Accountants use accounts receivables aging as a management technique to evaluate a company’s accounts receivables and find out existing irregularities. The accounts receivables aging report is an essential comparison and strategic financial mechanism that shows outstanding amounts of receivables for a period of time.
The accounts receivables aging method categorizes the receivables based on the range of time an invoice is due. The account receivables aging method sorts the unpaid invoices by date and number, and management uses the aging report to determine the company’s financial well-being.
Formula to Calculate Aging of Accounts Receivables
Aging of Accounts Receivables = (Average Accounts Receivables*360 Days)/Credit Sales
Accounts Receivables aging is used to reflect a company’s ability to recover its credit sales in a certain accounting period. If the average age of accounts receivables is large, its ability to recover credit sales is worse.
Accounts receivables aging is the time period from when sales are realized, and accounts receivables are created to the balance sheet.
Aging is considered the most important information when analyzing accounts receivables with ages above an appropriate number of turnover days that will negatively affect a company’s operations.
Types of Accounts Receivables Aging
Under Generally Accepted Accounting Principles (GAAPs), there are two types of accounts receivables aging:
- Up to 6 months accounts receivables and
- Greater than 6 months accounts receivables.
Accounts Receivables Aging Report
An aging report groups outstanding invoices based on the age of the invoices. The report provides the management team an overall picture of the company’s receivables portfolio.
The main categories of an aging report are:
- Current: Invoices which are due immediately.
- 0 to 30 days: Invoices due within the next 30 days.
- 31-60 days: 31 to 60 days invoices that past their due date.
- 61-90 days: 61 to 90 days invoices that past their due date.
- Greater than 90 days: Invoices more than 90 days past their due date.
How an Aging Report Works
An aging report is used to show outstanding customer invoices that show an outstanding number of days. If a company’s billing policy allows customers to pay for products in the future, then the aging report allows the company to monitor the customer invoices.
The company’s management should generate aging reports monthly to know about the due invoices and notify customers accordingly.
How to Use an Aging Report
The aging report is an essential tool to estimate potential bad debts used to revise allowance for doubtful debts. The general method is to derive the historical percentage of invoice dollar amounts and apply the percentage total columns of the aging report.
For example, an entity historically experiences 1% bad debts on items in its 30 day time period, 3% bad debts in its 31-60 day time period, and 10% bad debts in its 61+ day time period. In its most recent accounts receivables aging report, the balance is $300,000 in the 30 day time period, $200,000 in the 31-60 day time period, and 100,000 in the 61+ day time period. Based on the information, the company should have an allowance for doubtful debt, which is:
($300,000*1%) + ($200,000*3%) + (100,000*10%) = 19,000
Additional use of the aging report is to view the current payment status of outstanding invoices to see the customer’s credit limits. The credit department may review the invoices that have been paid by using the aging report. The company’s auditors may use the report to select invoices for issue confirmations as part of their year-ending audit activities.
Structure of Aging Report
An aging report lists invoices in 30 day time period where the columns contain the following information:
- The left column contains all 30 days old invoices.
- The next column contains 31-60 days old invoices.
- The next column contains 61-90 days old invoices.
- The final column contains all old invoices.
The aging report is generated by accounting software to structure the report for a different date range. The report contains invoices and credit memos that customers have not used.
Possible Problems in Aging Report
Although an aging report helps management monitor the company’s financial state, sometimes it may provide misleading information depending on the time of generating the aging report.
For example, there are fewer receivables in the aging report created before the month-end, but there are more receivables payments for the company. The company’s management should match their credit terms with the periods of the aging report to get a clear picture of the accounts receivables.
Formation of Aging Report
Under the accrual basis accounting method, accounts receivables are recorded when a company invoices its customer. All amounts in the aging receivable report are prepared based on some of the amounts invoiced to customers.
A critical situation that should not be overlooked is every invoice contains specific payment terms to customers, and some customers are applied to discounts or early payment benefits. These conditions should be considered while preparing the report.
Accounts Receivable Age Grouping
Several types of accounts receivable age grouping are classified below:
- Current Accounts Receivables Group: Receivables are paid timely according to a predetermined maturity.
- Non-current Accounts Receivables: Receivables whose payments exceed predetermined maturity date although the collection is active.
- Bad debt group: In addition to classifying accounts receivables age group companies should also estimate the probability of bad debts groups whose payments are due.
What is Aging Schedule and How Does it Works
In an aging schedule, accounts receivables are broken down into age categories, indicating the total outstanding receivables balance. The aging schedule shows the relationship between unpaid invoices and bills of a business with their due dates. The aging schedule is used to determine which clients are paying on time and may also estimate cash flow.
Many accounting software packages help in preparing the aging schedule automatically. Companies may face financial issues if it has so many accounts payable. Due to unpaid accounts company’s bottom line will be affected. An aging schedule helps companies to keep well-informed of accounts receivables in the hope of reducing doubtful debts.
How Aging Schedules Are Used
To Adjust Credit Policies
The aging schedule is used to identify customers with due payments. If a large amount applies to a single customer, the company should take the necessary steps to collect the customer’s due payments soon. When there are customers with overdue amounts beyond 60 days, it is required to tighten the credit policy.
To Identify Cash Flow Problems
The aging schedule may identify recent changes in accounts receivables, which may protect your business from cash flow problems.
To Calculate Allowance for Doubtful Debts
The aging method is used to estimate the number of doubtful debts, which includes the approximate amount of uncollected receivables. The general rule is when accounts receivables remain outstanding for a long period of time. There are fewer chances of its collection.
Advantages of Aging Report
- A company can identify those receivables who delay the payments and avoid to sell goods on credit to them for delaying the payment.
- To ensure timely payment, an entity can contact customers by calling them or sending email whose payments are due in the next period.
- A company can get many relevant information like sales transactions, receivables amount etc. from the aging report.
- To avoid delay payments a company can change their credit period policy for specific customers based on the aging report.
- A company can decide which customers should be avoided for credit sales by using the aging report.
- The aging report can help management in taking decisions related to sales.
- The aging report is useful in determining the allowance for doubtful accounts and total amount to be written-off.
Disadvantages of Aging Report
- A company has to bear a major part of its costs and time on the reporting of accounts receivables aging. The company has to hire separately skilled manpower to do the task of preparing aging report.
- A company has to prepare aging report on daily basis to identify higher accounts receivables and contact them for overdue payments.
- If management generate wrong aging report it will be harmful for the company’s reputation as collection manager may call to wrong accounts receivable whose payments are not due.
- The aging report should be accurate with proper information otherwise it will increase the cost of the company as the company needs to hire separate management staff for the aging report.
- Another problem is many companies raise invoice in month-end and prepare aging report days later. Outstanding payment will be reflected in the report even when payments for some bills will be received in next few days.