Reviewing your accounts receivable aging report at least monthly—and ideally more often—can help to ensure that your customers and clients are paying you. It at least tells you where they stand so you can take steps to collect if necessary.
Accounts Receivable Explained
Accounts receivable sometimes called "receivables" or "A/R", are the amounts owed to a company by its customers. You might consider them as "payments due to my business."
Receivables are considered a business asset because they have value. They're the total amount owed to your business. They're ranked high in the list of assets because they can be converted into cash. As soon as they're paid, they become cash.
Some cash businesses or businesses that rely heavily on a customer who uses credit cards don't have any receivables. But if you bill your customers and if you offer them terms such as paying over a certain time, you'll want to be able to run an A/R aging report so you can see how much is due from each of them.
Accounting Method and Receivables
You're probably using the accrual accounting method as opposed to cash accounting if your business has a fair number of customers who don't pay immediately. this accounting methid is used to match income and expenses in the correct year. With accrual accounting, you can include a receivable amount in gross income for the tax year if you can establish your right to receive the money and the amount, with an invoice, for example.
In accrual accounting, if you bill a customer $500 for work done in December, you count that $500 as income in December, even if you haven't received the money yet.
The process of collecting money from customers in this type of business typically begins with an invoice—a bill to the customer. The invoice states the amount due and when it's due, including terms of payment. The payment terms sometimes include a discount for early payment. It also may show the terms and the charge for extending payment time.
Accounts Receivable Aging Report
Accounts receivable aging, sometimes called accounts receivable reconciliation, is the process of categorizing all the amounts owed by all your customers, including the length of time the amounts have been outstanding and unpaid. You're "aging" this information. The aging report is used to collect debts and establish credit.
Standard categories for this type of report include:
- Current: Due immediately
- 1 to 30 days: Due within the next 30 days
- 31 to 60 days: A month overdue
- 61 to 90 days: Two months overdue
- 91 days and over: More than two months overdue
If a customer has several bills that were incurred at different times, the report will show how much is due and at what time. For example, a receivables aging report for JR's Delicatessen might read something like this:
- $230 30 days
- $120 60 days
- $390 Over 90 days.
The purpose of this accounts receivable aging is to show you what receivables must be dealt with more urgently because they've been overdue longer. This report is standard with most business accounting software programs, including online systems.
Importance of an Accounts Receivable Aging Report
Rule number one in debt collection is that the longer a debt is owed, the less likely it becomes that you're going to be able to collect it. Knowing about your customers and their debts is vital to collecting from them.
How to Use an A/R Aging Report
First look at the greatest amounts of money owed by all customers. Are these amounts current? Are they 30 days? Or have these bills been outstanding for 120 days or more?
Consider the 80/20 principle (sometimes called the Pareto Principle) that says that roughly 80% of problems are caused by 20% of the group. If you focus on the 20%, the customers with the highest balances, you are maximizing your collections. This will bring you the highest return. Determine how you'll handle each of these large bills, then write up a plan and have your accounts receivable manager start working.
Taking Customers to Collections
Now, look at those bills that have been due for a long period of time. Determine whether you're ready to take each of these customers to the next step of the collections process, sending the accounts to a collection agency or filing suit in small claims court. You might know that a customer's wife has terminal cancer so you might decide not to take that person to court. It's your company so you get to decide.
Finally, use your collections system to determine how you'll contact all customers with bills 30 days or more overdue. Let the system guide you, but don't hesitate to make exceptions.
Before you attempt to take someone to court over a bad debt, be aware of your state's statute of limitations on collections. This time period varies by state.
The Average Collection Period
You might also want to calculate a business analysis ratio called the "average collection period." This calculation shows the number of days, on average, that it takes to collect on your business sales. You can see whether this ratio goes up over time, taking a long time to collect.
The formula for average collection period is:
Days in Period x Average Accounts Receivable divided by Net Credit Sales - Days to Collection.
What if You Can't Collect?
You may be able to claim a bad debt deduction on your business tax return if you can't collect on a receivable. You must be using the accrual accounting method to do this.
If you work to improve your collections rate using the accounts receivable aging report and other financial analysis tools like the average collection period, you can improve payments and have more cash in your business. Use the collections process you set up, and always remember Rule No. 1.