Accounts receivable (A/R) represent the money owed to a business by its customers for goods or services sold on credit. It’s essentially a line of credit extended by the company to its customers, who are expected to pay within a specified timeframe outlined in credit terms or payment terms. It is a crucial metric for businesses, but how to calculate accounts receivable? In this article, we will outline the process of calculating AR, by also specifying other terms involved in the process.
How to Calculate Net Accounts Receivable?
Net accounts receivable is a financial metric that represents the amount of money a company expects to actually collect from its customers after considering the possibility of uncollectible debts. It provides a more realistic picture of a company’s liquidity and credit collection efficiency compared to gross accounts receivable.
Calculation
Net Accounts Receivable = Gross Accounts Receivable – Allowance for Doubtful Accounts
Calculating Gross Accounts Receivable
Gross accounts receivable is the total amount of money owed to a business by its customers for goods or services sold on credit. It represents the entire credit sales figure, essentially reflecting the amount of money your customers owe you before considering the likelihood of actually collecting everything.
Gather Your Data
Locate your records of credit sales for the chosen period. This could be a sales report, customer invoice log, or accounting software.
Identify Relevant Sales Data
Focus on sales made on credit during the chosen period (e.g., month, quarter, year). Identify any instances where customers returned goods or received price reductions (allowances) on credit purchases.
Sum the Net Credit Sales
Subtract the total amount of sales returns and allowances from the total credit sales. This will provide a more accurate picture of your actual credit sales after considering these adjustments.
Formula: Net Credit Sales = Total Credit Sales – Sales Returns & Allowances
Other Important Accounts Receivable Terms
Average AR
Average AR is like an estimate of the typical amount of money you’re owed by these customers at any given time. A higher average AR might indicate you are making more credit sales. A lower average AR suggests you are collecting payments faster. Average AR is a starting point. It doesn’t consider the possibility of some customers not paying at all.
AR Turnover Ratio
The AR turnover ratio tells you how many times you sell and collect all the money owed to you (your accounts receivable) in a certain period, like a week or a month. It is the ratio of a company’s effectiveness in extending credit and collecting debts. The higher AR turnover ratio indicates that you are collecting money faster from your customers.
Average Collection Period (ACP)
The average collection period (ACP), also known as the Days Sales Outstanding (DSO), is a metric used to gauge how long it takes a business to collect payment for its credit sales on average. In simpler terms, it tells you how many days, typically, customers take to settle their outstanding invoices.
ACP (in days) = (Average Accounts Receivable / Net Credit Sales) x 365
Why is Calculating Accounts Receivable Important?
Calculating accounts receivable is a crucial part of accounts receivable management for any business. Here’s why it holds significant importance:
Tracks Outstanding Debts
AR acts as a real-time picture of how much money customers owe the business on credit purchases. This allows for better cash flow management as you understand the incoming funds you can expect from collections.
Identifies Potential Cash Flow Issues
A high AR balance might indicate delayed collections, potentially leading to cash flow shortages. By monitoring AR, businesses can take proactive measures like offering discounts for early payments or tightening credit policies to address potential shortfalls.
Credit Risk Assessment
Analyzing AR trends can help assess credit risks associated with different customers or customer segments. By identifying customers with a history of late payments, businesses can adjust credit limits or implement stricter terms for high-risk customers.
Collection Efficiency
Monitoring AR allows businesses to track their collection efforts. They can identify overdue invoices and prioritize collection activities for outstanding debts, ultimately improving collection efficiency.
Accounts receivable is an important aspect of any business. Additionally, effective management of AR helps maintain healthy relationships with customers by facilitating regular communication and follow-up regarding payment expectations. This process not only ensures financial health but also enhances customer service by addressing payment issues promptly and professionally.
A BPO company can play a pivotal role in enhancing accounts receivable management for businesses. By outsourcing AR processes to specialized BPO firms, companies can leverage expert knowledge and advanced technological tools that these providers offer. First Credit Services is a BPO company that specializes in accounts receivable management and brings extensive experience to the table. When working with FCS our team works within your accounting suite, allowing for seamless integration and real-time updates.
Additionally, First Credit Services excels in first-party collections, which involves collecting payments on due invoices before they become significantly overdue. This proactive approach not only ensures that the required amounts are collected within the specified period but also helps maintain a healthy cash flow and positive customer relationships.
Contact First Credit Services today for accounts receivable management services!
