How do you calculate aging accounts receivable?

Introduction

Accounts receivables are the receivables which a company is yet to receive from one of its clients for the product or service it provided. Accounts receivables aging is a method of accounting which that organizes the receivables of a company according to the due date.

The latest ones, which have the nearest date, are organized first, and then the accounts receivables which are due to be received later are listed at the end. So, basically, accounts receivables are organized according to the date, for which they are outstanding.

The accounts receivable aging is a very important accounting that helps to analyze the financial health of the company. If a company is slowed to receive accounts receivables, it has a high accounts receivables aging, which shows the company is selling its product or service on credit more than usual, which means it is taking on a serious financial risk, because if the company does not get paid, its cash flow may dry up, which may result in losses for the company, and even eventual bankruptcy.

Explanation

Aging Accounts receivables is a management and accounting tool which helps a company distinguish between clients which pay on time, and clients which are a credit risk to the company, because they pay their dues late.

The company then use accounts receivables aging to prioritize clients, and even refuse to sell to the clients their products or service which may possess a real credit risk for the company. It allows for the company to find doubtful accounts receivables, doubtful accounts receivables are those accounts receivables about which the company is not sure would either pay or not.

Example

Consider a company ABC, which supplies beef to two restaurants D and E. Restaurant D pays the accounts receivables within a month, whereas restaurant E pays accounts receivables after 3 months. The company ABC does a accounts receivables aging analytics and found out that Restaurant E possesses a higher risk because they pay their accounts after three months.

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The company ABC is facing some financial problems, and as a result drops restaurant E, because it cannot afford to wait three months to get paid. The company ABC’s financial position gets strong as a result of dropping a bad client. It also improved its service which resulted in the existing clients giving it more of its business.

This was all possible because the company performed an accounts receivable aging process. This helped the company ABC not only tide over a financial crisis, but also improve its quality of service, which resulted in the Company ABC gaining more business.

How to calculate aging accounts receivables?

The formula for finding aging accounts receivables is as follows:

Aging accounts receivables = (Average accounts receivables* 360 days)/ Credit Sales

The accounts receivables are based on sales which are done on credit.  The aging accounts receivables are calculated by multiplying average accounts receivables by 360 days.

Instead of multiplying it by 365 days, which are the number of days in a year, is done to avoid fractions in the calculations of aging accounts receivables. Then this is divided by the credit sales.

Advantages of aging accounts receivables

The main advantages of keeping aging account receivables are as follows:

  1. The company can identify which companies are late in paying their accounts receivables, and as a result can delay the sales to that company and prioritize other companies which clear their accounts receivables on time.
  2. The company by identifying which companies are late in clearing their accounts receivables can call or email them to get paid.
  3. Aging accounts receivables can also help identify clients which are in financial distress so they can stop selling them on credit to avoid any financial distress on their sides.
  4. It helped the company and its management identify make real informed decision about the at-risk clients and whether to deliver them goods or services or not.
  5. V) By calculating doubtful accounts, the company can also identify what amount to write-off from its balance sheet.
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Disadvantages of aging accounts receivables

The main disadvantages of aging accounts receivables are as follows:

  1. Hiring and paying professional for calculating, analyzing and maintain aging accounts receivables, which can cause a lot of money.
  2. Keeping aging accounts receivables requires meticulous attention to details. Any little mistake can create tensions with the client, which may result in the reduction or total loss of the business from that particular client.
  3. The company needs to maintain a difference between the management and the accountants because it causes real tensions to arise between the management and the accounting department.
  4. The aging accounts receivables maintenance can cause a lot of money, so it is always a good idea to think long and hard before keeping a aging accounts receivable journal.

Types of Aging Accounts Receivables

There are four main types of aging accounts receivables which are shown in figure 1 below:

Figure 1: Types of accounts receivable

There are four main types of aging accounts receivables which are shown in figure 1 above. The four main types of aging accounts receivables are which are a month old, more than a month old, two to three months old, and more than six months old. The details of both are given below:

1 month old

These are the accounts receivables which are only a month old. These are the least aged accounts receivables. The accounts receivable which usually pay within a month are mostly small and medium enterprises which clear their dues within days. This is because they are not priorities and would not get the necessary service or product if they do not pay early.

2 Months old

These are the accounts receivables which are older than a month, but still have not cleared the two months marks.

3 Months

This is the usual aging accounts receivable period for the companies which are working with huge companies such as GM. This is written in the contract and most of the accounts receivables are cleared within three months. The three months is the usual time period for the payment of accounts receivables.

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More than 6 months

These are the types of aging accounts receivables for which companies worry most. These are older than 6 months and may go up to even more than a year. The doubtful accounts receivables are taken from this type of aging accounts receivables. So, these should worry the company the most. Most of the time what happens in this type of aging accounts receivables is the company is facing serious financial distress or is about to go bankrupt. The company may have even gone bankrupt.

Frequently asked questions

What is aging calculation?

Aging calculation is a management and accounting tools which is used by the company to tabulate a company’s accounts receivables and accounts payables in term of date. The receivables are those which a company has yet to receive from its customers for the product or service it provided.

The accounts payable are those for which a company is yet to pay to its suppliers for the product or service it received. Both allow aging management calculations to analyze the financial viability of the company.

What is aging of accounts receivable?

It is the same as aging accounts payable, but in this case, the company tabulates what its clients owe to the company for the product or service which it had provided to its clients. The aging of accounts receivables allows the company to analyze its best and worst client.

The company can then prioritize the clients which pay on time, and delay the delivery to those companies which do not pay on time. This can also provide a leveraging tool to the companies to deal with clients whom are always late in paying their accounts receivables.

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