Aging Schedule: How to Classify the Accounts Receivable Based on the Time Elapsed Since the Sale Using Capital Evaluation

1. What is an aging schedule and why is it important for businesses?

An aging schedule is a table that shows the breakdown of the accounts receivable of a business based on the time elapsed since the sale. It is a useful tool for analyzing the liquidity and credit quality of the business, as well as for managing the collection process. An aging schedule can help a business to:

1. Identify the customers who are overdue or at risk of defaulting on their payments, and take appropriate actions such as sending reminders, offering discounts, or initiating legal actions.

2. Estimate the amount of bad debts or uncollectible accounts that need to be written off or provisioned for, and adjust the allowance for doubtful accounts accordingly.

3. Evaluate the effectiveness of the credit policy and the collection efforts of the business, and make improvements if needed.

4. Assess the impact of the accounts receivable on the cash flow and working capital of the business, and plan for the financing needs accordingly.

An aging schedule typically divides the accounts receivable into several categories based on the number of days past the due date. For example, a common aging schedule may have the following categories:

- Current: Accounts that are not yet due or are within the credit terms.

- 1-30 days past due: Accounts that are slightly overdue but still within a reasonable period.

- 31-60 days past due: Accounts that are moderately overdue and may require more attention.

- 61-90 days past due: Accounts that are seriously overdue and may indicate a high risk of default.

- Over 90 days past due: Accounts that are very unlikely to be collected and may need to be written off.

The aging schedule can also show the percentage of each category to the total accounts receivable, as well as the percentage of each category that is expected to be uncollectible. These percentages can be based on historical data, industry averages, or management estimates. For example, a hypothetical aging schedule for a business may look like this:

| Category | Amount | Percentage | Uncollectible Percentage | Expected Loss |

| Current | $100,000 | 50% | 1% | $1,000 |

| 1-30 days past due | $50,000 | 25% | 5% | $2,500 |

| 31-60 days past due | $30,000 | 15% | 10% | $3,000 |

| 61-90 days past due | $10,000 | 5% | 20% | $2,000 |

| Over 90 days past due | $10,000 | 5% | 50% | $5,000 |

| Total | $200,000 | 100% | N/A | $13,500 |

From this aging schedule, we can see that the business has a total of $200,000 in accounts receivable, of which $13,500 or 6.75% is expected to be uncollectible. The business can use this information to adjust its allowance for doubtful accounts, which is a contra-asset account that reduces the net accounts receivable on the balance sheet. The business can also use this information to monitor the collection performance and the credit risk of its customers, and take appropriate actions to improve the cash flow and the profitability of the business.

2. The steps and data required to classify the accounts receivable by age groups

An aging schedule is a useful tool for analyzing the accounts receivable of a business. It helps to evaluate the credit quality of the customers and the collectability of the outstanding invoices. By classifying the accounts receivable by age groups, such as 0-30 days, 31-60 days, 61-90 days, and over 90 days, the aging schedule can reveal the patterns of payment behavior and the potential risk of bad debts. In this section, we will explain how to create an aging schedule and what data is required for this process. We will also provide some insights from different perspectives, such as the accounting, finance, and management point of views, on how to use the aging schedule for capital evaluation. Here are the steps to create an aging schedule:

1. Gather the data of the accounts receivable. The first step is to obtain the data of the accounts receivable from the accounting system or the general ledger. The data should include the customer name, the invoice number, the invoice date, the invoice amount, and the payment terms. The payment terms indicate the number of days that the customer has to pay the invoice, such as net 30, net 60, or net 90.

2. Sort the data by the invoice date. The next step is to sort the data by the invoice date in ascending order. This will help to arrange the invoices from the oldest to the newest. Sorting the data by the invoice date is important because it determines the age of the invoice and the due date of the payment.

3. Calculate the age of each invoice. The third step is to calculate the age of each invoice by subtracting the invoice date from the current date. The age of the invoice represents the number of days that the invoice has been outstanding. For example, if the current date is February 3, 2024 and the invoice date is January 15, 2024, then the age of the invoice is 19 days.

