One of the most important resources in any business is cash flow, and a huge percentage of that comes from sales.In a utopian business world, your company doesn’t have any debtor. Your customers, for example, always pay in cash.
In a less-than-ideal scenario, your business has several customers taking up debt. However, they always choose to pay on time.In reality, these stories are often rare. Usually, businesses deal with several customers who pay at a later period. In turn, companies have to incur accounts receivables.
Unfortunately, not all will pay up promptly or at all. To ensure that the company has a better idea about the situation, they need to learn to age these receivables.
What Is Accounts Receivable Aging?
Accounts receivable aging is one of the first things auditors check in an accounts receivable audit. Accounts receivables should be “aged” to show how long invoices have been outstanding and determine if there are any bad debts. The auditor can then calculate senior unsecured claims as a percentage of total assets, one of the financial ratios disclosed in banks’ call reports.
Aging of accounts receivable provides the following benefits:
- Provides another indicator to determine that there are no bad debts. An aging schedule showing more than one month of invoices is a risk factor.
- Determines whether customers are paying on time by monitoring how long invoices have been outstanding.
- Offers another indicator that the company has properly recorded all sales transactions. If there is an unusually high number of aged receivables, phone calls can be made to resolve disputes on individual account balances.
- Provides companies a better idea about their cash flow. This is especially important if the business has an increasingly large number of aged receivables.
- Identifies areas to help speed up the collection process.
The aging of accounts receivable can be done either manually or through automated software. In a manual system, the aging schedule is prepared by recording when invoice details are entered into the company’s invoices.
In an automated system, aged receivables are calculated by the software with the information from accounting records. In this case, you can keep your business processes simple and produce reports by using Excel or another reporting tool.
Methods of Aging of Receivables
There are three methods of aging accounts receivables:
- A simple method of aging accounts receivable is to calculate the percentage of an aged account balance against the total current accounts receivable.
- A more detailed method calculates the aging of specific categories within the aged accounts receivable balance. For example, if there are $3,000 in aged invoices that were more than 90 days old and there is a total of $15,000 in aged accounts receivable, then that is 20 percent ([$3,000*100]/ $15,000) of the aged balance.
- The most detailed method calculates the number of days invoices are outstanding for specific categories within the aged accounts receivable balance. For example, if there are $1,000 in aged invoices that were more than 90 days old and there is a total of $3,000 in aged accounts receivable, then that is 30 percent ([$1,000*100]/ $3,000) of the aged balance. This method can be particularly useful for identifying disputes on individual account balances.
How to Improve the Collection of Receivables
Can businesses choose not to have any debtor? Yes, they can. However, they severely limit their chances of acquiring customers, particularly if they are in the B2B market. Credit also allows other businesses to improve their cash flow.
What companies can do is to learn how to collect receivables as soon as possible. Here are some ideas:
1. Export Best Practices
The credit department should bring in a consultant with expertise in these matters to help them plan and implement new policies and procedures. Accounting outsourcing companies can guide the optimal mix of trade discounts, early payment discounts, and late payment fees to maximize cash flow without alienating customers or triggering customer disputes on invoice balances.
2. Reward Good Payers
Some companies reward good payers by giving them a 2 percent discount if they remit payment within five days of receiving the invoice. It creates a win-win situation since the company has a better cash flow and the customer pays on time.
3. Train Employees on Collection Procedures
A training program for employees will help them understand the importance of following correct procedures in recording invoices, entering data into accounts receivable, applying proper coding on accounts receivable, and other similar tasks.
4. Upgrade Accounting Systems
Computerized accounting systems make it easy to track the aging of receivables, quickly spot any disputes on individual account balances, and prioritize notifications to slow-paying customers. Upgrading the system is an excellent way to improve collections because it can reduce staff time spent contacting slow payers by electronic mail instead of by telephone.
The collection of accounts receivables is an ongoing process. There will always be invoices that are beyond their due date. It takes discipline to follow the company’s credit policy, but it can mean increased cash flow and perhaps improving customer relationships.