Accounts Receivable
AR is money customers owe you. When AR goes up, you've made sales but haven't collected cash yet — so it's a drag on cash flow.
Definition
Accounts receivable (AR) is the amount of money owed to a company by customers who have purchased goods or services on credit but have not yet paid. It is a current asset on the balance sheet and a key driver of working capital and cash flow.
Formula
DSO = (Accounts Receivable / Revenue) × 365
Accounts Receivable
Outstanding customer balances (from balance sheet)
Revenue
Total revenue for the period (from income statement)
DSO
Days Sales Outstanding — average days to collect payment
Cash Conversion Cycle
How long it takes to turn inventory into cash
DIO (30) + DSO (45) - DPO (35) = 40 days. This means the company needs to fund 40 days of operations before cash comes back in. Lower is better — it means less cash tied up in the cycle.
Working Capital Scenarios
Same formula, very different stories
The company has an $80M cushion. It can pay all short-term bills and still invest in growth. Most industrial and services companies operate this way.
AR and Cash Flow
Revenue recognition and cash collection are different. When a company records a sale on credit, revenue and AR both increase, but no cash is received. An increase in AR is a cash outflow (use of cash) in the working capital section of the cash flow statement. Companies want to minimize DSO — the faster they collect, the better their cash conversion.
Analyzing AR Trends
Rising DSO can signal that a company is struggling to collect, extending overly generous credit terms, or recognizing revenue aggressively. In due diligence, analyze the AR aging schedule — what percentage is current vs. 30/60/90+ days overdue. A spike in aged receivables may indicate future write-offs. Compare DSO to industry peers and the company's own historical trend.
AR in Financial Modeling
In a DCF model, project AR as DSO × (Revenue / 365). Changes in AR from period to period flow into the working capital adjustment for free cash flow. In LBO models, AR is part of the NWC projection. In M&A, the NWC peg includes AR, so sellers are incentivized to collect aggressively before close.
Worked Example — With Real Numbers
A company has $50M in AR and $365M in annual revenue. DSO = ($50M / $365M) × 365 = 50 days. If DSO was 45 days last year, the increase means the company is collecting 5 days slower, tying up approximately $5M more cash ($365M / 365 × 5 days = $5M).
Key Takeaways
AR represents sales made on credit where cash has not yet been collected
An increase in AR reduces cash flow — you've earned revenue but not collected cash
DSO measures collection efficiency — lower DSO is generally better
Rising DSO is a red flag for potential collection issues or aggressive revenue recognition
Common Mistakes in Interviews
Confusing revenue with cash collected — AR is the difference between the two
Ignoring AR growth when evaluating a company's cash generation capabilities
Not analyzing the AR aging schedule for concentration risk or overdue balances
How Interviewers Test This
If asked 'how does a $10M increase in accounts receivable affect the financial statements?', walk through all three: income statement is unaffected (revenue was already recognized), balance sheet AR goes up by $10M, and cash flow from operations decreases by $10M.
Related Concepts
Directly referenced in this topic
Net Working Capital (NWC)
Net working capital (NWC) measures the difference between a company's operating ...
Accounts Payable
Accounts payable (AP) is the amount a company owes to its suppliers and vendors ...
Cash Flow Statement
The cash flow statement reconciles net income from the [income statement](https:...
Balance Sheet
The balance sheet is a financial statement that reports a company's assets, liab...
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