4. Classify the invoices by age groups. The fourth step is to classify the invoices by age groups based on the age of the invoice. The age groups can be customized according to the needs of the business, but a common practice is to use the following categories: 0-30 days, 31-60 days, 61-90 days, and over 90 days. The invoices that fall within each category are summed up to get the total amount of the accounts receivable for that age group.

5. Calculate the percentage of each age group. The fifth step is to calculate the percentage of each age group by dividing the total amount of the accounts receivable for that age group by the total amount of the accounts receivable for all age groups. The percentage of each age group shows the proportion of the accounts receivable that is in that category. For example, if the total amount of the accounts receivable for the 0-30 days category is $100,000 and the total amount of the accounts receivable for all age groups is $500,000, then the percentage of the 0-30 days category is 20%.

6. Create the aging schedule. The final step is to create the aging schedule by presenting the data in a table format. The table should have the following columns: customer name, invoice number, invoice date, invoice amount, age of invoice, age group, and percentage of age group. The table should also have a row for the total amount and the total percentage of each age group, as well as the grand total of the accounts receivable. The aging schedule can be created using a spreadsheet software or a reporting tool.

An example of an aging schedule is shown below:

| Customer Name | invoice Number | invoice Date | Invoice Amount | Age of Invoice | Age Group | Percentage of Age Group |

| ABC Inc. | 1001 | Jan 2, 2024 | $50,000 | 32 | 31-60 | 10% |

| XYZ Ltd. | 1002 | Jan 10, 2024 | $25,000 | 24 | 0-30 | 5% |

| PQR Co. | 1003 | Jan 15, 2024 | $75,000 | 19 | 0-30 | 15% |

| LMN LLC | 1004 | Jan 20, 2024 | $100,000 | 14 | 0-30 | 20% |

| DEF Corp. | 1005 | Jan 25, 2024 | $150,000 | 9 | 0-30 | 30% |

| GHI Plc. | 1006 | Jan 30, 2024 | $50,000 | 4 | 0-30 | 10% |

| JKL Ltd. | 1007 | Feb 1, 2024 | $25,000 | 2 | 0-30 | 5% |

| RST Co. | 1008 | Dec 15, 2023 | $10,000 | 50 | 31-60 | 2% |

| UVW LLC | 1009 | Dec 1, 2023 | $15,000 | 64 | 61-90 | 3% |

| NOP Corp. | 1010 | Nov 15, 2023 | $20,000 | 80 | 61-90 | 4% |

| Total | | | $500,000 | | | 100% |

The aging schedule can provide valuable insights for the capital evaluation of the business. From the accounting perspective, the aging schedule can help to estimate the allowance for doubtful accounts, which is the amount of the accounts receivable that is expected to be uncollectible. The allowance for doubtful accounts is calculated by multiplying the total amount of the accounts receivable for each age group by a percentage of bad debt rate, which is based on the historical experience of the business. The higher the age group, the higher the bad debt rate. For example, if the bad debt rate for the 0-30 days category is 1%, for the 31-60 days category is 5%, for the 61-90 days category is 10%, and for the over 90 days category is 50%, then the allowance for doubtful accounts is:

$500,000 \times 1\% + $60,000 \times 5\% + $35,000 \times 10\% + $0 \times 50\% = $10,250$

The allowance for doubtful accounts is deducted from the accounts receivable to get the net realizable value, which is the amount of the accounts receivable that is expected to be collected. The net realizable value is:

