How to Perform an Accounts Receivable Analysis

Why perform an accounts receivable analysis 

How do you know if your A/R accounts are considered good? The easy way of determining is by answering the question, “How likely is it that this customer will pay me and pay me on time?” Most accounts receivable departments know to weigh several factors, including payment history, size of the debt, and length of the business relationship, when asking this question on a client-by-client basis. 

For example, if you have a customer that you’ve done business with for a decade and rarely makes late payments, you can consider them reliable and feel comfortable making business decisions that count on that account being paid in full. On the other side, young or unreliable accounts are considered contra-asset accounts, which are typically designated with a zero or negative balance to account for their questionable status and reduce the number of variables on your balance sheet. Contra asset accounts can be considered bad debts; the fewer you have, the better.

An accounts receivable analysis provides qualitative data that give clear-cut answers to questions like: 

• How quickly do my clients pay their invoices? 
• How efficient is my business at collecting on the credit we extend to our customers?
• Where does my company stand financially daily, monthly, and yearly? 
• How frequently do accounts and invoices become delinquent?
• Are we offering too much or too little credit to particular clients?

… and many more. An account receivable analysis allows you to look at the bigger financial picture across all of your clients, their payments, and their outstanding debts. It also helps pinpoint areas that can be improved internally, within your accounts receivable department.

How to perform a quantitative account receivable analysis

There are several ways to investigate which of your accounts are reliable and which may need adjustment. These widely accepted formulas can be used to establish key performance indicators for A/R operations. They will measure and track liquidity, efficiency, profitability, and more and give an easy-to-digest view of performance.

Average Collection Period

The average collection period measures the time it takes for a business to receive payments. It is usually used to track the amount of cash available on hand and is best used by companies that require a healthy cash flow.

Average Collection Period Formula:

A/R Balance/Total Net Sales (x 365)

Average Collection Period Example:

A company records a yearly A/R balance of $100,000 and logs $300,000 in net sales. You would calculate the average collection period as:

100,000/300,000 (x365) = 121.67

Accounts Receivable Turnover

Accounts receivable turnover reflects how often a business collects its average accounts receivable per year. It is a measure of how efficiently you collect on the credit provided to customers.

Accounts Receivable Turnover Formula:

Net Credit Sales/Average Accounts Receivable

A/R Turnover Example:

A company, after returns, has net credit sales of $150,000, and the average accounts receivable for a year is $25,000.

150,000/25,000 = 6

Days Sales Outstanding (DSO) 

Days sales outstanding show the average number of days it takes to collect payment on an account. It shows if a company is extending too much or too little credit to customers.

DSO Formula:

(Total A/R / Total Credit Sales) x Number of Days

DSO Example:

For 30 days, a company has a total A/R of $500,000 and extends credit on sales worth $250,000.

(500,000 / 250,000) x 30 = 60

Collection Effectiveness Index (CEI)

Collection effectiveness index measures how effective you are at collecting on customer accounts. It’s a more precise measurement than DSO; the two are often grouped together.

CEI Formula:

(Beginning Receivables + Monthly Credit Sales – Ending Total Receivables) / Beginning Receivables + Monthly Credit Sales – Ending Current Receivables) x 100

CEI Example:

For 30 days, a company begins a month with $500,000 in sales, extends $100,000 in credit sales, and ends the month with total receivables of $200,000 and has current receivables of $300,000.

(500,000 + 100,000 – 200,000) / (500,000 + 100,000 – 300,000) x 100 = 88.9

Bad Debt Ratio  

Also called the write-off rate, the bad debt ratio shows how much accounts receivable cannot be collected. It can also indicate when you should monitor the extension of credit to certain customers. In very general terms, debt ratios of .4 (40%) or lower are considered satisfactory.

Bad Debt Ratio Formula: 

(Uncollected sales/yearly sales) x 100

Bad Debt Ratio Example:

Over a year, a company can collect $100,000 in revenue but cannot collect $7,000. 

(7,000 / 100,000) x 100 = .07 = 7%

Additional accounts receivable analysis reports & insights

Aging Reports

An aging report gives you an overview of the amount of time that has elapsed since the original invoices were sent out. These reports typically “bucket” invoices into different ranges, with the standard ranges being 0-30 days, 31-60 days, 61-90 days, and 90+ days.

Aging reports generation comes standard with most modern accounts receivable automation software. Whether you create your own aging report or your software does it for you, many companies send out dunning notices (either manually or automatically) when a client passes each delinquency increment. 

Trend Analyses

Plotting a trend line that shows your outstanding account receivable balance at the end of each month for your past year of sales can help you predict and plan for seasonal variations in revenue as well as allow you to compare a percentage of bad debt vs. sales over time. A trend analysis is especially useful for raising the red flag on issues long before they become serious. 

As with aging reports, most accounts receivable automation solutions provide a trend analysis report as part of their analytics capabilities.

Accounts receivable analysis KPIs

After you conduct your accounts receivable analysis, it’s important to benchmark the metrics you measured above to monitor for improvements or issues over time. Keep track of your average collection period, accounts receivable turnover ratio, DSO,  CEI, and bad debt ratio as you implement changes. These key performance indicators (KPIs) will tell you whether any updates you’re making are working or if you need to make additional changes to your processes. 

Invoiced: Improve Your Insights & Cash Flow with Automated Accounts Receivable Software

The Invoiced platform makes keeping track of the metrics that surfaced in your accounts receivable analysis simple, accessible, and actionable. Our software includes aging reports, cash flow forecasting, and many more analytics capabilities, making it easier to plan for your next month, quarter, or year. 

If you are having problems maintaining a consistent cash flow, Invoiced can help. We’ve helped customers in dozens of industries automate their A/R operations and get paid quicker while using fewer resources.

Ready to get paid faster? Check out our accounts receivable automation software and schedule a demo today.