An open account refers to a line of credit extended by a seller to a buyer, allowing the buyer to purchase goods or services and pay for them later. The term is often used in international trade but also applies to other business settings.
In an open account arrangement, the buyer promises to pay within a certain time period, often 30, 60, or 90 days. This arrangement is beneficial for the buyer because it improves cash flow by allowing them to receive goods or services immediately but pay for them later.
On the other hand, selling on open account can be risky for the supplier because the goods are shipped and delivered before payment is due. If the buyer fails to pay, the supplier may have to absorb the loss or pursue collection efforts.
To mitigate the risks associated with open account transactions, especially in international trade, sellers often use export credit insurance. Buyers may also be carefully screened for creditworthiness.
It’s important to note that “open account” can also refer to an account that is active and in use, particularly in the context of banking. For example, an open bank account is one that is active, allowing transactions like deposits and withdrawals.
Example of an Open Account
Suppose there’s a manufacturer named “GadgetPro” that makes high-quality electronic gadgets. A retailer named “TechShop” is interested in stocking their products.
To facilitate this, GadgetPro extends an open account to TechShop. This means that TechShop can order products from GadgetPro and is allowed to pay for these products at a later date, say within 30 days from the delivery of the goods.
TechShop places an order for $50,000 worth of gadgets. GadgetPro ships the products immediately, and TechShop receives and begins selling the gadgets in its stores. Meanwhile, GadgetPro records this as an account receivable on its balance sheet.
30 days later, TechShop, after having sold many of the gadgets, pays GadgetPro the $50,000 owed. GadgetPro then closes the open account for this particular transaction, removing the account receivable from its books.
In this example, the open account arrangement allowed TechShop to stock and sell the gadgets without having to pay upfront, improving their cash flow. At the same time, GadgetPro was able to make a sale, but they took on the risk of TechShop potentially not paying on time or at all. GadgetPro could mitigate this risk by insuring the account receivable or by thoroughly checking TechShop’s creditworthiness before extending the open account.