From the finance perspective, the aging schedule can help to evaluate the liquidity and the cash flow of the business. Liquidity is the ability of the business to meet its short-term obligations, such as paying suppliers, employees, and creditors. cash flow is the amount of cash that the business generates or consumes in a given period. The aging schedule can indicate the liquidity and the cash flow of the business by showing how quickly the customers pay their invoices and how much cash is tied up in the accounts receivable. The faster the customers pay, the higher the liquidity and the cash flow of the business. The slower the customers pay, the lower the liquidity and the cash flow of the business. A common measure of liquidity and cash flow is the accounts receivable turnover ratio, which is calculated by dividing the annual sales by the average accounts receivable. The accounts receivable turnover ratio shows how many times the accounts receivable are collected in a year. The higher the ratio, the faster the collection and the better the liquidity and the cash flow. The lower the ratio, the slower the collection and the worse the liquidity and the cash flow. For example, if the annual sales of the business are $2,000,000 and the average accounts receivable are $500,000, then the accounts receivable turnover ratio is:

$\frac{$2,000,000}{$500,000} = 4$

This means that the accounts receivable are collected four times in a year, or every three months on average.

From the management perspective, the aging schedule can help to monitor the performance and the efficiency of the credit and collection policies of the business. The credit and collection policies are the rules and procedures that the business follows to grant credit to the customers and to collect the payments from them. The aging schedule can show how effective the credit and collection policies are by comparing the actual payment behavior of the customers with the expected payment terms. The closer the actual payment behavior is to the expected payment terms, the more effective the credit and collection policies are. The farther the actual payment behavior is from the expected payment terms, the less effective the credit and collection policies are. A common measure of the effectiveness of the credit and collection policies is the average collection period, which is calculated by dividing the average accounts receivable by the average daily sales. The average collection period shows how many days it takes to collect the accounts receivable on average. The lower the average collection period, the more effective the credit and collection policies are. The higher the average collection period, the less effective the credit and collection policies are.

3. A summary of the main points and takeaways from the blog

In this blog, we have learned how to use an aging schedule to classify the accounts receivable based on the time elapsed since the sale using capital evaluation. This is a useful technique for assessing the creditworthiness of customers and the quality of the receivables. It can also help to improve the cash flow management and the collection efficiency of the business. In this section, we will summarize the main points and takeaways from the blog and provide some insights from different perspectives.

- The aging schedule is a table that shows the breakdown of the accounts receivable by the age of the invoices. It can be used to calculate the allowance for doubtful accounts, which is an estimate of the amount of receivables that are expected to be uncollectible. The allowance for doubtful accounts is subtracted from the accounts receivable to get the net realizable value, which is the amount of cash that the business expects to receive from the receivables.

- The capital evaluation is a method of assigning different interest rates to the receivables based on their age. It can be used to calculate the present value of the receivables, which is the amount of cash that the receivables are worth today. The present value of the receivables can be compared to the net realizable value to measure the opportunity cost of holding the receivables, which is the difference between the two values. The opportunity cost represents the potential income that the business could have earned if it had collected the receivables earlier and invested the cash at the interest rate.

- The benefits of using an aging schedule and capital evaluation are:

1. They can help to identify the customers who are late in paying their invoices and take appropriate actions to collect the payments or adjust the credit terms.

2. They can help to evaluate the effectiveness of the credit policy and the collection procedures of the business and make necessary improvements or changes.

3. They can help to estimate the bad debt expense and the allowance for doubtful accounts more accurately and realistically.

4. They can help to measure the opportunity cost of holding the receivables and the impact of the receivables on the profitability and liquidity of the business.

- The limitations of using an aging schedule and capital evaluation are:

1. They rely on historical data and assumptions that may not reflect the current or future situation of the customers and the market conditions.

2. They may not capture the qualitative factors that affect the collectibility of the receivables, such as the customer relationship, the reputation, the industry, the competition, etc.

3. They may not account for the variability and uncertainty of the cash inflows and outflows of the business and the time value of money.

4. They may not consider the trade-offs and opportunity costs of other alternatives, such as factoring, discounting, or securitizing the receivables.

We hope that this blog has helped you to understand the concept and application of the aging schedule and capital evaluation for the accounts receivable. We encourage you to practice this technique with your own data and see how it can help you to improve your financial management and decision making. Thank you for reading and please share your feedback and comments with us.