Aging is an accounting process that tells you how long you've had an asset or how long a bill has gone unpaid. Unlike turnover ratios, which give you averages, aging tracks specific line items and can help you to identify outliers.
The first step in the aging process is to list each item in an account, such as all of your outstanding invoices in accounts receivable. Next, divide the list by date range. Using 30-day intervals is common, so an accounts receivable aging report would have one column with all invoices you issued in the last 30 days, all invoices issued 31-60 days ago and so on.
When you get this report from your controller services, you can identify which specific items need attention and identify broader trends. Below are some of the lessons you can learn from each type of aging report.
Lessons Learned From Accounts Receivable Aging
The first step you should take when you receive your accounts receivable aging report is to work back from the oldest invoice and try to obtain immediate payment. There are three lessons you can learn from the number of invoices in each bracket and the total amounts outstanding in each bracket.
Older accounts receivable represent a credit risk to your company because, if customers haven't paid, one possible reason is that they are unable to. Compare your overall accounts receivable aging against industry standards to determine if the amount of risk you're taking on is appropriate for your industry.
Also, look at individual customers. If some are much slower to pay than others, consider whether you should adjust the terms of your agreement or stop doing business with the slow payers to lower your risk.
Sometimes, older receivables are a sign of weak collection practices. Some customers simply wait until the second or third invoice or until you call. Be sure you continue to follow up on outstanding invoices, especially when the customer is taking longer than average to pay.
Bad Debt Allowance
One final takeaway is the need to have your balance sheet accurately reflect your current financial state. Your balance sheet should only reflect 100 percent of accounts receivable if you are reasonably certain of a 100 percent collection rate.
If, for example, you know there is only a 50 percent chance of collecting on receivables older than six months, you should write down half the value of those receivables.
Lessons Learned From Inventory Management
Aging can also shed light on your inventory management practices. The immediate action point is to identify inventory that may spoil or become obsolete and take steps to move it, for example, by offering discounts.
In the long run, you should also consider the cost of storing inventory. While being out of stock risks a lost sale, retail and warehouse space is valuable and could be put toward additional items or downsized to cut costs.
If there is a mismatch between your inventory aging and your turnover ratio or average days to sell, it may indicate that you aren't ordering new inventory at the right intervals or in the needed quantities.
Lessons Learned From Accounts Payable Aging
Accounts payable aging analyzes the bills you owe. While taking longer to pay bills could help pad your cash flow, it's not always the best option. You could be missing out on early payment discounts or be incurring financing fees.
If you have older accounts payable because you can't pay all of your bills, it's time to take immediate action to correct the underlying cash flow problem.
For best results, review your aging reports monthly to identify any specific items that need action and to track the progress of any strategic adjustments you make.
Our Controllers are excellent at helping our clients get a handle on their aging accounts. See what is available to help you!