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Accounts Receivable Aging

A management tool used by accountants to evaluate the accounts receivables and identify existing irregularities

What is Accounts Receivable Aging?

Accounts receivable aging refers to a management tool used by accountants to evaluate the accounts receivables of a company and identify existing irregularities. The aging method categorizes the receivables based on the length of time an invoice’s been due to determine which customers to send collections and who to target for follow-up invoices.

 

Accounts Receivable Aging

 

Aging the accounts receivables sorts the unpaid customers and credit memos by date ranges such as due in 30 days, due in 31 to 60 days, and 61 to 90 days. The aging report itemizes each invoice by date and number. The management uses the information to determine the financial health of the company and see if the company is taking too much credit risk than it can handle.

 

How Management Uses Accounts Receivable Aging

Below are a few ways that the management can use the accounts receivable aging report:

 

1. Collection practices

One of the ways that the management can use accounts receivable aging is to determine the effectiveness of the company’s collections function. If the aging report shows a lot of older receivables, it means that the company’s collection practices are weak.

Some customers tend to not pay their invoices when they are due, and they may wait until the second and third invoice reminders to settle their outstanding balance. If some customers are taking too long to settle pending invoices, the company should review the collection practices so that it follows up on outstanding debts immediately they fall due.

 

2. Credit risk

The accounts receivable aging report can also indicate which customers are becoming a credit risk to the company. Older accounts receivable expose the company to insolvency due to the risk that the debtors may be unable to pay the invoice.

If the report shows that some customers are slow payers than others, the company may decide to review their billing policy or stop doing business with such customers who are chronically late payers. The management may also compare its credit risk against industry standards to determine if it is taking too much credit risks or the risk is within the allowed limits in the specific industry.

 

3. Allowance for bad debts

The management may also use the aging report to estimate potential bad debts during the reporting period. The management evaluates the percentage of an invoice dollar amount that becomes bad debts per period and then applies the percentage to the current period’s aging reports.

For example, assume that Company XYZ allows for a 1% bad debts allowance for the 0 to 30 days period and 3% bad debts allowance in the 31 to 60 days period. In the current period, the company reports $100,000 debts in the 0 to 30 days period and $50,000 debts in the 31 to 60 days period. It means that the allowance for bad debts is $2,500 based on the following calculation:

Allowance for Bad Debts = [($100,000 x1%) + ($50,000 x 3%)]

= $1,000 + $1,500

= $2,500

 

Accounts Receivable Aging Reports

An aging report provides information about specific receivables based on the age of the invoices. It gives the management a better overview of the company’s receivables portfolio. It groups outstanding invoices based on the duration they’ve been due and unpaid.

 

Main Categories of an Aging Report

  • Current: Invoices that are due immediately.
  • 0 to 30 days: Invoices that due within the next 30 days.
  • 31-60 days: Invoices that are 31 to 60 days past their due date.
  • 61- 90 days: Invoices that are 61 to 90 days past their due date.
  • Greater than 90 days: Invoices that are more than 90 days past their due date.

 

How an Aging Report Works

An aging report is used to show the outstanding customer invoices and the number of days they’ve been outstanding. If the company’s billing policy is to allow customers to pay for products and services in the future, the aging report allows the company to keep track of the invoices when they are due so that the customers can pay them promptly.

The aging report also shows the total invoices due for each customer when grouped based on the age of the invoice. The company’s management should generate an aging report once a month so that they know the invoices that are coming due so that they can notify customers of invoices that are past the due date.

 

Possible issues in Account Receivable Aging Reports

Although an accounts receivable aging report helps the management know the financial state of the company, it may provide information that is misleading depending on the time when the aging report is generated. For example, most companies bill their customers towards the end of the month, and the aging report is generated days later. It means that the report will show the previous month’s invoices as past the due date, thereby portraying some customers as being unable to pay.

Also, generating the report before the month ends will show fewer receivables whereas, in reality, there are more receivables pending payment for the company. The management should match their credit terms to the periods of the aging reports to get an accurate presentation of the accounts receivable.

 

Related Readings

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Cash Conversion Cycle
  • How to Record Payment in Accounting
  • Sales and Collection Cycle
  • Top Accounting Scandals

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