Accounting automation

Trade receivable: What is it & how does it work?

Apr 05, 2024

Trade receivables are an important part of a business’s everyday functioning. Also known as accounts receivable, a trade receivable is a financial asset that arises when a business provides goods or services on credit to its customers.

It is a liability for the customer and an asset for the business that has provided the goods or services. Trade receivables are an important asset for businesses as they represent potential future income from customers.

They can also be used as collateral for loans and other forms of financing. To understand what are trade receivables, it is important to understand the concept of accounts receivable, the process of invoicing, and the different methods of collecting payment from customers.

What is trade receivable?

Trade receivables meaning include the amounts owed to a business by its customers, usually in exchange for goods or services that have been provided on credit. They are considered an asset on the company's balance sheet since they represent money expected to be received.

Trade receivables usually have a repayment period of 30 to 90 days. The company must actively manage the accounts receivable to ensure that customers make their payments on time and the company does not suffer any bad debts.

What is the importance of trade receivable?

1. Cash flow management

Cash flow management is a major concern for any business, and trade receivables are a key factor in managing cash flow. Trade receivables can help maintain liquidity which is essential for a company to operate and grow.

If a company has a large number of trade or accounts receivables, it can access funds quickly, allowing it to take advantage of opportunities and invest in new projects.

Suggested read: How to manage cash flow effectively?

2. Working capital

Trade receivables are also important for working capital. Working capital is the amount of money used to cover short-term expenses and obligations.

Trade or accounts receivables can be used to finance working capital, allowing a company to maintain operations while waiting to collect payment from customers.

3. Credit management

Finally, trade receivables are important for credit management. Companies use trade or accounts receivable numbers to determine the amount of credit they are willing to extend to customers.

By monitoring these numbers, companies can ensure they are only extending credit to customers who are likely to pay on time. This helps companies maintain their cash flow and minimize their risk of bad debt.

What is the formula to calculate trade receivable?

The trade receivable formula is used to measure the amount of money owed to a business by its customers.

The formula is calculated by taking the total amount of sales to customers, subtracting any returns and discounts, and then subtracting the amount of cash collected from customers. The resulting total is the amount of money owed in trade receivables.

The formula is expressed as:

Trade Receivables = Total Sales to Customers - Returns and Discounts - Cash Collected from Customers

For example, if a company had $1,000 in Total Sales to Customers, $100 in Returns and Discounts, and $500 in Cash Collected from Customers, then the Trade Receivables would be calculated as follows:

Trade Receivables = $1,000 - $100 - $500

Trade Receivables = $400

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What are the different types of trade receivables?

Recourse and non-recourse receivables

Recourse receivables are those that are covered by a contractual agreement between a seller and buyer, whereby if the buyer fails to pay the debt, the seller has the right to reclaim the goods sold.

Non-recourse receivables are those where the seller does not have any right to reclaim the goods or services sold if the buyer fails to pay the debt.

Secured and unsecured receivables

Secured receivables are those where the buyer has provided some form of an asset as security to guarantee payment of the debt. Examples of secured receivables are mortgages and auto loans.

Unsecured receivables are those where the buyer has not provided any security to guarantee payment, but the seller still has a legal right to claim payment of the debt.

Domestic and international receivables

Domestic receivables are those that are between two parties within the same country. International receivables are those that are between two parties in different countries.

These types of receivables involve different currencies and require additional documentation to ensure compliance with international laws.

Factored and non-factored receivables

Factored receivables are those where the seller has sold the debt to a financial institution, referred to as a factor. The factor then collects the debt from the buyer and pays the seller a percentage of the total debt.

Non-factored receivables are those that the seller has retained, and is responsible for collecting the debt from the buyer.

What are the 5 ways to reduce trade receivables?

1. Clear payment terms

Firstly, businesses should be clear on payment terms and make them known to their customers. This could include setting out the payment terms clearly on the invoice and providing customers with a timeline of when payment should be made.

2. Credit checks on customers

Secondly, businesses can enforce credit checks on their customers. This will help to ensure that they are dealing with customers who are able to pay their invoices on time. The credit check should include a credit score, any past payment history, as well as an analysis of the customer’s financial health.

Related read: Tips to improve your business credit score

3. Invoice accuracy

Thirdly, businesses should also ensure that their invoices are accurate and up to date. This means that the invoices should be sent out promptly and any changes or additions should be reflected on the invoice in a timely manner.

4. Collections process

Fourthly, businesses should have a well-defined collections process in place. This should include regular follow-up of invoices, regular communication with customers, and the use of collection agencies if necessary.

5. Offering discounts

Finally, businesses can offer discounts to customers who pay their invoices on time. This could include a discount on the total amount due or a reduced interest rate. This will help to incentivize customers to pay their invoices on time and can help reduce the number of trade receivables.

Volopay for all your business accounting needs

A business accounting automation system can be an invaluable asset for companies who want to conveniently manage their trade receivables. Volopay is an invoice management and accounting automation tool designed to help businesses with this task. The platform provides a unique, comprehensive suite of features that enable companies to quickly and accurately manage their finances.

For starters, Volopay helps businesses easily create, manage, and track their invoices. This allows companies to closely monitor their sales and expenses and helps them to stay on top of their cash flow processes. It also helps businesses to remain compliant with taxation regulations, reducing the need for costly accounting fees.

In addition, Volopay’s system enables businesses to automate their payment processes. Companies can set up payment schedules, automate bank payments and reconcile accounts all on one unified platform. This saves time and reduces the need for manual bookkeeping, allowing businesses to focus more time and resources on running their operations.

Furthermore, the platform provides powerful reporting capabilities that allow businesses to get a comprehensive overview of their finances. They can quickly and easily generate financial reports and insights, which will help them to make informed decisions on future actions.

Overall, Volopay is an ideal solution for businesses looking to streamline their business accounting processes. It provides an intuitive platform with powerful features that can help businesses to save time, money, and resources.

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