Calculating net accounts receivable holds a pivotal role, especially for enterprises extending credit to customers. It offers a transparent view of the anticipated amount a company expects to receive, factoring in allowances, discounts, and doubtful debts. Regularly conducting this assessment is crucial, providing businesses with an accurate understanding of their cash flow.
In this blog, we aim to demonstrate the steps in calculating net accounts receivable, its importance, and strategies to improve it.
What is Net Accounts Receivable?
Net accounts receivable is the total amount of money customers owe a company. It shows what the AR team expects to collect within a specific timeframe. Understanding the formula is just the start; managers must use this information to enhance collection efforts. This metric is a key tool for ensuring the company gets the money it’s owed. By tapping into its potential, managers can boost the effectiveness of their collection strategies and improve overall financial health.
Benefits of Calculating the Net Accounts Receivable
Calculating the net accounts receivable is a crucial financial practice that contributes to better financial management, informed decision-making, and overall business resilience. Listed below are some of the benefits:
Accurate Cash Flow Management
Provides a clear picture of expected cash collections, enabling more precise cash flow projections and helping businesses plan for expenses and investments.
Enhanced Financial Decision-Making
Empowers executives to make informed decisions about critical aspects such as payroll, expansion, innovation, and credit, based on a realistic understanding of the company’s expected cash position.
Reduced Reliance on Credit
Enables businesses to minimize their reliance on credit by having a better grasp of anticipated cash inflows, reducing the need for last-minute borrowing, and avoiding potentially costly financing options.
Improved Vendor Relationships
Helps build stronger relationships with vendors by allowing businesses to predict and manage payments more effectively. This can lead to more confident negotiations for favorable terms, discounts, and improved overall collaboration.
Optimized Credit Policies
Aids in evaluating and refining credit policies by providing insights into the efficiency of the credit and collection processes. This optimization can contribute to healthier cash flow and reduce doubtful debt.
Strategic Business Planning
Facilitates strategic business planning by offering a comprehensive understanding of the financial health of the company. This insight is valuable for setting realistic goals, allocating resources wisely, and fostering sustainable growth.
Bad Debt Management
Allows businesses to identify and manage bad debts more effectively, either by taking proactive measures to recover funds or by making informed decisions to write off irrecoverable amounts, thereby minimizing financial losses.
How To Calculate Net Accounts Receivable?
Net accounts receivable represents the money a company anticipates receiving from customers after deducting allowances, discounts, and doubtful debts from the total gross accounts receivable.
The formula for calculating net accounts receivable is:
Step-by-Step Guide to Calculate Net Accounts Receivable
Step 1: Calculating Gross Accounts Receivable
Gross accounts receivable is the total amount customers owe for products or services bought on credit. It represents the cash inflow anticipated to be received from customers.
Calculating gross accounts receivable involves two steps:
- Identify the outstanding invoices that have not been paid
- Add up the total amount of outstanding invoices
For example, Company ABC Inc. has five outstanding invoices with amounts of $1500, $3000, $2500, $1200, and $2800. Therefore the gross accounts receivable will be $11,000.
Step 2: Adding up Allowances, Discounts, and Doubtful Debt
Allowances are agreed-upon deductions from the invoice due to issues with the provided product or service such as quantity issues or damaged items. Discounts on the other hand are agreed-upon deductions from the invoice if the customer pays before the due date. Whereas, doubtful debts are the amounts owed by customers that are unlikely to be paid. It can occur for a variety of reasons, such as the customer going bankrupt or refusing to pay. To calculate follow these three steps:
- Identify the allowances and discounts offered to customers
- Identify the doubtful debts by reviewing the accounts receivable aging report where invoices have been overdue for a long time.
- Add up all the allowances, discounts, and doubtful debts.
Let’s say Company ABC Inc. has offered allowances in amounts of $200 and $150 and discounts in amounts of $100 and $180. The company has incurred a doubtful debt of $1,200. Therefore, by adding up allowances, discounts, and doubtful debt we get $1830.
Step 3: Calculate Net Accounts Receivable
Deduct allowances, discounts, and doubtful debt from gross accounts receivable to get the net accounts receivable.
Therefore, for Company ABC Inc.,
Net accounts receivable = $11,000 – ( $200 + $150 + $100 + $180 + $1,200) = $11,000 – $1830
Net accounts receivable = $9170
The calculation provides a clear view of the company’s expected net receivables after considering adjustments for potential issues, ensuring a more accurate representation of the money the company is likely to collect.
How to Include the Net Receivables on the Balance Sheet?
In year-end financial reports, certain companies present net accounts receivable as an asset on their balance sheets. It is categorized alongside other essential assets such as cash and inventory, all crucial for the company’s day-to-day operations. Even if a balance sheet doesn’t explicitly show the net amount, it typically includes gross receivables, highlighting the total amount expected from customers. This practice offers a comprehensive view of the company’s financial standing, emphasizing the importance of accounts receivable in its overall asset portfolio.
How to Improve Net Accounts Receivable?
Implementing strategies can contribute to a healthier net accounts receivable, promoting efficient cash flow management and strengthening your company’s financial position. Here are some strategies to consider:
Conduct Proactive Credit Reviews
Regularly assess and review the creditworthiness of customers before extending credit. Implementing a proactive credit review process helps identify potential risks and ensures that your company is working with customers who have a reliable payment history.
Assess Doubtful Accounts
Keep a close eye on accounts that show signs of uncertainty or payment delays. Implement robust monitoring systems to identify doubtful accounts early, allowing your team to take swift action and mitigate potential losses.
Incentivize Early Payments
Encourage timely payments by offering incentives for early settlement of invoices. This can include discounts or other favorable terms for customers who settle their accounts ahead of schedule, fostering a positive payment culture.
Follow-Up On Overdue Invoices
Establish a systematic follow-up process for overdue invoices. Consistent communication with customers regarding outstanding payments not only reinforces the importance of timely settlements but also helps resolve any potential issues and disputes.
Peakflo’s Accounts Receivable solution offers a streamlined and enhanced receivable process for businesses. This solution provides real-time visibility into accounts receivable metrics through AI-powered reports, offering businesses an accurate and immediate understanding of their performance. By leveraging this tool, companies can optimize their net accounts receivable, fostering efficiency and informed decision-making for sustained financial health.
