates collections are weak or terms are too generous. For agencies and consulting firms with enterprise clients, 45 to 60 days is unfortunately standard because enterprise buyers dictate net 45 to net 60 terms. The fix is upfront deposits, not chasing collection cycles you cannot change.
Can I sell my AR for cash?
Yes, via factoring or asset-based lending. Factoring sells specific invoices to a factor at a discount (typically 1 to 5 percent for 30 to 60 day invoices). The factor advances 70 to 90 percent of invoice value immediately and pays the balance minus fees when the customer pays. Asset-based lending (ABL) is a revolving credit line secured by AR, typically advancing up to 85 percent of eligible AR. Both are common for US SMBs needing working capital but cost more than bank lines of credit.
How does AR affect my income tax?
On accrual basis, AR is taxable income in the year invoiced, even if not collected. This creates 'phantom income' tax exposure - you owe tax on revenue you have not yet collected. On cash basis, only collected revenue is taxable. This is one of several reasons US small businesses often prefer cash basis for tax purposes, even while using accrual for management reporting. Consult your CPA before switching methods.
What if a customer files bankruptcy with my invoice unpaid?
You become an unsecured creditor and file a proof of claim with the bankruptcy court. Recovery for unsecured creditors in US Chapter 7 (liquidation) is typically 0 to 20 cents on the dollar. Chapter 11 (reorganization) sometimes pays out over years. Write off the bad debt for tax purposes once it is clearly uncollectible. Going forward, run credit checks (Experian Business, D&B) on large new customers and require deposits or LCs for high-risk buyers.
In your business
- →Track DSO monthly - rising DSO is an early warning of bigger trouble
- →Age AR weekly: anything past 60 days needs a personal call, not another email
- →Offer 1-2% early-payment discount on terms 2/10 net 30 - the math usually works