How to calculate net accounts receivable
Managing a business’s finances depends heavily on accurately measuring and monitoring key financial indicators. One such vital indicator known as Net Accounts Receivable (NAR) plays a significant role in assessing a company’s cash flow and overall financial health. This article will guide you through the essential steps to calculate net accounts receivable, ensuring you have an accurate measure of your business’s liquidity and credit management capabilities.
Understanding Accounts Receivable:
Accounts Receivable (AR) refers to the outstanding invoices or money owed by customers to a business for goods or services provided on credit. The Sum of outstanding invoices represents the total accounts receivable, which forms an essential component of a company’s balance sheet.
Net Accounts Receivable:
Net Accounts Receivable (NAR) is the amount remaining after deducting doubtful accounts or bad debts (uncollectible accounts) from the total accounts receivable. It establishes the actual amount that a company is likely to collect from its customers, thus providing a clear understanding of its cash flow and the effectiveness of its credit control policy.
Calculating Net Accounts Receivable:
To calculate net accounts receivable, follow these simple steps:
Step 1: Determine Gross Accounts Receivable
Gather all outstanding invoices owed by your customers as of a specific date. Sum up these unpaid balances to calculate your gross accounts receivable.
Step 2: Estimate Allowance for Doubtful Accounts
Businesses need to understand that not all outstanding invoices may be fully collectible. Therefore, estimate an allowance for doubtful accounts based on past records or industry standards. You may use methods such as percentage of sales, ageing schedule analysis, or any other suitable method to estimate this figure.
Step 3: Calculate Net Accounts Receivable
Subtract the estimated allowance for doubtful accounts from your gross accounts receivable to arrive at the net accounts receivable figure.
Net Accounts Receivable (NAR) = Gross Accounts Receivable – Allowance for Doubtful Accounts
Analyzing Net Accounts Receivable:
Once you have calculated net accounts receivable, it is crucial to understand its implications on your business:
1. Cash Flow: A high NAR implies that more customers are paying their bills and ensures steady cash flow, allowing a company to meet its obligations smoothly.
2. Credit Policy: Monitoring NAR regularly can help evaluate the effectiveness of a company’s credit control policies and make any necessary adjustments.
3. Customer Relations: Keeping track of NAR can highlight problematic customers or patterns, enabling better credit management and customer relationship strategies.
4. Financial Ratios: Net accounts receivable forms an essential component in calculating various financial ratios like Average Collection Period, Receivables Turnover Ratio, and Days Sales Outstanding (DSO), which help evaluate a company’s liquidity and financial performance.
Calculating net accounts receivable is a critical step in understanding and managing your business finances. By accurately measuring this essential financial metric, you can make informed decisions to improve cash flow, develop effective credit control policies, and ensure the overall financial health of your business.