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Trade receivable are essentially the money that customers owe a business for the goods or services they’ve bought. It’s like a running tab between them. This owed money is tracked on a balanced sheet, a financial report card for a company. For businesses selling other businesses, offering credit is common. So, when a company sells goods or services on credit, that money becomes trade receivable. This is a big deal on the balance sheet because it can be turned into cash pretty quickly, showing how financially fit a company is.
Alongside TR, there are also non-receivable. This is money that the company expects from things like tax refunds or insurance claims, not directly linked to selling stuff. Both trade and non-trade receivable give a snapshot of the company’s financial health and how well-prepared it is to handle its bills and future plans.
What are Trade Receivable?
Trade receivable, or account receivable, are the amounts owed to a business by its customers when they buy goods or services on credit. Essentially, it’s like a friendly IOU. When a company lets customers pay later for what they bought, that outstanding amount becomes trade receivable, marked on the company’s balance sheet.
These receivable are assets because they mean the company will get cash in the future. They’re part of regular business operations, and companies usually expect to collect the owed money, within a short time often 30 to 90 days. So, it’s like a waiting game for the business to turn those IOUs into real cash.
How To Calculate It with Formula?
Calculating TR involves adding up the amounts owed by all customers, which is typically divided into two categories: Debtors and Bill Receivable. The formula for Trade receivable is straightforward.
Trade Receivable = Debtors + Bill Receivable
Bill receivable represent a formal agreement between a customer and the business to pay a specified amount within a set period for the goods or services received. On the flip side, debtors are the bill receivable that remain unpaid after the due date.
For a practical example,
Let’s say a company begins with TR of ₹50,000. During the month, it makes credit sales of ₹80,000 and collects ₹70,000 in cash from customers.
Applying Formula:
TR = ₹50,000+₹80,000−₹70,000 =₹60,000
Therefore, at the end of the period, the company’s TR amount to ₹60,000.
How to Account for Trade Receivable
Accounting for TR involves systematically recording credit sales, tracking customer debts, and managing customer potential losses.
Add the bills receivable
Recording Credit Sales:
- When goods or services are sold on credit, initiate the recording process.
- Debit the Trade receivable or accounts receivable account.
- Credit the sales revenue account.
For Example, for ₹10,000 in credit sales, the entry would be:
Debit: TR ₹10,000
Credit: Sales Revenue ₹10,000
Recognizing Cash Collections:
- Record cash collections when customers make payments.
- Debit the cash account.
- Credit the trade receivable account.
For Example, for a ₹5,000 cash collection,
Debit: Cash ₹5,000
Credit: TR ₹5,000
Adjusting for Bad Debts:
- Factor in potential losses by establishing an allowance for bad debts.
- Estimate the amount that might go uncollected.
- Debit the bad debt expense account and credit the allowance for doubtful accounts.
Debit: Bad Debt Expense ₹5,000
Credit: Allowance for Doubtful Accounts ₹5,000
Year-End Adjustment:
- Towards the close of the accounting period, make essential adjustments to the TR balance.
- Modify for estimated uncollectible accounts or acknowledge additional sales on credit.
- The adjusting entry varies based on specific circumstances and accounting policies.
Write-Offs:
- If a customer’s debt is deemed uncollectible, write off that amount.
- Debit the allowance for doubtful accounts and credit the TR.
Debit: Allowance for Doubtful Accounts ₹5,000
Credit: TR ₹5,000
Reporting in Financial Statements:
Financial statements should include TR in the balance sheet’s current assets section. The balance indicates the total amount customers owe, accounting for any allowances for doubtful accounts. It’s important to recognize that accounting practices may vary, emphasizing the need to follow the company’s specific policies and guidelines. Ongoing oversight and proactive TR management play a key role in maintaining accurate financial reporting and effective control over cash flow.
Add the debtors to the bills receivable
Including debtors alongside bills receivable enhances the efficiency of your cash flow management. Debtors represent customer obligations for goods or services on credit, highlighting the short-term credit extended by the business. The comprehensive approach streamlines the tracking and optimization of funds simply and effectively.
Calculate the amount of time for debtors to pay their bill
Determining the average collection period, which measures the time it takes for debtors (customers) to settle their bills, is a crucial metric for evaluating a company’s credit and collection policies.
The average account receivable formula is calculated as:
Average Collection Period = Trade Receivable / Average Daily Credit Sales
And the trade receivable Turnover Ratio Formula is calculated as:
Average TR/ Net Credit Sales
Examples of Trade Receivable
Let’s illustrate one simple example of TRs:
- One Electronics company sells electronic components to a retail outlet on credit, meaning the retail outlet agrees to pay for the components at a later date.
- The initial entry records the sale on credit, creating an accounts receivable for the amount owed by the retail outlet.
- When the retail outlet makes the payment within the agreed-upon credit period (30 days in this case), the accounts receivable is reduced, and cash is increased.
This process reflects a common trade receivable scenario where a business extends credit terms to a customer, creating an account receivable until the customer fulfills the payment.
Importance and Benefits of Trade Receivable
TRs are essential for a business’s financial well-being, providing various advantages. Here are key importance and benefits:
Working Capital Management:
- Crucial for daily operations, TRs contribute to a company’s working capital cycle.
