Discover the fundamentals of accounting with a clear explanation of net accounts receivables. Learn what it is, how to calculate it, and why it matters in financial management
A modern growing business will require an ERP that supports the Accounts Receivables (AR)Workflows i.e. the Order to Cash cycles.
Previously businesses followed a very hands-on approach to day-to-day accounting. But as companies grew in scale, they also outgrew manual accounting.
One of the main business functions that outgrew the expansion is cash management. Businesses while starting out could manage to sign off every outgoing check and follow up with customers for payments. But, as more and more customers and suppliers it’s impossible to follow up on every single transaction. Added to that a customer payment can be delayed and a supplier invoice may be incorrect, or there may be a return of merchandise, return of damaged goods, issue of credit, or applying for credit.
This may increase the complexity of managing the cash flow in the business.
How does a business define Accounts Receivables?
Accounts Receivables: Accounts receivable are money that is owed to the business by its customers for the goods to services provided by the business. It is shown as an asset on the company’s balance sheet.
If your customers have been vetted thoroughly and invoices handled correctly, payments should flow in smoothly as agreed, requiring little or no further intervention until it’s time to record them. However, despite efficient credit extension processes, you might still encounter challenges with collections. Late or missed payments from clients can disrupt cash flow, making it harder to secure loans or attract investors. This underscores the importance of mastering the accounts receivable process.
What is Net Accounts Receivable
The net accounts receivable refers to the total amount of money owed to a company by its customers. This figure represents how much money the A/R team expects to collect from customers within a certain period. Calculating net accounts receivable involves subtracting allowances and discounts from the total accounts receivable. This figure is essential for assessing the company’s liquidity and the effectiveness of its accounts receivable management. Knowing the net receivables formula is only the beginning of harnessing the power of this metric.
How to Calculate Net Accounts Receivable
Accountants typically express the final figure as a percentage, representing the net realizable value of accounts receivable. This calculation involves two primary components:
- Total Accounts Receivable: This denotes the overall amount of money owed to the business by its customers, often referred to as gross receivables.
- Allowance for Doubtful Accounts: This serves as an estimation of receivables that the company may not be able to collect. It encompasses accounts that the Accounts Receivable (A/R) team may have written off as uncollectible, as well as those with delayed or potentially unfulfilled payments. Notably, this figure may fluctuate over time; for instance, it could start at 5% within the first 30 days but increase to 30% after 90 days.
Example of Net Accounts Receivable
Example:
Company A specializes in manufacturing high-performance e-bikes and directly sells them to local adventure outfitters. By the end of January 2023, the company anticipates gross receivables of $300,000. Recognizing that 10% of these payments might not materialize due to the winter season, which tends to strain outfitters’ finances, they estimate an allowance for doubtful accounts accordingly.
Total Accounts Receivable: $300,000
Allowance for Doubtful Accounts: 10% of $300,000 = $30,000
Net Accounts Receivable Realizable Value: $300,000 – $30,000 = $270,000
To express this as a percentage:
($270,000 / $300,000) * 100% = 90%
This indicates that the company has a collection rate of 90%, expecting to realize $270,000 in accounts receivable by the month’s end. However, there remains a possibility of $30,000 remaining outstanding.
Benefits of Calculating the Net Accounts Receivables Value
Enhanced Cash Flow Projections:
Including this metric in balance sheets or performance, evaluations provides AR teams and executives with more accurate insights into cash flow. By understanding the net realizable value, companies can make informed decisions about crucial aspects like payroll, expansion, and credit, especially in industries facing economic challenges.
Decreased Reliance on Credit:
Accurate cash flow projections reduce the need for sudden credit reliance. With better foresight, companies can explore alternative cost-cutting measures instead of resorting to high-interest credit solutions, promoting financial stability.
Improved Supplier Relationships:
Calculating net receivable values enables companies to predict payments accurately and plan accordingly. This fosters stronger relationships with suppliers, as companies can negotiate confidently and maintain timely payments, enhancing trust and collaboration.
Ways to Enhance Net Accounts Receivables Percentage:
Thoroughly Vet New Customers:
Prevent poor collections by rigorously evaluating new customers’ creditworthiness through credit checks, financial analysis, and references before extending credit.
Regularly Review Existing Accounts:
Continuously assess existing customer accounts to ensure their financial viability and ability to fulfill payments. Stay abreast of industry changes, offer modifications as needed, and monitor payment histories closely.
Align Sales Team with Credit Policies:
Ensure alignment between sales and credit teams to uphold company credit policies. Educate sales teams about credit terms and encourage realistic customer expectations during the sales process.
Monitor Allowances for Doubtful Accounts:
Regularly review and adjust allowances for doubtful accounts to accurately reflect receivable performance and mitigate potential losses.
Offer Incentives for Timely Payment:
Encourage early or on-time payments by providing incentives such as discounts or priority in product selection or deliveries, fostering a prompt payment culture among customers.
Prompt Follow-Up on Invoices:
Implement effective follow-up procedures to remind customers of unpaid invoices before they become overdue. Utilize dunning notice strategies to facilitate communication and prompt payment.
