Not all companies will find that growing sales lead to a positive cash flow situation. Companies may be earning well, but may not do so much financially if they have customers who are slow to pay their invoices. This is why it is essential to have an eye on the accounts receivable process in order to make sure that cash flows remain stable.
One of the best ways to handle the accounts receivable process is through the use of AR aging reports. These are one of the tools for making sure that companies can handle their collections better.
This guide explores what the AR aging report is, how to interpret the report, what to watch out for, and how to create an effective collections strategy using these reports.
What Is an Accounts Receivable Aging Report?
An account receivable aging report is a financial statement that classifies outstanding invoices of clients according to the duration they remain unpaid.
Unlike just showing the outstanding invoices, an aging report divides the receivables into time periods so that a business can know which clients are paying their bills and which should be followed up.
An aging report shows the status of outstanding amounts and helps a company evaluate the condition of its receivables.
Why Is an AR Aging Report Important?
An aged report will give you insights into how your customers make payments and will help you find any cash flow problems before they cause trouble to your business.
Advantages of having an AR aged report review on a regular basis are:
- Cash flow forecasting improvement
- Collections improvement
- Less bad debt risk
- Payment tracking improvement for customers
- Financial planning improvement
- Credit decision making improvement
Overdue invoices may start piling up without regular monitoring.
Understanding the Structure of an AR Aging Report
The majority of aging reports categorize unpaid invoices according to the number of days outstanding.
Categories of invoices include:
Current
These are invoices which have not yet fallen due.
The balances in such an account are usually good receivables and no action is required.
1-30 Days Outstanding
These are recent invoices which have fallen due.
This could be the first step towards collecting these invoices.
31-60 Days Outstanding
Invoices which have been left unpaid for over a month.
These are invoices which may need extra work and communication from the customer.
61-90 Days Outstanding
Such balances show increased risk in collection.
It is important to pay close attention to such invoices.
Over 90 Days Outstanding
These are invoices which have been outstanding for over 90 days and pose the greatest risk of bad debts.
Such invoices will need action to be taken.
How to Read an AR Aging Report
More is involved in reading an aging report than checking totals.
Companies should analyze an aging report to discern trends, risks, and areas for collections.
Review Total Amount of Outstanding Receivables
Begin by assessing the total amount of customer receivables.
This will give you a basic idea of receivable risk and cash flow.
Analyze Aging Categories
Check where the balance stands in each of the aging categories.
A good receivables portfolio will have the majority of the balance falling under the current category.
Balances found in the higher aging categories are indicative of collection problems.
Highlight High-Risk Customers
Identify customers with:
- Highly overdue receivables
- Late payments on several occasions
- Receivables in several aging categories
- Long payment delay periods
Trends in Time
Compare aging reports month after month and quarter after quarter.
Increasing amounts of overdue receivables can point to possible collection problems.
Key Metrics to Monitor in an AR Aging Report
There are several ratios that could help companies assess their receivables management better.
Percentage of Current Receivables
High percentage of current receivables is typically a sign of good receivables management.
Percentage of Overdue Receivables
This ratio shows what share of total receivables is overdue.
Higher ratios may suggest increasing receivables collection risks.
Aging Concentration
Very high levels of balances that concentrate in old categories indicate poor receivables collection.
Customer Payment History
Check payment history of specific customers to detect the problematic accounts.
Signs of Problems That Could Be Detected via an AR Aging Report
An AR aging report could give companies advance notice about financial and managerial problems.
Increasing Accounts in Old Categories
If there is an increasing tendency for invoices to be shifted to 60-day, 90-day, and even higher categories, then receivables collection problems may arise.
Customer Payment Delays
Late paying customers may have increased credit risks.
Big Concentration With Limited Number of Customers
Being dependent on few customers may be dangerous for companies.
Increasing Total Receivables
Rapid increases in total receivables may indicate receivables collection problems.
How to Build a Collections Strategy Using Aging Reports
An effective collections strategy should be driven by aging report data.
Instead of using the same approach to recover money from all overdue debts, companies can concentrate on the accounts depending on their aging and risk factors.
Work on Recently Overdue Debts
Recently overdue invoices are relatively easier to collect.
Prompt follow-up prevents accounts from getting older.
Collection efforts might include:
- Polite reminder letters
- Email reminders
- Friendly calls
Quick action will help improve the result of collecting payments.
Increase Effort for Aging Debts
The more the aging of invoices is advanced, the more serious collection efforts should be applied.
For example:
- Sending a formal letter
- Getting the management involved
- Discussing a payment plan
Increasing effort will show customers how important it is to pay on time.
Prioritize Large Debts
Large balances can affect cash flow significantly.
Therefore, companies should concentrate on collection activity based on aging and dollar value.
Watch Customers with Late Payment Pattern
Sometimes customers need new credit terms because of their payment history.
Best Practices for Improving Collections
A good collections process is not just about pursuing past-due invoices.
Businesses must put in place a process that promotes prompt payments right from the start.
Invoicing Right Away
Late invoices will usually result in late payments. Invoicing must be done immediately after delivery of goods and/or services.
Specify Clear Payment Terms
It must be known by your customers when and how they must pay.
Implement Automated Reminders
Automated reminders can minimize missed payments and inconsistencies.
Provide Various Payment Methods
Providing multiple payment methods can make it easier for customers to pay you promptly.
Keep Follow-up Consistent
Following up consistently can greatly improve collections success. Consistency is far more effective than tough collection measures.
How AR Aging Reports Support Cash Flow Management
Cash flow continues to be one of the topmost indicators of the health of any organization.
The account aging analysis provides useful information that will help in planning for cash flows.
Improves Forecasting
An organization can forecast future cash flows from existing receivables.
Helps Identify Cash Flow Problems
Any rise in outstanding receivables can be an indication of problems with cash flows.
Useful for Financial Planning
Information on aging will assist the management in making appropriate decisions about finances.
The regular aging of accounts receivable will help in improving visibility.
Common Mistakes Businesses Make With Aging Reports
Even though there is an availability of aging information, many companies do not make full use of this data.
These mistakes are:
Checking the Report Rarely
Companies with many invoices cannot afford monthly reviews.
Not Taking Action On Overdue Invoices
It is pointless to have an overdue invoice identified but no action taken.
Considering all Customers Equal
Various customers need different methods of collection.
Neglecting the Financial Standing of the Customers
Recurrent delayed payment indicates a larger problem. Such avoidance will increase chances of effective collections and cash flow.
AR aging report is among the most important things to help in accounts receivable management and protection of the cash flow. With the help of categorizing the unpaid bills, companies will be able to discover how much money is past due, analyze the behavior of their customers and collect payments.
By using an aging report along with a good collection policy, a company will be able to lower its bad debts, predict cash flow, improve customer payment performance and achieve financial stability. Get professional help with your accounts receivable by contacting The Fino Partners today.
