Accounts Receivable Analysis
A Guide to Understanding Trade Debtors for Business Owners
A business consultant is often tasked with analyzing a company’s financial performance in order to initiate performance improvement. Analyzing a company’s financial performance definitely includes performing accounts receivable analysis.
Accounts receivable, otherwise known as trade debtors or AR or A/R, is a type of working capital that refers to amounts from which business owners have yet to receive from their customers for goods sold. Receivables are a result of business owners extending credit to their customers. The amount of accounts receivable, which is an asset on a company’s financial report, depends on the number of customers the company has, the volume of the company’s sales and the amount of credit extended to its customers.
Collection of accounts receivable or debt collection is an important source of a company’s cash flow and business finance. As such, learning about accounts receivable analysis can prove vital for business owners.
Types and Calculation of Accounts Receivable
There are mainly two types of accounts receivable:
- Current debts
- Debts that are past due
Past due debts are accounts receivable that are overdue for payment from the customers. For example, a sale of $100 made on 15 January 2010 to customer ABC with credit terms of 30 days means that as of 31 March 2010, the amounts are past due and there is a required debt collection of $100.
In order to calculate a company’s accounts receivable, the business owner first has to maintain an accounts receivable subledger. The subledger will list all debtors and age the debts according to the respective sub-categories (current, 0-30 days, 30-60 days etc).
The longer an accounts is unpaid by the customer, the harder it becomes to collect for the business owner. Sometimes, not all debts are collectible, such as in the event of a customer's failing business. In such instances, the company has to make an allowance for doubtful debts, which will be charged to the income statement. Sometimes, it can be proven outright that a customer will not make payment, such as in event of bankruptcy of the customer with no recourse for creditors. In such cases, the amount is directly written off to the income statement.
Accounts Receivable Analysis and How Companies Analyze their Receivables
Trend analysis is often used to analyze accounts receivable and other working capital figures to identify significant changes in the company’s operations and financial accounts. When using trend analysis, the business owner may use various sources of information from the business, its competitors, and peer companies, industry averages, and other relevant information such as industry benchmarks. Trends could also vary depending on the nature and principal activity of the business venture, such as an e-commerce outlet or a high-tech biotechnology venture.
Trend analysis over a period of time provides information that is useful in evaluating operating performance and assessing the current year’s expected condition of a Company’s accounts receivable and efficiency of debt collection. This can be done either over a two year or five year period, depending on the extent of information required for the analysis. Learn how to make income statement projections for business plans in a related article. Also learn about balance sheet projections for business plans in another article.
Sample Analysis of Accounts Receivable for Business Owners
- Compare sales by major customers against prior periods.
- Compare the related debt collection periods with prior periods.
- Compare current-year’s to prior-year’s allowance for doubtful debts, write-offs, and related expense as a percentage of accounts receivable and sales.
When performing comparisons over years, certain trends may be distorted by non-recurring items such as:
- Changes in customers preferences or business strategies.
- Restructuring or acquisition of new business units.
- Accounting changes.
- Credit crunches or economic depressions affecting debt collection.
- Unusual accounts receivable charges.
As such, care must be taken to factor these items in a business' considerations when performing accounts receivable analysis.
The analysis can also be performed against budgets. In such instances, the business owner should:
- Compare actual sales with forecasts of industry sales.
- Compare actual accounts receivable collected and/or with forecasted sales.
- Compare actual allowance for doubtful debts against expected allowances.
Accounts Receivable Ratio Analysis
Ratio analysis is a popular method of enhancing our understanding of the company’s accounts receivable holdings and assessing its overall financial condition and profitability as well as efficiency of debt collection. It provides a quick insight into significant changes in the client’s operations or accounts receivable characteristics. Activity ratios measure how effectively a company uses its available resources.
Key Accounts Receivable Activity Ratios
Accounts receivable turnover = Sales / Average Accounts receivable
Average age of accounts receivable/ collection period = 365 days / Accounts receivable Turnover
Accounts receivable turnover or AR turnover is an overall indicator of credit management and of the liquidity of a company’s accounts receivable. Business owners should compare accounts receivable turnover and age with prior periods and budgets. A current accounts receivable turnover rate that is much slower than prior years or is slower than competitors’ could indicate inefficient debt collection or bad debts.
As such, an increasing average collection period of receivables indicates that necessary steps should be taken to increase efficiency of debt collection and to tighten the company’s credit policy. However, ratio analysis should not be conclusive or used in isolation. Although a high accounts receivable turnover may indicate efficient debts collection it also may indicate that the private company could be having excessively aggressive credit policy which may frighten off existing and future customers.
Debt Collection
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