Today we continue our series describing essential financial reports, and we’re going to talk about why you should embrace aging!
In our personal lives, many of us try to think of “aging” as rarely as possible. But when you are looking at your business, aging becomes a critical element in reviewing the health of your finances.
WHAT IS “AGING”?
Simply put, aging is a categorizing method used by accountants and management to identify any irregularities within a company’s accounts receivable (money coming in) and accounts payable (money going out).
Aging is achieved by sorting accounts according to the amount of time the bill is outstanding.
WHAT IS INCLUDED IN AGING REPORT?
The accounts receivable (A/R) aging report details unpaid invoices that have been sent to customers and reflects whether the accounts are current or past due. Typically, accounts are aged into the following buckets:
- 1-30 days
- 31-60 days
- 61-90 days
- 91+ days
The A/R aging report is the primary tool used by businesses to determine which invoices are overdue for payment.
With the A/R aging report, a business owner can quickly see the total amount due to them, the totals due at varying aging periods (for example, everything that’s 61-90 days past due), and the totals due from each customer. Because funds are due to the business, the accounts receivable account is an asset account on your books. The total from your accounts receivable report will match the accounts receivable balance on your Balance Sheet for the same time period.
Now you may be thinking, “But 30, 60, 90, days don’t mean much to my business” because maybe you are on different payment terms. Not to worry! Many accounting systems will allow for customization of this feature. QuickBooks Online allows for customization of the “buckets”, and we have a quick video to show you how to make the report work better for you.
The accounts payable (A/P) report is similar in format to the A/R report. However, in this case the report is detailing amounts owed by the business to vendors – so this account is a liability account on your books. Like the A/R balance, the total of the A/P report can be matched back to the Balance Sheet.
Like the A/R report, it details the companies or individuals, and then ages the amounts due into the same time buckets. A total by vendor is also provided.
And reviewing the accounts payable (A/P) report allows you to see what payables are due to suppliers and others, and whether you are current on your payables.
WHY SHOULD YOU PREPARE REGULAR AGING REPORTS?
The most obvious reason is to allow you to have a quick, visual reference for money owed to and from the company. Knowing this information can help you manage cash (the lifeblood of small business) effectively.
If a company recognizes that it regularly has old invoices outstanding, it may be an indicator that accounts receivable processes and practices should be reassessed and improved for faster collectability.
Likewise, the longer an invoice goes unpaid, the risk increases that the invoice will become uncollectible. Therefore, accounts receivable may need to be “written off” if they are too old to be realistically collected.
Monitoring the aged receivables carefully allows your company to send follow-up invoices, and when to send accounts to collection.
Positive cash flow is the key to staying in business, and your aging reports help you keep a close eye on cash flow.
A second reason to run aging reports is related to planning. Let’s say your company has a history of 2% of bad debts in its 30-60 day bucket, 7% in its 60-90 day bucket, and 12% in it’s 91+ day bucket.
And let’s assume that those buckets include the following receivables:
- 30-60 days – $250,000
- 61-90 days – $120,000
- 91+ days – $65,000
Based on the historical data from your aging reports, you can estimate that you should allow for doubtful accounts as follows:
($250,000 x 2%) + ($120,000 x 7%) + ($65,000 x 12%) = $21,200
Of course, this is just an example, but it’s a helpful one to have as you are planning and evaluating your bottom line.
HOW OFTEN SHOULD YOU RUN AGING REPORTS?
Most businesses benefit from running their aging reports – both for payables and receivables – on a monthly basis (typically at month end).
You may also find it helpful to run an AP aging report throughout the month to determine what bills should be paid first if you are trying to prioritize the use of your cash.
We will discuss one of our favorite analytical reports – the Budget vs. Actual report.