- Efficient management ensures sufficient liquidity for short-term obligations.
Cash Flow:
- While representing customer debts, accounts receivable also indicate future cash flows.
- Effective collection management maintains a steady and predictable cash flow.
Sales Growth:
Offering credit terms stimulates sales growth, making products accessible to customers lacking immediate funds.
Financial Planning:
Valuable for financial planning and forecasting, TRs aid in estimating future cash inflows.
Diversification of Customer Base:
Credit offerings attract a diverse customer base, fostering stability during economic downturns in specific industries or regions.
Data for Credit Risk Assessment:
- TRs data provides insights into customer creditworthiness.
- Valuable for informed decisions on credit limits and terms.
While offering these benefits, careful management is crucial to mitigate bad debt risks and ensure a healthy cash flow. This involves setting appropriate credit terms, monitoring receivable, and implementing effective collection strategies.
Trade vs Non-Trade Receivable
Trade and non-trade receivable both signify amounts owed to a company, yet they vary in the nature of underlying transactions.
Trade receivable
TRs or trade receivable, stem from selling goods or services on credit in the regular course of business. For instance, if a company extends credit terms to a customer for purchase goods, the resulting amount owed becomes a TR.
Non-trade receivable
Non-trade receivable consist of amounts owed to a company that does not directly relate to its core business operations. For instance, if a company lends money to an employee, the resulting debts fall under non-trade receivable. Similarly, anticipated tax refunds from government agencies are also classified as non-trade receivable.
What is trade receivable financing?
TR financing, alternatively called trade receivable financing or factoring, is a financial practice where a business leverages its outstanding invoices (TR) as collateral to secure immediate cash from a financial institution or a specialized financing company. Through this arrangement, the financing entity advances a portion of the invoice value to the business, enhancing cash flow and working capital.
In the process, the financing entity takes on the task of collecting payments from customers, effectively transferring credit risk and collection responsibilities to the financing partner. This allows the business to swiftly access funds, promoting financial flexibility while offloading the challenges associated with credit management and collection efforts.
How to reduce trade receivable?
Reducing TR requires strategies to accelerate customer bill payments. Strategies include incentivizing early payments with discounts, establishing transparent credit terms, conducting regular credit assessments, promptly invoicing, and maintaining proactive collection practices. Strong communication and swift resolution of billing or service issues foster quicker payments, aiding in reducing outstanding receivable.
Regular monitoring, coupled with effective risk management, is essential for optimizing cash flow and minimizing the risk of bad debts. These practices collectively contribute to a streamlined receivable process and healthier financial operations.
How does M1xchange TReDS help in reducing the Trade Receivable?
M1xchange, Trade Receivable Discounting System (TReDS) platform in India, plays a pivotal role in reducing trade Dept for MSMEs. The platform offers several advantages in achieving this goal of reducing TR:
Fast Funds Access:
MSMEs can swiftly access funds by uploading their Trade Receivable on M1xchange, facilitating quick invoice discounting.
Better Cash Flow:
By turning receivable into quick cash, businesses improve their cash flow, helping them with day-to-day expenses and urgent financial needs.
Improved Cash Flow:
By accelerating the payment of receivable, businesses can improve their working capital position. This is especially important for SMEs that may face cash flow challenges. Access to funds earlier than the stipulated payment terms can help in meeting immediate financial obligations and funding day-to-day operations.
Discounting receivable provides an immediate advance on the invoice value
By discounting receivable, businesses receive an immediate advance on the invoice value, supporting cash flow to meet working capital needs and address short-term financial requirements.
Early Payment Discounts:
M1xchnage empowers suppliers to offer early payment discounts, encouraging prompt settlements and reducing receivable collection time.
Streamlined Invoice Discounting:
The platform streamlines the invoice discounting process, reducing administrative burdens and ensuring a smoother, faster financing experience.
Digitalized Trade Transactions:
M1xchange promotes the digitalization of trade transactions, reducing paperwork and manual processes for enhanced operational efficiency and quicker invoice and payment processing.
Risk Management:
TReDS mitigates credit risk by enabling financiers to assess the creditworthiness of buyers, supporting informed decisions, and reducing the risk of bad debts.
Transparency and Visibility:
M1xchange provides transparency in the receivable financing process, allowing suppliers to track invoice status for improved visibility into the payment cycle and effective financial planning.
Enhanced Relationships with Banks and Financiers:
Connecting MSMEs with a network of banks and financiers, M1xchange broadens financing options, fostering stronger relationships with financial institutions and supporting overall financial health.
FAQs
Trade Receivable are assets, including customer debts for goods or services provided on credit. Recorded on the balance sheet, they remain assets until collected.
Non-account receivable are amounts owed to a company unrelated to its core operations. Unlike account receivable from goods or service sales, non-account receivable can result from various transactions and activities.
Trade receivable are specific amounts that a company earns from its core business operations by selling its goods are services on credit. In contrast, accounts receivable encompass the total outstanding amounts owed to the company, including those from core business transactions and other financial dealings like loans or advances.
