Accounts receivable aging report - everything you need to know
Many business owners know the headache that comes from a backlog of unpaid invoices. An accounts receivable aging report can help you organize your collection process and provide insight into the overall financial health of your company.
This article will help you understand how to use an aging report and provide some helpful tips on how to optimize the collection practices of your small business.
What is an aging report?
An accounts receivable (AR) aging report tells you how long an invoice has been due for payment. The AR aging report will summarize all of your unpaid invoices and include data that indicates how much the customer owes and how much time has elapsed since their due date.
Why it's important to manage accounts receivables
First, it's important to remember the distinction between accounts receivable and accounts payable (AP). Accounts payable refers to the money you owe to others, while accounts receivable refers to the debts others owe your company. For small business owners, your accounts receivables are usually in the form of customer debts.
In a perfect world, every client would pay their bills on time. But according to a 2021 survey by Melio and YouGov, 25% of small business owners say that they don't get paid until 20-30 days after the payment due date listed on their invoice.
This slow payment is problematic since roughly one in three small businesses (30%) say that these outstanding invoices create cash flow problems that jeopardize their ability to remain in business.
How an AR aging report helps
These figures might seem daunting, especially if you're dealing with multiple unpaid customer invoices. How do you prioritize your collection processes?
That's where the accounts receivable aging report comes in. The AR aging report helps you get organized, allowing you to identify which invoices you want to tackle. For example, placing greater priority on high-dollar-amount invoices can ensure that your business maintains a healthy cash flow.
Accounts receivable aging reports are also useful in helping you evaluate your overall invoicing processes. If you're experiencing cash flow issues resulting from late payments, it may be time to reevaluate your payment terms to find a way to encourage your customers to pay promptly.
How to prepare accounts receivable aging reports
Hopefully, you're already using accounting software to manage your company's accounts receivables and other crucial business data. Invoice2go, a Bill.com company provides various business reporting tools that you can use to evaluate your finances and stay on top of your company's cash flow.
Of course, it's always good to know how to prepare your own accounts receivable aging reports. The following steps will help you create your aging reports so you can better evaluate your company's financial health.
Make a list of all open invoices
Start by simply compiling a list of all open invoices. You don't have to be super-detailed with your list, but make sure to include such data as:
- Customer name
- The amount of each invoice
- Invoice date
Keep your customer invoices grouped together, as this will be important in a later step. In other words, if you have multiple pending invoices for Company X, then you can group these invoices together for now, though you'll organize them by the due date in the next step.
Create an aging schedule
This insight may sound obvious, but not all of your outstanding invoices are necessarily past due. You'll have to review invoices from each client and organize your accounts receivable aging report based on the aging schedule.
What is the aging schedule? An aging schedule shows the due dates for your invoices. Typically, an aging schedule is organized around a range of dates rather than specific deadlines. A common aging schedule might include the following date ranges:
- Current (Invoices due immediately or upon receipt)
- 1-30 days (Invoices due within the next 30 days)
- 31-60 days (Invoices that are more than 31 days overdue)
- 61-90 days (Invoices that are more than 61 days overdue)
- 91+ days (Invoices that are more than 91 days overdue)
These date ranges are suggestions, of course, but most companies will find it easiest to deal with 30-day increments.
When you create your accounts receivable aging report, you'll create a series of columns, each column representing a different range from your aging schedule. You'll put the name of each customer along the left side, and you'll fill in the amount they owe in the next step.
Organize your invoices according to their due dates
After completing the aging schedule step, you're ready to start filling in your accounts receivable aging report. Start by ensuring that all of your customers are represented along the left side of your chart, then review each invoice and place the dollar amount in the column that corresponds to their due dates.
For example, if Company X owes you $100 and its due date was six weeks ago, you'd put "$100" in the column marked "31-60," indicating that the client's invoice is now more than 30 days past due.
If you have more than one invoice for each client, you'll put the total amount they owe in each column. So again, if Company X owes you $100 for two invoices that are both six weeks old, you'll put "$200" in the "31-60" column. Likewise, if they have one 6-week-old invoice and one 95-day-old invoice, you'll put "$100" in the "31-60" date range and "$100" in the "91+" column.
Identify which accounts are past due
Once you start filling in data, your accounts receivable aging report will start to make more sense. You'll be able to visualize your invoice timeline and more quickly identify overdue accounts.
