Benefits of a customer aging report and reveal why it’s a good idea to automate it.
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.
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 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.
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.
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.
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
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.
Here is an outline to compile a simplified customer aging report using a spreadsheet:
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.
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:
Therefore, the DDA for Company A is equal to $680.
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.
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:
If the terms vary greatly between customers, you may need to calculate multiple ACPs for each type of contract.
As your company scales, you’ll require a system that can keep up with your expanding customer database and support best practices in data management. 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.
