As a company owner, thinking about accounting reports may seem as interesting as watching grass grow. You’re busy with the big picture, so you leave all that esoteric financial analysis to your accountant or bookkeeper. Your primary interest is to keep your finger on the pulse of what your business is all about—selling products and services and keeping a healthy cash flow.
Lately, you may have noticed that your cash reserves are on a downward slope. But your sales have remained steady and even slightly higher with the pandemic bounce-back. The obvious cause is that, as the saying goes, you have “cash out on the street.” Some of your customers are not paying their invoices on time, and those invoices are aging in the jargon of accountants.
The old excuse that “the check is in the mail” no longer has traction in these days of online, instantaneous money transactions. Likewise, your business is equipped with automated financial technology that sifts, sorts, and reports what you need to know—past, present, and projected.
So, if you’re noticing low cash reserves with steady sales, you should get in touch with your bookkeeper. If they confirm the hypothesis of customers not paying their bills in a timely manner, they may walk you through your company’s AR Aging Report—AR signifying accounts receivable. Accounts receivables are shown on the company balance sheet as an asset, but, as we shall see, they can become a distinct liability as the age of the outstanding receivables.
AR Aging and Company Valuation
In the meantime, you have begun thinking about an exit strategy and are looking around for someone to buy your business—not right away, but probably within the next 18 months. Your decision has resulted in some personal insights into the actual value of your business. That valuation, you realize, is less than the sum of its sentimental parts, and is all about an honest assessment of its true valuation or, stated simply, how much someone would be willing to pay for it.
Your company’s true, non-sentimental value is based on analyzing the financial data and other documents that chronicle its performance over the past 3-5 years. Heading the list of financial reports used in valuation is the AR Aging Report. Essentially, the report shows how successful your company has been at collecting debts, or, conversely, if unpaid amounts have diminished the company’s cash value.
Stated another way, according to Investopedia: “If the accounts receivable aging shows a company’s receivables are being collected much slower than normal, this is a warning sign that business may be slowing down or that the company is taking greater credit risk in its sales practices.”
While your eyes may occasionally glaze over when looking at financial reports and spreadsheets, the AR Aging Report in front of you now has your undivided attention. You are not an accountant, but it doesn’t take a financial genius to read and understand what it says. The report is an alphabetical listing of all your clients. It shows:
- Each client’s unpaid invoice totals broken down into how old the invoices are, with columns of Current, 1-30, 31-60, 61-90, 90, and over.
- Unpaid amounts totaled horizontally by the company and vertically by amounts. The amounts on the summary report could indicate that an individual customer could have more than one invoice due.
- The “Current,” or first, column shows amounts owed but not yet due if your payment terms are 30 days. Here’s where you want most of the amounts. Higher totals in the column mean that most of your customers pay their invoices promptly.
- The remaining columns indicate how the invoices are aging. Anything past the 1-30 column indicates that your business has cash-flow problems and could require corrective actions as mild as a polite collection notice or as extreme as refusing further credit and referring the account to collections.
Using Your AR Aging Report to Calculate Receivables Turnover Ratio
Now that you’re more into tracking that money owed to your company, you should pay attention to your Receivables Turnover Ratio. The Receivables Turnover Ratio is a mathematical iteration that divides your net credit sales by the average dollar amounts of your beginning and ending accounts receivables balances.
A result is a whole number that shows how many times, on average, the company converted its receivables to cash. That number can also be divided into 365 to find the average accounts receivable turnover in days for any given period. A high ratio indicates a healthy cash flow.
See example computations in the Investopedia online article “Receivables Turnover Ratio.”
You Should Be Concerned When…
If you had been reviewing your company financial statements on a monthly basis, you might have noticed that the AR aging balance has been steadily increasing. You may have also used the “stubby-pencil” calculation method and see that your Receivables Turnover Ratio is consistently low, which means a not-so-healthy cash flow.
Your next step should be looking at the past few months’ accounts receivable aging reports, where you will notice that several of your customers are maintaining large balances in the 61-90 column—and beyond. The rule of thumb is that the older the debt is, the less likely you will be able to collect it. So that means:
1. You must attend quickly to customers who aren’t paying their invoices; and
2. your knowledge of your customers’ businesses and their personal situations, and their own cash flow problems are essential factors in how you go about collecting from them. For example, the pandemic might have slowed their business, or there may be family crises involved.
Obviously, bills due past the 90-120-day period are ready for referral to the collection agent. Whatever collections system you use is your general guide. You should let the circumstances and your knowledge of your customers guide your exceptions.
The bad news is that there are statutes of limitations varying by state limiting collections actions. The better news is that the IRS allows businesses bad debt tax deductions for, among other things, credit sales to customers.
“Generally,” according to the IRS, “a business bad debt is a loss from the worthlessness of a debt (resulting from..business..when it became partly to totally worthless.” So, you can deduct your bad debts from gross income when figuring out your company’s taxable income.
Accounts Receivable Aging indicates how well your cash flow serves your business operation. The AR Aging report is an accounting report used in the valuation of your company and can cause red flags in evaluating sales practices. The report is a matrix of customers with current and past due invoices.
Use the AR Aging report to measure and take corrective action on your debt collection practices, ranging from polite reminders to referring the past-due accounts to collections. You also can write the debts off and take bad debt tax reductions.
What Is Your Business Really Worth? Quantive Can Help…
You may not be planning an exit strategy, but there are other great reasons to get a professional valuation for your company. Quantive has done hundreds for clients seeking help with financial reporting, divorce matters, SBA loans, and more. Contact us and tell us how we can help.