Definition: Classified as a current asset, which is entered as a debit on the balance sheet. An asset which is a result of a sale made on credit.
Classified as a current asset on the balance sheet, accounts receivables are the most liquid assets behind cash.
An invoice with specific terms stated such as (net 60 days) is a sign that a sale was actually made on account rather than in cash. The net 60 days term means that the total to be paid back is due in 60 days.
Accounts Receivables are increased on the debit side and decreased on the credit side. When payment in cash is received from the debtor, cash is increased and accounts receivables is decreased. When recording the transaction, cash is debited, and accounts receivables are credited.
Accounts Payable is recorded in much the same manner, except that you are the one making the purchase on account and you now have an accounts payable on your books.
The purpose of the ratio is to measure the amount of time it takes for a company to collect their accounts receivables on an average basis.
Turnover Ratio = Net Sales/ Average Net Receivables.
For example, a ratio of 20 would mean that the company's accounts receivables are turning over 20 times per year.
To analyze how many days it takes on average to collect accounts receivables, divide 365 (days in a year) by the ratio, (20) and this would provide you with an answer of approximately 18 days.
The collection period is a very important indicator of when the company can expect to receive cash and therefore provides an image of the present liduidity situation.