What Is the Best Method to Analyze Your Receivables?
Jul 13, 2022
Your Accounts Receivables tell a story about your company: that of its cash flow. Tracking your AR means ensuring your business’ liquidity at all times. Sales are good, but it’s the concrete cash inflows that matter.
Your AR tells you how well your business is doing, and helps you manage your cash better - now and in the future. It is quintessential to have an accurate picture of when your cash is coming in - especially for small businesses and scale-ups.
For that, you can track different AR-related metrics: your total AR of course, but also your DSO, CEI, aging report and billing cohorts. These are the essential metrics to track for scaling companies.
What is the best method to analyze your Accounts Receivable? Using Excel seems like an obvious idea, but is it the best way? What about accounting software? Is there a better alternative?
To cut to the chase: the best accounts receivable method is one that’s done through an AR software - like Upflow. Automation makes your life easier, so you can get paid faster and focus on your business’s core activities.
The Manual Method of Analyzing AR (and Why It’s Not Enough)
How to Record and Analyze Your Receivables.
To track and analyze your AR, you need to account for 2 things:
Your accounts receivables (or credit sales),
Your bad debt allowance.
Calculating your AR.
Every company should be tracking their AR just as they track their sales.
When a sale takes place, two scenarios can happen:
Cash is directly exchanged for the product or service.
The invoice’s due date is set for a later date. That’s a credit sale, which will increase your AR credit balance
In and of itself, calculating your AR is quite straightforward: you just need to make a list of all the invoices that are owed to you. We’ll see later on how this process might not be as straightforward as it seems.
That’s part one of your AR done. In financial accounting, there is another part: accounting for your uncollectible invoices.
Bad Debt Expense: How to Track Uncollectible Accounts.
Cash-basis accounting doesn’t have to bother with bad debt write-off, as this method of accounting only records transactions when cash is exchanged.
In accrual accounting, however, a transaction is recorded when a sale of a product or service is agreed upon. However, some invoices end up never being paid: they’re deemed uncollectible. Uncollectible accounts are also called doubtful accounts, or bad debt.
That’s a risk that comes with credit sales, which should be accounted for as an operational expense in your income statement. Using the aging method will help you determine the percentage of your overdue invoices that is likely to turn into uncollectible accounts.
When an invoice you recorded turns into bad debt, you then have to make an adjusting entry in your books.
There are two ways to do this:
The direct write-off method: you manually add a journal entry to perform a “write-off”. The amount of the adjusting entry has to match your previously recorded one to keep your t-accounts balanced. This is a straightforward method, used when you only have a few uncollectible receivables over the year.
The allowance method: you plan ahead by allocating a percentage of your total credit sales to a contra asset account. This allowance account serves as a budget for your doubtful accounts.
When a bad debt does happen, you can subtract it from this account to buffer your losses. You then need to make another journal entry to take this amount from your balance of allowance.
If your company uses a lot of credit sales as a sales method, using the allowance method makes more sense. The normal balance of allowance - the percentage you’d set aside for bad debt - depends on your company and its typical turnover and AR amount.
Once you’ve accounted for your bad debt allowance, you can get your realizable value of accounts receivable, which is the amount you can expect to receive. It is your total current receivable minus your bad debt, which affects your accounts receivable debit balance (or credit balance).
Using the realizable value of accounts is a conservatism concept of conservatism accounting, that has the advantage of giving you a realistic picture of what to expect in terms of future cash inflow. It’s also useful in order to be more accurate in your financial statements, as you’re factoring in your potential unpaid invoices.
Another option is to turn your overdue accounts receivable into notes receivable, which act as a promise to be paid. It gives your customer more time to pay you, and shows up as an asset on your balance sheet:
A current asset if the note is due at the end of the current year,
A non-current asset for longer time periods.
Now you know what to track in your AR, let’s have a look at how to do it.
Analysis of Receivables Method 1: Excel.
The reflex of many financial professionals (and business owners) is to turn to spreadsheets for tracking their accounts receivables.
You can just open up a new Excel file and add your AR data. Remember to add your invoice amount, due date, and also the name and contact of your clients.
A big part of staying on top of your AR is following up on your invoices, so including contact information will make your life easier down the line.
Once your AR info is all updated on your Excel, you’re done! While this method has the advantage of being easy and straightforward on paper… The reality can be different.
Need help tracking your main AR metrics? Have a look at our free spreadsheet.
The Problem with Using Spreadsheet for AR Tracking and Analysis.
There are several downsides to using a spreadsheet for tracking your AR - let alone extracting any metrics and analysis from them:
It’s not centralized: if you already use spreadsheets in your financial accounting, you know they’re a nightmare to keep up-to-date. Unless you (and your team) are very thorough at recording each and every invoice, you’ll have a hard time keeping it up-to-date. And if you can’t trust that your Excel is accurate, it defeats its own purpose.
It’s not time-savvy: even if you’re meticulous about tracking your invoices, you’ll probably often have to switch between software (and possibly people) to ensure you have the latest data. You also have to manually track any and all contacts you have with your client regarding their pending invoice.
