What Is It and Why Does It Matter?
Account receivable helps to measure the money that is owed by the customer in business for the goods and services provided. This is done to set the future predictions of receivable assets in the business balance sheet by the accountants. However, they don’t expect all the money to be collected, as shown in the account receivable.
Many people might wonder why business takes such a risk of non-payment while providing goods and services in advance. So, when the company deals with their regular and reliable customers, they acquire a benefit by selling those goods on credit. They can sell more products while reducing the transaction cost by processing the payment periodically instead of numerous small amounts. The problem arises with unreliable customers and their default payments, which leads to a loss in business. The business assumes in their financial reporting about such non-reliable customers who wouldn’t pay and by referring as the allowance for bad debts. However, it’s still not clear that these initiatives are healthy or unhealthy business practices.
How to Analyze Accounts Receivable
There are various ways discovered over the years to analyze the quality of account receivable. The simplest one amongst all is the use of account receivable to sales ratio. This ratio is obtained by dividing the sales by account receivable so that the investors can ascertain the approximate degree of purchase that hasn’t been paid by customers at that point in time.
The other method is to examine or analyze the change in a recent graph of business allowance for bad debt. You can find these records in financial statements and balance sheets. If it has grown over time, then there is a high possibility of business to suffer structural deficiency in collecting payments. You can investigate the creditworthiness of the debt owing to the customer by collecting their names. However, this could yield valuable insights and are time-consuming, making it overall a complicated procedure. The process of investigating each customer is known as aging. This method produces more informative results by answering the problem of a specific customer.
You can also analyze the debtor’s customers being diversified by industry sector. If the business possesses in the particular industry where the customer owes the debts, it can lead to a vulnerable economic downturn while affecting the industry. If a highly diversified customer base owes the account receivable, it can be comparatively less susceptible as the economic downturn will not affect the repayment rate as a whole. In this case, the investors may consider the business to be more secure due to the customer owning to a small portion of account receivable, which wouldn’t create any adverse impact on the overall financial health of the business.
There are many more methods to analyze the account receivable, but every individual investor possesses a different opinion on it and would debate.
Many companies bill their invoices at the end of the month, which shows outstanding accounts receivable from one month ago, after running the aging report a few days later, including the full amount of all the billed receivables. This shows receivable in the wrong state. However, if you run the report before the month-end, there would only be fewer account receivable demonstrated in the report with little cash uncollected from the receivable.
It may also happen that there are unapplied credits on the report, so make sure you clean it and research the ones who need to be applied. It will help to reduce the overdue amount of receivables from the list.
Changes to improve AR performance
These modern reporting tools help to capture the data quickly and make adjustments accordingly for improving AR performance. If you keep sending your customer an email for constant reminders, which isn’t proved to be much useful so you can decide to handle it differently by calling up them. These come under knowing customer payment behaviors and visibility. By looking at the entire account receivable, you can take effective measures about where to improve the strategies and change the credit policy. Apart from these, you can also work on improving customer service by analyzing weak spots about customer late payments. Managers can use these reports, executives, and others working on the same goal. The reports come in a simple and visual format, which helps to improve the cash flow.
You can also get the account receivable report printed and further report it to any software package. It will help dividing it into various categories at a different time-lapse. Once the invoice falls in greater than 30 days, it could be an alarming sign. Make sure you match the time duration of the report according to the company’s credit terms. This may also occur due to change in a business line or lousy business conditions.
What is account receivable software
Account receivable software speeds up the process of invoices by eliminating the errors inherited by initiating features like invoice processing and receipt capture and tracking the compliances. It integrates with comprehensive accounting platforms and bills the addon strictly. It provides a broader platform and a more detailed accounting solution.
Accounts receivable turnover ratio
Account receivable turnover is the average account receivable collected by a business per year. This ratio helps in evaluating the efficiency of the company for issuing credit to its customers and accordingly collects funds from them. You can also plot the outstanding accounts receivable balance at the end of each month for the past year and use it to analyze the amount in the near future for seasonal sales to get the estimates. If the percentage of bad debt increases, the management can tighten the credit terms, whereas if the percentage remains low, the credit can be loosened to expand the sales. It also states the requirement of extra staff or reason for the worsening situation.
The formula is as follows:
Net Annual Credit Sales ? ((Beginning Accounts Receivable + Ending Accounts Receivable) / 2)
Make sure you don’t use total sales in the numerator to avoid misleading results of higher sales.
The best way to analyze the account receivable is by using all the techniques mentioned above. You can determine the collection period and add the analysis report accordingly to the company. Further, you can add the problem causing invoice to aging report and analyze if they have been changed over time.