Entrepreneurship, Second Edition

11.4. Using Accounts Receivable as Working Capital

Accounts receivable—that is, the money owed to the company as a result of sales made on credit for which payment has not yet been received—are a major element in working capital for most companies. And they are one of the reasons we can assert that working capital is not the same as available cash and that the timing of short-term flows is vitally important.

If a company is selling a major part of its output on credit and giving 30 days' credit, its accounts receivable will be about equal to sales of30 days—that is, to one-twelfth of its annual sales—if sales are reasonably stable over the year. And if the company's collection policies are so liberal or ineffective that in practice customers are paying an average of, say, 45 days after they are billed, accounts receivable are no less than one-eighth of annual sales. Investment in accounts receivable is a use of funds. The company has to finance the credit it is giving to its customers by allowing its money to be tied up in this way instead of being available for investment in productive uses. Therefore, accounts receivable, like cash, have an opportunity cost.

The magnitude of a company's accounts receivable obviously depends on a number of factors:

The level and the pattern of sales

The breakdown between cash and credit sales

The nominal credit terms offered

The way these credit ...