It’s not accurate: between your never-quite up-to-date data, the manual entry of formulas needed to calculate your AR metrics, and the human errors waiting to happen, you cannot be 100% sure the data displayed is accurate.
The bottom line is: Excel spreadsheets aren’t efficient. As you deal with an increasing number of clients and your turnover increases, you’ll no longer have the time to do it manually.
So, what’s a better method to deal with your AR tracking and analyzing?
Analyzing Your AR With Your Accounting Software.
Analysis of Receivables Method 2: Accounting Software.
You very likely already have accounting software as part of your finance stack, so it makes sense to consider using it for your accounts receivable analysis too.
Most software have a few AR-related features alongside their core activity, and can help you keep track of your pending invoices. Some also have a dashboard with one or two AR metrics like your DSO or billing cohort.
The good thing about your accounting software is that it’s already integrated into your finance ecosystem. All the data most likely synchronizes with your other software like your billing tool, or even your CRM. If that’s not the case - your accounting software might need an upgrade!
The problem with Using Accounting Software for Your AR.
Using your accounting software, as we’ve just seen, is a convenient option. But… there is a but: you have to pay attention to a few things:
Make sure you have one source of truth.
The one source of truth is a concept we’re adamant about at Upflow. It means that you have one tool that has all the information you need for your financial accounting in one place.
No switching between different software or tabs, no doubting if your numbers are accurate. Your one source of truth is the place you can go to find your latest data, the one that has all the most up-to-date and accurate information at all times.
Your other software synchronizes with it, it’s the hub that links them all together.
Accounting Software is Designed for Accounting.
It sounds obvious, and yet it’s essential to understand that. Even with a few handy AR features, accounting software will always be the best at accounting - that’s what they do!
This means that their nice-to-have features are not what the software was originally designed for. Plus, your accounts receivable isn’t where they’re going to be focusing their next development efforts on.
When it comes to AR, it’s great to be able to track your invoices and look at a few metrics. But it’s even better if you can detect actionable tasks directly from the same software.
Specialized AR Software is The Best Method for AR Analysis.
Analysis of Receivables Method 3: AR software.
At Upflow, we think the best analysis of receivables is performed with specialized AR software.
Yes, we may be a little biased, because that’s what we specialize in! We’ve designed our software with financial professionals in mind, to make your life easier. Here is what your AR process would look like using Upflow:
All your data is centralized in real-time.
Your KPIs are calculated using the most accurate formulas and metrics.
All your information is presented on a financial dashboard.
You can create customized reports that help with your long-term decision-making and financial statements.
Why AR Software is Best to Analyze Your AR.
Using a tool like Upflow allows you to streamline your accounts receivable process. One look at your dashboard will give you the insights you needto directly take action straight from within the app.
No more chasing the latest data. No more losing track of your customer’s contacts. No more leaving it to later because you don’t even know where to begin with your payment reminders.
Because Upflow is designed for effective collaboration, you can leave internal notes and even reminders to yourself and your team to make sure everyone is on the same page.
Looking at your aging schedule (or aging reports) will let you know what length of time has passed since your invoice was issued - and in which category your invoices are piling up. It’s a very useful tool for your accounts receivable analysis, and lets you know ahead of time if there might be any cash flow issues coming up.
On Upflow, you can look at your Days Sales Outstanding and take action to reduce it straight from our software.
Looking at your billing cohort helps you see which invoices are still unpaid. You can also directly click on customer accounts to see the list of invoices. From there, you can decide to follow up with your client via a phone call, an email, or even a letter!
Knowing your receivables balance in a matter of seconds has never been easier! And you can rest assured knowing that all information is accurate thanks to real-time synchronization with the rest of your finance stack
Upflow gives you the option to plan for your doubtful accounts too, by showing you an at-risk rate based on your 90-day overdue invoices. All of that contributes to giving you a more accurate net realizable value.
Tracking Accounts Receivable means knowing your receivables account balance, and knowing how effective your processes are by keeping track of a few key AR metrics.
To calculate your receivables balance, you need to have your pending credit sales. You should also be factoring in your bad debt expenses.
Your bad debt is invoices that are deemed uncollectible after a certain period of time. Accounting for them can be done by either a direct write-off or by using the allowance method.
Concretely, AR tracking is a list of your invoices with their due date, amount and customer contact. Technically speaking, this can be done using Excel spreadsheets, but we don’t recommend it as they can be inaccurate and inefficient.
Your accounting software might have a few AR features to help you track and analyze your receivables which is a good start. But at the end of the day, AR is not their expertise and won’t be able to provide you with detailed metrics and actionable insights.
The best method to analyze your receivables is to use software specialized in accounts receivable, such as Upflow. It synchronizes your data in real-time so you can trust it to be your one source of truth for your AR. It also provides in-depth analytics to measure the efficiency of your collectible process. And you can take action to improve your workflow straight from the app.
Upflow is designed for AR, and will help you get paid faster so you can focus on the growth of your business.