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How to Do an Accounts Receivable Analysis

A good accounts receivable operation continuously evaluates how a business is doing and uses data to determine effective things. It also determines the problems in the company's finances and...
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What is Accounts Receivable Days Outstanding and Why is it Important?

In any business, you spend a lot of time working hard to pay your employees, suppliers, and others involved in creating your company's products. Unfortunately, you're also responsible for collecting these outstanding accounts receivable from your customers. This accounting term refers to the time customers take to pay their bills after being charged.

Sometimes, you might only realize you're responsible once you're faced with a massive bill from a vendor who wants to be paid. This is a serious problem because you don't have enough cash to cover it, which can lead to financial irregularities and even insolvency.

You'll want to track and examine the accounts receivable collections process to protect your company from financial ruin. So that you can see if there are any unusual spikes or dips in the amount.

Accounts Receivable Days Outstanding

What are Accounts Receivable Days Outstanding?

In the business world, the term ‘accounts receivable days outstanding’ measures the average days a company takes to collect customer payments. This important metric provides insight into a company's operational efficiency and ability to generate cash flow.

ARDO can give insights into a company's credit and collections policies. It can also assess how a company's customers pay their invoices.

A higher ARDO indicates that a company is taking longer to collect its receivables. This could be due to lax credit and collections policies. As a result, the company might have difficulty meeting its short-term obligations. Conversely, a lower ARDO indicates that a company collects its receivables more quickly. This could be due to stricter credit and collections policies. Meaning the company has good liquidity.

The Importance of Accounts Receivable Days Outstanding

As a business owner, you're probably familiar with the term "accounts receivable." But why is it important?

ARDO is a financial ratio that determines the average days a company can take to collect its accounts receivable. This ratio is also sometimes referred to as days sales outstanding. This metric assesses a company's credit and collections policies and financial health.

The number of ARDO is significant because it provides a general idea of your company's creditworthiness. How likely you are to meet your customer's demands for payment.

The standard practice is to check the number of days past due and present it alongside the ARDO. This is often referred to as a "days outstanding vs. days past due" comparison. This puts the responsibility on the customer to pay their bills on time. Sometimes, by extending the payment terms, this gap can be bridged. extending the payment terms. Something to be aware of if your company grants extended payment options to its customers.

In other instances, your company might need extra debt to provide the funds for payment. Potentially putting your company in a risky financial situation. Either way, monitoring and understanding account receivable days outstanding is essential.

Importance of Accounts Receivable Days Outstanding

As a business owner, it's your job to ensure your company's financial security. You've worked hard to build a solid reputation for your product or service. It would help if you weren't afraid to take the time to prove it to your customers. One way to do this is by ensuring they know your company's financial responsibility. Payments received on time will show your efforts.

Showing them that you're a reliable business by demonstrating that you're willing to work hard to get your money back. This is the best way to create long-term trust and confidence in your company and brand. This will assist you in establishing yourself as a go-to source for all your future financial needs.

Point to ponder: Do you know the average Accounts Receivable Collection Period for a business?

How are Accounts Receivable Days Outstanding Calculated?

Days outstanding is the total number of days your accounts receivable status is past due. The ARDO is calculated by adding the number of days your customers have outstanding invoices plus the number of days past due on those invoices. This number does not include any amounts already paid by you or on your behalf.

ARDO is a metric that determines the average days a company takes to collect payment on its invoices. This metric is vital because it can give you an idea of how well your business is doing in collections.

Accounts Receivable Days Outstanding Formula

There are a few different ways to calculate Accounts Receivable Days Outstanding. Still, the most common method is to divide the total amount of accounts receivable by the total sales for the period. Then multiply it by the number of days. This will give you the average days it takes to collect payment.

ARDO = (Accounts Receivables / Net Credit Sales) * Number of Days

If your ARDO is high, it could show that your collections process needs improvement.

What Does a High ARDO Mean?

A high ARDO indicates that a company's customers take longer to pay their invoices, which can strain its cash flow. This can lead to missed opportunities for investment or growth and may result in default.

What Does a Low ARDO Mean?

On the flip side, a low ARDO suggests that a company effectively manages its credit and collections policies. This can help to ensure the timely payment of invoices. This can, in turn, improve cash flow and allow for more significant opportunities for investment or growth.

Companies usually aim to keep their accounts receivable days outstanding at a level that is comfortable for them. For example, a manufacturing company may target an accounts receivable days outstanding of 30 days. In comparison, a retail company may target an accounts receivable days outstanding of 45 days.

How to Improve Accounts Receivable Days Outstanding

Improve Accounts Receivable Days Outstanding ARDO is vital because it provides insights into a company's collections process and ability to generate cash from its sales. So, monitoring your company's ARDO is essential to maintaining financial health. Here are some ways you can improve your accounts receivable days outstanding.

  • Implement Stricter Payment Terms

Strict payment conditions might affect the organization's relationships with new customers. But reducing your account receivable days outstanding is an excellent way. Also, you can impose late payment fees to payment terms to make the payment terms effective and avert customers from defaulting on their due date.

  • Incentivize Payments

Offer a small discount to customers that pay with cash or in their credit period when it's time to pay to minimize AR days. Of course, it only applies to some customers. But it'll be helpful if you work with businesses with healthy cash flow yet delay their payments by the due date.

  • Collect Proactively

To avert lousy debt, companies should reach out to unpaid clients. Identify accounts that show delays if a company wants to be proactive in its collections. Then, it can have strict policies for establishing accounts showing late payment signs.

  • Make it Easy to Pay

Sometimes, not having conveniently available payment methods keeps a customer from paying promptly. By adding many payment options. Like bank cards, debit cards, electronic funds transfers, and checks. This way, businesses can reduce the friction of payment processes. This can help with accounts receivable days reduction for many businesses.

  • Automate the Accounts Receivable Process

Automating credit and collections processes makes it possible to make these processes more efficient and cut down on AR days. An assessment from PYMNTS indicates that 88% of businesses have automated their accounts receivable processes. As a result, we have now seen a significant reduction in accounts receivable days outstanding.

Do you want to know more about optimizing your Accounts Receivable Process?

Conclusion.

The Accounts Receivable Days Outstanding is an essential metric for assessing a company's financial health. A high ARDO means a company takes longer to collect payments, which could indicate financial difficulties.

A company's ARDO can be improved by offering discounts for early payment and improving collections processes.

By monitoring the accounts receivable days outstanding, companies can identify potential financial problems. Then take steps to improve their Accounts Receivable management.

Do check out ZarMoney's leading accounts receivable software for growing businesses. Manage invoices, receive payments, and stay updated with the receivables. ZarMoney is a flexible and feature-rich solution for all your financial needs.

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