Calculating accounts receivable (AR) becomes a frustrating game of cat and mouse for many small business owners. You've delivered a product or service, and now you're just waiting - and sometimes, endlessly chasing - to get paid.
It's a common scenario: invoices are sent, gentle reminders are emailed, and yet the cash flow remains stagnant. This isn't just a number on a balance sheet - it affects everything from payroll to new investments.
While AR can indeed cause stress and waste vital time, it can also be a powerful tool when managed correctly. With the right insights, you can turn it into an advantage for your business. That’s why we’re going to walk you through how to calculate accounts receivable in this guide.
We’ll demystify a myriad of different formulas and ratios you need to know - from how to calculate accounts receivable turnover ratio to how to calculate net accounts receivable. You’ll even learn what to do with this figure once you find it, and how you can automate AR for good and never even think about it again.
First, let’s provide a brief overview of the significance of this financial figure.
Understanding the nuances of accounts receivable and its implications is akin to being handed the compass for your business’s financial journey. So, what is AR in the first place?
Accounts receivable represents money owed to your business by clients or customers for goods or services provided but not yet paid for.
Think of it as an IOU, a promise to pay. Instead of immediate cash exchange after a sale, you extend a line of credit, offering your customers time to pay.
While this can boost customer relations and sales, it also means your cash isn't instantly in hand. This can lead to a range of challenges if not addressed.
Imagine planning a road trip without knowing how much gas you have. Will you end up at your destination? Maybe - but maybe not! It’s a bit of a guessing game. The same is true for not knowing how much AR you have outstanding.
AR is the gas gauge for your business. When calculated correctly, it provides insights into cash flow - the very essence that fuels a company's operations. A business might be making sales left and right, but if those sales are tied up in AR, it can lead to a dangerous illusion of prosperity.
The truth is, while sales are essential, cash is king. Without a precise handle on AR, a business may find itself unable to meet immediate financial obligations, from salaries to overhead costs.
Your AR isn't just an internal metric. It plays a starring role in how external entities, like banks, investors, or potential partners, view your business. It provides a snapshot of your company's liquidity and efficiency in credit management.
High AR might indicate sluggish collection processes, signaling potential inefficiencies or even deeper financial challenges.
Conversely, a well-managed AR showcases a business that’s adept at balancing customer relationships with robust financial health. It boosts creditworthiness, essential for securing loans or attracting investors.
The ripple effect of AR is vast: it affects valuation, trust in your brand, and even your company’s capacity for growth. That being said, knowing how to calculate accounts receivable is obviously of the utmost importance. So, let’s get into it!
Calculating accounts receivable (AR) can be intricate, but it's also empowering. Being well-versed in the metrics and calculations offers a bird's-eye view into the financial currents of your business.
Below, we'll break down some essential equations to help you master AR's various facets. That being said, let’s start with the basics - how to calculate average accounts receivable.
Average accounts receivable provides insight into the average amount of receivables a business holds over a specific period, which can indicate the flow of cash tied up in credit. Many of the other accounts receivable formulations work off of this one, so it’s a great starting point.
Formula: Average Accounts Receivable = (Beginning AR + Ending AR)/2.
This straightforward calculation can hint at trends, especially when evaluated over multiple periods. Now, let’s move on to one of the most important figures: how to calculate accounts receivable turnover ratio.
This ratio measures a company's effectiveness in extending credit and collecting debts from its customers. A higher ratio indicates that collections are efficient.
The formula is fairly simple: AR Turnover Ratio = Net Credit Sales/Average Accounts Receivable.
For more context, net credit sales are those made on credit minus any returns or allowances. Average accounts receivable, as you name now, is derived from the sum of the beginning and ending accounts receivable for a period divided by two.
By determining this ratio, businesses can get a clearer picture of their collection efficiency.
Gross accounts receivable represents the total amount of outstanding invoices or the sum owed by customers.
It’s perhaps the easiest to calculate, too - you simply add up all the outstanding invoices at a given time! It’s a raw figure without any adjustments and sets the stage for more nuanced metrics.
This reflects the total amount the business can realistically expect to collect. It’s the gross AR minus any allowances for doubtful accounts that you aren’t positive are going to pay. As such, there’s a bit of nuance here in calculating this ratio:
Net Accounts Receivable = Gross Accounts Receivable/Allowance for Doubtful Accounts.
