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Understanding and Applying Accounting Reports and Ratios

General Business News

August, 2019

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Understanding and Applying Accounting Reports and Ratios

Understanding Accounting RatiosWhen it comes to tracking incoming sales and outgoing expenses, there are many ways businesses can keep up with their invoices and implement strategies to reduce the time they spend on unpaid sales.

Accounts Receivable Turnover Ratio

Simply defined, the accounts receivable turnover ratio is a way of showing what percent of a company’s receivables or invoices are paid by clients. 

The U.S. Small Business Administration explains this ratio is determined by "dividing average accounts receivable by sales." Determining average accounts receivable is done by adding the beginning and ending figures -- be it a month, quarter or year, then dividing by 2. Determining the sales figure is calculated by taking the total sales still on credit and deducting any allowances or returns from the gross sales figure.    

If the beginning and ending accounts receivables for a 12-month period were $20,000 and $30,000, the average accounts receivable would be $50,000/2 or $25,000. If the gross sales were $200,000 for the 12-month period and there were $20,000 in returns, it would leave $180,000/$25,000 or an accounts receivable turnover ratio of 7.2

Accounts Payable Turnover Ratio

The payable turnover ratio is determined by taking all purchases from suppliers and dividing the supplier purchase figure by the mean accounts payable figure. The average accounts payable figure is calculated by adding the starting accounts payable figure and the ending accounts payable figure, normally at the beginning and ending of a period, such as 12 months. From there, the summed up accounts payable figure is divided by 2 to get an average.  

A business made yearly purchases on credit for about $250,000 from suppliers and had returns to those suppliers for about $20,000. If at the beginning of the 12-month period accounts payable were $11,000, then at the end of the period the accounts payable balance was $26,000, the total figures would equal $37,000.

From that point, there would be $230,000 in net yearly purchases on credit for the business and an average of $18,500 for the period's accounts payable. Dividing the $230,000 by $18,500 equals 12.43. Therefore, the business' accounts payable turned over about 12.5 times during the period. As the SBA explains, the higher the ratio, the more dependent companies are on accounts payable to acquire inventory.   

Accounts Payable Aging Report

When it comes to defining an accounts payable aging report, businesses can use this tool to determine and organize outstanding accounts payable to vendors or suppliers and how much each is owed. While it can be broken into discreet time frames, such as net-14 or net-60 or net-90, depending on how the supplier and business decided on payment terms, commonly accepted time frames established are: up to 30 days; 31 to 60 days; and so on.

This report is used to organize which supplier invoices are due and when. One important consideration to note is if the report assumes that all invoices are due within 30 days. If there's special arrangements or terms from important suppliers, it could need adjusting as determined by individual supplier payment terms.  

By using an accounts payable aging report, businesses will see when they need to pay their bills on time and what percentage are being paid on time (or not). It will help businesses see if they're paying late fees by organizing invoices. Businesses can also identify if there’s a need to negotiate with suppliers for reduced payments for early payments or for extended time to pay invoices if cash flow is an issue. 

Accounts Receivable Aging Report

Similar to an accounts payable aging report, an accounts receivable aging report helps businesses track outstanding invoices owed by clients. It also contains the client name, the time when payment is due and how late, if at all, client invoices are for issued invoices.

These reports help businesses determine the likelihood of debt becoming bad, and if unpaid invoices need to be sent to collections or written off. It can also measure in short and long terms how clients have made timely payments on their invoices. This can help businesses determine if they should reduce existing credit terms to their clients or to make an offer to discount what’s owed in order to get an otherwise uncollectible invoice paid.

Whether a company owes money or expects to be paid for a product or service, with the proper accounting tools, there’s a way to keep track of all inflows and outflows.

Sources

https://www.sba.gov/offices/district/nd/fargo/resources/capacity-and-credit

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These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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