Something many business owners must consider when managing their own business is the possibility of extending credit to customers as a method of payment. This would open the door to a variety of customers but it may also harm a small business due to the length of time a receivable remains open. It remains key that owners understand the pros and cons of this choice which includes establishing a firm policy that will protect their business sustainability. In addition, the US small business administration advises,"if your business extends credit to customers, you should become aware of consumer credit laws. The Federal Trade Commission (FTC) enforces the nation’s consumer protection laws. These laws regulate how you advertise interest rates, how much time you have to respond to billing-mistake claims, how aggressive you can be when attempting to collect a debt, and other aspects of extending credit and debt collections."
Business owners and those responsible for the day to day task should understand that the analysis of receivables method is based on the assumption that the longer an account receivable is outstanding, the less likely that it will be collected. Accounts receivable constitute the primary source of incoming cash flow for most businesses, so you should analyze these invoices in aggregate to ascertain the health of the underlying cash flows.
The analysis of receivable method is applies as follows:
Step 1: The due date of each account receivable is determined
Step 2: The number of days each account is past due is determined. This is the number of days between the due date of the account and the date of the analysis.
Step 3: Each account is placed in an aged class according to its days past due which is typically aged as follows:
Step 5: The total for each aged class is multiplied by an estimated percentage of uncollectible accounts for that class
Step 6: The estimated total of uncollectible accounts is determined as the sum of the uncollectible accounts for each ages class.
The preceding steps include summarizing an aging schedule and this overall process is called aging the receivables. An example of a businesses aging report is provided below.
A detailed process such as accounts receivable should be an extensive documented process for any business. This process will ensure cash flow is managed appropriately by those responsible. Fontenot & Associates Solutions LLC can support with the development and analytical process of the monthly accounts receivable, we are just a click away.
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