Understanding Trade Receivables: Meaning, Formula, Calculation & Advantages
Introduction
Every business requires sufficient cash flow to run smoothly, although not every transaction involves immediate payment. Whenever a company sells products or services on credit, the amount owed by customers becomes a trade receivable.
It is very important to efficiently manage accounts receivables for liquidity, for trust with the customers, and for sustainable business growth. In this comprehensive guide, let’s learn what trade receivables are, the formula for calculating their value, their benefits, and how TReDS platforms like DTX would help reduce delays in the payment cycle for businesses.
What Are Trade Receivables?
A trade receivable is an amount that the company is entitled to receive from its customers for goods or services sold on credit, it serves as an asset of payment, usually within a specific period, approximately from 30 to 90 days.
Meaning of Trade Receivable
Trade receivables are current assets because they are expected to be converted to cash within the normal operating cycle of a business. These are naturally from day-to-day sales transactions and play an important role in sustaining business operations, especially for companies that give credit terms to their customers on a regular basis.
In accounting, trade receivables are recorded at the time an invoice is issued, which means revenue earned has been realised but not yet collected in cash. The ultimate objective is to collect these receivables in time to ensure a healthy flow of funds.
Why Trade Receivables Are Important for Businesses
Trade receivables bridge the gap between sales and cash inflow. When enterprises grant credit, they provide an opportunity to customers for making more purchases, and in turn, long-term relationships are built. On the other hand, delays in collection exert pressure on working capital, disturb operations, and also increase the risk of bad debts.
By closely monitoring trade receivables, businesses can manage liquidity more effectively and plan financial strategies with greater precision and plan for overall efficiency and expansion.
In practice, trade receivables provide the opportunity for growth through credit sales but require disciplined financial oversight.
Trade Receivable Formula & Calculation
Basic Formula of Trade Receivables
One of the most widespread receivable efficiency performance indicators is the Trade Receivable Turnover Ratio, calculated as
Trade Receivable Turnover Ratio = Net Credit Sales / Average Trade Receivables
It shows the number of times a company collects its average receivables during a financial year. A higher ratio signifies that the firm is collecting at a faster rate and more effectively managing credit, while a lower ratio can imply either slower collections or lenient credit policies.
Step-by-Step Calculation
Let’s understand this with an example:
Net Credit Sales: ₹10,00,000
Opening Trade Receivables: ₹1,00,000
Closing Trade Receivables: ₹1,40,000
Step 1: Calculate the Average Trade Receivables
(₹1,00,000 + ₹1,40,000)/ 2 = ₹1,20,000
Step 2: Calculate the Turnover Ratio
₹10,00,000 / ₹1,20,000= 8.33 times
Solution
Timely analysis of accounts receivable turnover ratios helps companies benchmark their performance and identify areas for improvement.
Trade Receivable Turnover Ratio Explained
The trade receivable turnover is a key indicator of financial health. A high ratio value reflects strong collection efficiency, indicating that customers are paying their dues on time. A low value may indicate slower collections and may signal to management about credit access or inefficient follow-up.
This helps monitor the effectiveness of credit policies and minimises cases of tied-up resources in receivables for long periods.
How the Trade Receivables Are Recorded in Accounting
Journal Entries and Posting
When a company makes a credit, it records the transaction as:
Debit: Trade Receivables
Credit: Sales Revenue
This entry recognises that the revenue has been earned even though cash has not yet been received.
Upon receiving payment from the customer:
Debit: Cash/Bank
Credit: Trade Receivables
This clears the receivable from the company’s books and reflects the actual inflow of funds.
Adjusting for Bad Debts
Despite careful credit management, some customers may default. Businesses therefore, record an allowance for doubtful debts to anticipate potential losses. This ensures that the financial statements present a realistic picture of receivables likely to be collected.
Balance Sheet Presentation
Trade receivables are the current assets that usually appear under the balance sheet heading receivables. The amount is net of any allowances for doubtful debts, being the amount expected to be realised.
Proper presentation means adhering to accounting standards, but it also contributes to clarity for stakeholders about the company’s short-term financial health.
Advantages of Trade Receivables
Improved cash flow management
Trade Receivable Discounting System(TReDS) enable instant cash-flow access for businesses focusing on expansion and can bring in predictable inflows if well managed. It enables the alignment of collections with expenses to maintain operational stability in a business.
Increasing Credit Sales to Boost Business Growth
The offer of credit encourages customers to place large orders and build stable relationships. The ability to offer flexible payment terms is a clear competitive advantage in those industries where extended credit periods are the norm.
Therefore, trade receivables enable business enterprises to expand their market share while keeping customers happy.
Better financial planning and forecasting
Receivables on account of credit sales provide an analysis of sales trends, payment habits, and seasonal fluctuations in cash flows. The forecasts enable an enterprise to optimise working capital, plan investments, and allocate resources accordingly.
Trade Receivable vs Non-Trade Receivable
What are non-trade receivables?
Non-trade receivables are the amounts owed to an entity, but they are not related to the direct operation of the business. The best examples include items such as tax refunds, employee loans, and insurance claims. These still assets derive from incidental rather than sales transactions.
Key differences between trade and non-trade receivables
The principal difference is their origin.
- Trade receivables result from day-to-day sales in the business on credit.
- Non-trade receivables arise from non-operating activities.
Trade receivables affect the day-to-day cash cycle of the company, whereas non-trade receivables have little consequence on operational liquidity.
How to Manage & Reduce Trade Receivables
Setting Clear Credit Terms
Establish clear credit policies that include payment terms, credit limits, and penalties for late payment. Check the credit standing of each customer in advance to minimize chances of default.
Regular Monitoring and Follow-Ups
Set up an aging schedule to group receivables according to their due date. Regular checking reveals which accounts are overdue. Early detection and follow-up with reminders often result in timely payment and fewer bad debts.
Using Receivables Financing
Invoice discounting or factoring can be used to raise cash tied up in the enterprise’s accounts receivable. These techniques involve the sale of outstanding invoices to financiers at a discount to create immediate liquidity. A factoring arrangement improves cash flow without increasing debt on the balance sheet.
How DTX TReDS Platform Helps in Reducing Trade Receivables
Delayed payments are a hurdle for MSMEs and enterprises, limiting their ability to scale operations. DTX by KredX, an RBI-licensed Trade Receivables Discounting platform, provides a digital solution to this challenge.
Through DTXIndia, suppliers can upload their approved invoices, which are then made available to multiple financiers for competitive bidding. Once the best offer is accepted, funds are credited directly to the supplier’s account often within 24 hours.
This innovative mechanism not only improves liquidity but also ensures transparency and fairness in the receivables financing process. Buyers benefit by maintaining positive supplier relationships, while financiers gain access to secure and diversified investment opportunities.
By using DTX by KredX, businesses can significantly reduce their receivable cycles, eliminate the stress of delayed payments, and focus on growth.
Final Thoughts
Trade receivables form an essential part of every enterprise’s financial structure. Understanding how to calculate, record, and manage them ensures steady cash flow, low credit risk, and much higher levels of operational flexibility.
TReDS platforms like DTX by KredX therefore, empowered MSMEs and corporate suppliers to gain immediate access to working capital by liquidating their receivables efficiently and safely in the shortest time. By embracing this digital ecosystem, businesses not only reduce the burden of delayed payments but also unlock new growth opportunities.
To learn more about how TReDS can help your business smoothen its cash flow, feel free to visit DTXIndia and start your journey toward faster payments and stronger financial stability.