Ideally, every customer you sell to will end up paying at some point - but if you’ve been in business long enough you realize this isn’t always the case. By differentiating between gross and net AR, businesses can brace for potential losses from non-paying customers.
Learning how to calculate cash collections from accounts receivable reveals the amount of cash collected from customers within a period. It shines a light on the efficiency of your collections process, which is vital for cash flow management.
Cash Collections = Beginning AR + Credit Sales − Ending AR.
From there, you’re able to compare your cash collections ratio over different periods or to different segments and determine where changes need to be made.
This metric provides the average number of days it takes to collect an outstanding invoice after a sale has been made. It helps you forecast how much cash flow you can expect in the future based on sales you made today.
Average Collection Period = Average Accounts Receivable / (Net Credit Sales/Number of Days).
For instance, if the period is 365 days, you'll divide the Net Credit Sales by 365. This formula helps businesses assess if they're granting too lenient or strict credit terms.
These are the most common AR formulas you’ll need to know how to use in your business. But remember that every business is unique, and context matters.
Regularly evaluating and understanding these figures can guide adjustments in credit policies, optimizing both customer relations and financial health.
And if manually calculating these seems cumbersome, stay tuned - we’ll introduce you to a platform that can streamline and automate the process for you. In just a moment. First, let’s talk about what to do with accounts receivable after calculating it.
So, you know how to calculate accounts receivable, you’ve tallied the figures, and now what? Much like a map without a compass, those figures alone won't guide your business decisions unless you know how to interpret and implement them. Let's delve into how to convert those AR figures into actionable strategies.
The balance sheet provides a snapshot of a company's financial health. Including AR figures ensures this snapshot is comprehensive. So, here’s how to calculate accounts receivable on balance sheets:
Make a habit of consistently recording any changes, which ensures the balance sheet remains a reliable tool for internal assessments or external presentations.
Understanding the nuances behind the numbers you’ve calculated is pivotal. This is where things get tricky - as actually calculating accounts receivable is the easy part.
If your AR figures are consistently high, it may indicate that clients aren't paying promptly. Delve deeper to pinpoint if it’s an industry trend, specific to a few clients, or perhaps your credit terms are too lenient.
Conversely, a low AR might seem positive, but if it’s combined with declining sales, there's a bigger issue at hand. Whatever you find, don't just look at AR in isolation. Track the trend over quarters or years to catch underlying patterns.
AR figures are a direct reflection of your credit policies. If you're seeing troubling patterns, consider revisiting these policies:
Ultimately, your AR figures are a story of your business's relationship with its clients and its internal financial health.
If you’re tired of chasing down clients with an invoice or bill and you want to stop stressing so much about cash flow, you can automate the process with InvoiceSherpa. Here’s what we can do for your company…
The intricacies of Accounts Receivable, while fundamental to business, can be a colossal drain on time and energy. If you've ever felt the weight of chasing down payments, deciphering financial jargon, or spending endless hours manually updating sheets, you're not alone.
But here's the thing - it doesn't have to be this way. Our accounts receivable automation software is your partner in revolutionizing your AR processes:
Businesses leveraging InvoiceSherpa see a 25% reduction in past-due receivables and a 15% decrease in bad debt reserves. In essence, we're like that indispensable A/R employee you've always wanted - except we're available round the clock, and all it costs is $49/month.
Don't let AR complexities detract from your core business operations. With InvoiceSherpa, you get peace of mind knowing that your invoicing is on auto-pilot. So, take the leap towards streamlined, stress-free AR management and learn how to automate accounts receivable with our software today.
Calculating accounts receivable isn't just a financial exercise - it's a vital step towards understanding your business's financial health, assessing client relationships, and making informed decisions.
Whether you came here to learn how to calculate average accounts receivable or how to calculate net accounts receivable, we hope this guide to calculating accounts receivable has provided you with clarity and confidence in your next steps. Knowledge, after all, is not just power - it's the key to sustainability and growth in the ever-evolving world of business
Learn more about the need for credit control, how long to keep accounts payable records, or
what is an a/r aging report in our blog. Otherwise, it’s time to take control of your AR management process with a hands-off approach at InvoiceSherpa.
Let us guide you beyond the numbers, ensuring you always stay on top of your cash flow with streamlined, automated processes. Dive into a world where AR becomes a breeze, not a burden!
Posted on September 1, 2023