More specifically, your AR aging report will help you pinpoint the accounts that have missed their payment deadline. Remember, your aging schedule allows you to identify invoices that are still pending, so you'll need to focus on customers who have missed their payment deadline.
Calculate the total amount past due
Next, you may need to determine the total amount past due. To clarify, you'll want to calculate the total for each client, not the total for your business as a whole. To do this, add up the total dollar amount in every column representing an overdue invoice.
If you assess any late fees or penalties, you'll also add these figures to create the grand total. When you contact your clients, you'll need to present them with this grand total, as well as support this figure with details from their past invoices.
Organize outstanding invoices according to the amount past due
Record the customer totals in the last column, to the right of your "91+" date range. Now, you can reorganize your list based on the amount that your customers owe you, which instantly creates a prioritized list. Pursuing clients who owe you larger amounts can help you avoid the kind of cash flow problems that can stall out your business.
Review your aging report periodically
Plan on reviewing your accounts receivable aging report at least once a month. Unless customers pay their bills, you'll need to make adjustments to where their outstanding debts fall on your aging schedule. You may also have additional clients to add to your report to better monitor your financial processes.
How to use an accounts receivable aging report
Like all of your financial statements, you can use the accounts receivable aging report to identify existing irregularities and promote healthy cash flow. Here are just a few things you can do with an accounts receivable aging report:
Follow up with clients
One of the most practical things you can do with an accounts receivables aging report is follow up with clients who have overdue balances. You might consider sending follow-up invoices or simple payment reminders, though you may also need to take stronger action if these initial efforts prove unsuccessful.
Calculate your average collection period
Your average collection period is a ratio that identifies the average number of days it takes to collect payments from your customers. To find this ratio, complete the following steps:
- Multiply your average accounts receivable by the number of days in your accounting period
- Divide this number by the number of credit sales in one day
A lower collection period is usually preferred over a long one. If you find that your collection period is long, you might want to take steps to encourage your customers to submit timely payments.
Estimate bad debts
Bad debts are those that a company determines to be uncollectible. You can use your aging reports to estimate the amount of money lost to bad debts for each accounting period.
For instance, you might allow for the following bad debts:
- 0% for the first 30 days
- 5% for days 31-60
- 10% for days 61-90
- 15% for days 91+
You can typically use previous reports to determine the historical percentage of invoice dollar amounts for each date range that results in bad debt.
By estimating bad debts, you can adjust your allowance for doubtful accounts, which basically means you'll determine how much money you're prepared to lose on unpaid bills.
What to do about overdue accounts
After surveying your accounts receivable aging report, you might note a frequent pattern of outstanding balances. What can you do to avoid these credit risks and evaluate the effectiveness of your collection functions?
Incentivize early payments
You can avoid late payments by encouraging your customers to pay early. For instance, you might offer your clients a 10% discount if they pay within seven days of receiving their invoice. Granted, this reduces your total profits, but it may be worth it to have the working capital now instead of waiting for an outstanding bill.
Penalize late payments
Conversely, you can charge late fees for overdue invoices. Charging 10% to 15% for late payments might encourage your clients to take you more seriously. Make sure to specify these penalties under your invoice's payment terms, and be upfront about these policies when forming a relationship with your client.
Contact a collections agency
If you send a few payment reminders to your client and still haven't heard back, it may be time to turn their bill over to a collection agency or an invoice factoring company. While you'll have to pay for the service, you'll stand a better chance of collecting your debt without having to invest your own time in tracking down delinquent payments.
Adjust your credit policies
While you might make an allowance for doubtful accounts, a consistent pattern of late payments might reveal potential credit risks to your company. You might want to reevaluate your credit policy and see how your credit risk stacks up against industry standards. Too much credit risk can jeopardize your cash flow and leave you vulnerable to bad debts.
Data you can bank on
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Frequently asked questions
Here are answers to common questions about aging reports:
The IRS allows you to deduct the cost of bad debt from your annual income tax returns. However, the IRS will also expect you to demonstrate reasonable attempts to collect this debt, so you'll need to save any emails, letters, or other correspondence with the client.
Credit memos act as a kind of payment or reduction. If the client hasn't applied this credit memo to a particular invoice, you can reduce it from their grand total, though you'll need to contact your client to ensure they understand this process.
Most businesses give their customers 30 days from the time of receiving the invoice. If the customer pays in this time frame, you'll have no need to contact them further. Otherwise, you'll need to pursue your clients to prompt them to submit payment.