How to Calculate Collection of Accounts Receivable
Calculating the collection of accounts receivable is a crucial aspect of managing a business’s finances. Accounts receivable refer to the money that a company is owed by its customers for goods or services provided on credit. Accurately tracking and calculating these receivables is essential for maintaining healthy cash flow and financial stability. In this article, we will discuss the steps and methods to calculate the collection of accounts receivable effectively.
Understanding Accounts Receivable
Before diving into the calculation process, it is important to have a clear understanding of accounts receivable. These are the amounts that customers owe to a business, and they are typically listed on the company’s balance sheet as a current asset. Accounts receivable can arise from various transactions, such as sales on credit, services rendered, or other forms of credit extended to customers.
Step 1: Gather the Necessary Data
To calculate the collection of accounts receivable, you will need to gather the following data:
1. Open accounts receivable balance: This is the total amount of money owed to the company at the beginning of the period you are analyzing.
2. Aging of accounts receivable: This refers to the classification of receivables based on the length of time they have been outstanding. It helps in identifying which receivables are most likely to be collected and which may require follow-up actions.
3. Cash collected during the period: This is the total amount of money received from customers during the period you are analyzing.
4. Bad debt expense: This is the estimated amount of money that may not be collected from customers due to defaults or other reasons.
Step 2: Calculate the Net Accounts Receivable
The first step in calculating the collection of accounts receivable is to determine the net accounts receivable. This can be done by subtracting the cash collected during the period from the open accounts receivable balance:
Net Accounts Receivable = Open Accounts Receivable Balance – Cash Collected During the Period
Step 3: Calculate the Aging of Accounts Receivable
Next, you need to classify the accounts receivable based on their aging. This will help you identify which receivables are more likely to be collected and which may require follow-up actions. Typically, accounts receivable are classified into the following categories:
1. Current: Receivables that are due within 30 days.
2. 31-60 days: Receivables that are past due but still expected to be collected within 60 days.
3. 61-90 days: Receivables that are past due but may take longer to collect.
4. Over 90 days: Receivables that are highly unlikely to be collected and may be written off as bad debt.
To calculate the aging of accounts receivable, you can follow these steps:
1. List all accounts receivable by customer.
2. Determine the due date for each receivable.
3. Categorize each receivable based on its aging.
4. Sum up the amounts in each category.
Step 4: Calculate the Allowance for Doubtful Accounts
The allowance for doubtful accounts is an estimate of the amount of receivables that may not be collected. It is a contra-asset account that is deducted from the accounts receivable balance on the balance sheet. To calculate the allowance for doubtful accounts, you can use the following formula:
Allowance for Doubtful Accounts = (Total Accounts Receivable Percentage of Uncollectible)
The percentage of uncollectible can be determined based on historical data or industry standards.
Step 5: Calculate the Net Realizable Value of Accounts Receivable
Finally, to calculate the collection of accounts receivable, you need to determine the net realizable value of accounts receivable. This is the amount of accounts receivable that is expected to be collected after accounting for the allowance for doubtful accounts:
Net Realizable Value of Accounts Receivable = Net Accounts Receivable – Allowance for Doubtful Accounts
By following these steps, you can effectively calculate the collection of accounts receivable and gain valuable insights into your business’s financial health. Keeping a close eye on accounts receivable is essential for maintaining a healthy cash flow and ensuring the financial stability of your business.
