How to take advantage of your customer aging report

Published on: September 6, 2022

When companies struggle with a pile-up of outstanding invoices, they often suffer from poor cash flow management and strained customer relationships. That’s why accounting departments need to pay close attention to due payments. A key component of maintaining efficient credit policies is a customer aging report. This document provides insight into customer behaviour and supports a phased approach to collecting the total due from your customers while minimizing bad debt. This blog will introduce you to the benefits of a customer aging report and reveal why it’s a good idea to automate it.

What is a customer aging report?

A customer aging report, also referred to as an accounts receivable aging report or receivables aging, shows the outstanding balances from customers sorted by time intervals. These time intervals are called aging periods, so the longer a customer owes an overdue amount the more their balance ‘ages’.

The standard aging periods used in customer aging reports

 

What is the purpose of a customer aging report?

The customer aging report is one of the main reports used to reconcile the customer ledger with the general ledger. It aids accounting teams in analyzing the efficacy of credit and collection functions and identifying any hiccups in the collection process. Below outlines four of the benefits of using a customer aging report.

1. Develop a better understanding of cash flow

According to a study by U.S. Bank, 82% of all companies fail because of cash flow mismanagement. A large component of maintaining strong financial health is ensuring that your customers pay you on time. Customer aging reports allow you to spot and correct credit risks before your cash flow spirals out of control.

2. Maintain better relationships with customers

In some cases, the reason why you don’t get paid on time is simply that your customer is on a different pay cycle than what your business offers. Customer aging reports help you to identify issues early, so you can act fast to rectify the situation and retain positive relationships with customers.

Whether that ends up being a quick fix, like realigning your invoice date alerting mechanism, or a longer conversation that involves following up on routine customer behaviours, you’ll have the opportunity to improve your collections strategy and customer service.

3. Inform credit policies

Customer aging reports help evaluate the efficacy of your credit policies. If most of your overdue payments result from one customer’s tardiness, you might consider withholding any additional credit.  However, when multiple customers are lagging on their payments, it could indicate that it’s time to audit your processes as there may be an underlying issue with your credit policy. Implementing a discount for early payments or charging fees for late payments are two strategies that may be necessary to streamline cash flow.

Further reading: The ultimate ERP requirements checklist and template

4. Reveal doubtful debts and average collection period

A customer aging report is valuable for calculating your doubtful debt allowance (DDA) and average collection period (ACP). Doubtful debts are balances owed by customers where it’s implausible that you will receive the overdue amount, resulting in bad debt.

The DDA is the acceptable value of bad debts to be written off in your company’s financial statements during the period ends. The ACP is the average number of days it takes for accounts receivable to convert to cash and is one of the main parameters used to determine a company’s short-term liquidity.

 

4 steps to create a customer aging report

Here is an outline to compile a simplified customer aging report using a spreadsheet:

  1. Create a spreadsheet with all overdue invoices broken down by customer, invoice date, invoice number, original monetary amount, and unpaid balance.
  2. Add a column for each aging period. You can add as many aging periods as needed. If you need a place to start, include the standards intervals: 0–30 days, 31–60 days, 61–90 days, 91+ days.
  3. Group each invoice into an aging period by copying the unpaid balance into the relevant column.
  4. Add subtotals for each customer and a grand total at the bottom of the document.

Example customer aging report

How to calculate doubtful debt allowance

Given that the probability of defaulting increases with the time an invoice has been overdue, leadership can assign incrementally higher fixed default percentages to each aging period. These percentages are often determined by analyzing historical data to see how much was uncollectible during previous aging periods. Applying these percentages to the current value in each aging period and calculating the aggregate returns the expected credit loss, which the accounting department books as the DDA.

Example | DDA calculation for Company A

Using the example above, Company A reviews its customer aging report to calculate its DDA. They have $4,000 of accounts receivables overdue for less than thirty days. Company A usually has high collectability for this aging period and assumes that none of the accounts will be doubtful.

Based on prior experience, the likelihood of default increases by 2% for every additional thirty days the invoice remains outstanding. Company A applies the following formula to determine its allowance for doubtful accounts:

Doubtful debt allowance = (0% x $4,000) + (2% x $7,000) + (4% x $9,000) + (6% x $3,000) = $680 

Therefore, the DDA for Company A is equal to $680.

Calculating the doubtful debt allowance for example

How to calculate average collection period

Calculating the average collection period can help you to evaluate your business’ collectability performance and minimize long overdue receivables. The ACP is the difference between the days sales outstanding (DSO) ratio and the credit period given to your clients.

ACP = DSO – Credit days 

The DSO ratio provides the average period between when a sale is closed, and the client settles the amount. The DSO ratio can be calculated using the following formula:

DSO = (Average receivables / Credit sales) x Days in period 

If the terms vary greatly between customers, you may need to calculate multiple ACPs for each type of contract.

 

Harness the power of automation to streamline your finances

As your company scales, you’ll require a system that can keep up with your expanding customer database. Investing in an ERP solution will allow you to upgrade from spreadsheets. By automating processes like customer aging reports, you can significantly reduce human errors from manual data entry, time spent on redundant tasks, and overhead to achieve a positive impact on your bottom line. If you would like to learn more about how financial transformation can benefit your business, check out our whitepaper.

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