Net Accounts Receivable

What is Net Accounts Receivable

The net accounts receivable refers to the total amount of money owed to a company by its customers. This figure represents how much money the A/R team expects to collect from customers within a certain period. Knowing the net receivables formula is only the beginning of harnessing the power of this metric. Managers must also leverage its power to improve collections efforts.

How To Calculate Net Accounts Receivable

Accountants express the final figure as a percentage. This percentage represents the net realizable value of accounts receivable. Its calculation requires two main components:

1. Total Accounts Receivable: This is the total amount of money due to the business https://gaviti.com/what-is-the-accounts-receivable-process/ess from its customers. Some financial professionals refer to this as the gross receivables.
2. Allowance for Doubtful Accounts: This is an estimate of the amount of receivables a company will not be able to collect. It can include receivables that the A/R team may have written off as uncollectible, as well as accounts whose payment may be delayed or not received at all. Note that this figure may change based on the period. For example, it could be 5% during the first 30 days but climb to 30% by the 90-day mark.

Example

Company A manufactures high-performance e-bikes and sells directly to local adventure outfitters. It has gross receivables of $300,000 due at the end of January 2023. The company has estimated that they might not receive 10% of payments because winter is the down season and outfitters might be strapped for cash.

Total Accounts Receivable

300,000

Allowance for Doubtful Accounts

10%

300,000 x 0.10 = $30,000

Accounts Receivable Net Realizable Value

300,000 – 30,000

= $270,000 / 300,000 * 100%

= 90%

This means that the company has a collection rate of 90% and can expect to receive an accounts receivable net realizable value of $270,000 by the end of the month. However, $30,000 might remain in arrears.

How To Include The Net Receivables on the Balance Sheet

Some companies include the net accounts receivable on their year-end and quarterly accounting documents. When they add it to the balance sheet, they include it as an asset. Receivables fall under the same classification as cash, inventory, and other assets the company routinely uses to conduct business.

Even balance sheets that do not include a net amount will have gross receivables. These companies should also include the allowance for doubtful accounts on the sheet. Consequently, you can add another line to show the net balance by subtracting the doubtful allowance from gross receivables.

The Benefits of Calculating the Net Realizable Value

AR teams have a growing number of metrics to choose from when calculating collection performance. What are the benefits of adding this metric to the balance sheet or their performance measuring strategies?

More Accurate Cash Flow Projections

A company with $1,000,000 in billed receivables seems to be doing well. But, what happens if the company caters to a struggling industry and its customers face new economic realities that lead to an expectation of a 50% collection value? That million-dollar company swiftly becomes worth half as much in cash value. Executives need this information to make accurate decisions about payroll, expansion, innovation, credit, and other critical business operations.

Reduced Reliance on Credit

When companies do not make accurate cash projections, they inevitably need credit to make ends meet. The more unexpected the need for credit, the higher the likelihood of choosing a hasty solution that could involve higher interest rates. When companies have more accurate projections, they can use other cost-cutting methods, such as delaying investments in product development.

Better Relationship With Suppliers

A company’s relationship with its suppliers can suffer when it does not have total control of its cash flow. Calculating the net value of receivables helps companies accurately predict their payments and plan accordingly. This helps build better relationships and allows companies to negotiate prices and discounts confidently.

How To Improve the Net A/R Percentage for Your Company

The net A/R value measures the performance of the collection team, but it also reflects the trade and credit policies of the company. Consequently, companies must take a multi-faceted approach when taking steps to improve their net A/R performance.

Vet New Customers Carefully

The most common cause of poor collections is extending credit to customers who cannot pay. Companies should thoroughly vet any new customer before granting them access to credit. This includes running a credit check, analyzing their industry and financials, and asking for references.

Regularly Review Existing Accounts

Companies should also review the accounts of their existing customers to ensure they are still viable and able to pay. This requires staying up-to-date with the industry, analyzing customer financials regularly, researching any changes in their operations, offering modifications, and monitoring payment history.

Coordinate With the Sales Team

The sales team plays a crucial role in the credit approval process. Companies should ensure that their sales teams know the company’s credit policies and offer customers terms they can realistically meet.

Monitor Allowances for Doubtful Accounts

An allowance for doubtful accounts is necessary to anticipate non-performing receivables and adjust accounting numbers. Companies should monitor their allowances regularly to ensure that they reflect the current state of their receivables.

Provide Incentives for Early Payment

What are you willing to provide customers who pay their invoices early or on time? A small discount could speed up the payment process if you need cash quickly. You could also consider priority in product selection or deliveries, especially if you have a waitlist for hard-to-get products.

Promptly Follow Up With Invoices

Be sure to follow up on payment before invoices have gone unpaid for too long. Send reminders and communicate regularly to prompt payment. This is where creating an effective dunning notice strategy comes in handy.

How Gaviti Can Help Companies Improve AR Performance

Accounts receivable teams can streamline their efforts to improve performance by leveraging technology. At Gaviti, we have automated the entire invoice management process, including the execution of your dunning notice strategy. Our software also calculates the net accounts receivable formula and other metrics in real time so that ARs teams have an accurate picture of their performance.

Are you ready to see automation in action at your organization? Speak to a Specialist to get started.

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