According to the Federal Reserve Bank of St. Louis, collection agencies saw $16.28 billion in revenue in 2019. While revenues have declined somewhat in recent years, unpaid invoices are still big business. Accounts receivable aging reports can help companies identify and mitigate unpaid invoices and potentially lower a business’ need to send unpaid invoices to collection agencies.

An accounts receivable aging report analyzes how well a company manages its accounts receivables (AR) and identifies the level of any abnormalities. It looks at receivables based on their age; specifically, the time the invoice has been unpaid and outstanding. Then, once receivables have been analyzed for non-payment based on different time frames, the business can determine whether to follow up with the customer, send it to collections, or write the invoice off.

Whether it’s created manually through a spreadsheet or done in conjunction with accounting or billing software, either way the AR aging report takes data from the company’s accounts receivable ledger. The following is a general overview of how to create this report:

Step 1: Aggregate invoices and determine if any credit memos or outstanding adjustments on outstanding invoices need to be addressed first.

Step 2: Create time frames for the invoices, be it buckets such as: 1. 0-30 days. 2. 31-60 days. 3. 60+ days. These can be referred to as “aging buckets” to categorize the invoices.

Step 3: Ensure fields for customer information, invoice details, invoice amounts, notes, etc., are ready for the information to flow into.

Step 4: Calculate unpaid invoice balances and group them by customer and time frame.

While this is only an example and can be modified based upon the company’s needs, it’s a starting point for further analysis. From there, along with updating the report on a monthly, quarterly or annual basis, the company can identify how to improve its cash position by determining its weak points.

One important consideration, especially for businesses with high levels of old, uncollected receivables, is that the company’s collection practices can be re-evaluated more effectively. The analysis can show that some customers take too long, and the company needs to be more proactive in following up with them sooner. It can also convey the need to incentivize their collections with early payment discounts.

This data also enables a company to identify customers who have outstanding payments and assess the associated risk to the company’s credit rating. Especially for publicly traded companies, and even for private equity investment evaluations, investors can see how competitive or not their credit rating is compared to similar companies in the same industry. When analyzing customers, it may be necessary to tighten terms or simply stop doing business with the customer.

Companies can offer pre- or early payment terms, with discounts available to customers who pay their invoices upon receipt or within a certain time frame. During challenging conditions for a particular sector or for the economy overall, businesses can set up payment plans to maintain positive relations with certain customers.

While there’s no perfect accounts receivable aging report, an effective one will organize, identify, and reduce the likelihood of increasing numbers of unpaid invoices.

Sources

https://fred.stlouisfed.org/series/REVEF56144ALLEST

When it comes to businesses and asset depreciation, there are many types available, such as straight-line, units of production, double declining balance, and sum of years digits. While these aren’t the only ones, they are available via the IRS code and help businesses reduce their taxable income. However, under certain circumstances, businesses have to be mindful when selling assets for a gain that could cause a tax liability through depreciation recapture.

Understanding Depreciation

Depreciation is defined as the reduction in the value of an asset through wear and tear. It can be a rental property or production equipment. Investors can use depreciation to lower their taxable income. While some companies can depreciate an asset’s value to $0, other companies may determine if an asset has salvage or scrap value when they sell it off to replace it with a more productive asset.

When an asset is sold off and it’s sold for a gain, the Internal Revenue Service considers this depreciation recapture. The IRS makes this determination because it missed the business’ taxable income that was otherwise reduced through depreciation at an earlier point in time.

When a business or investor has had possession of such assets for more than 12 months and it was depreciated to reduce taxable income, taxes may be collected if the asset is sold for a gain. It’s important to note that for assets sold at a loss, depreciation recapture doesn’t apply.

Assets that fall under Section 1250 and Section 1245 of the IRS Code, and what rate the asset is taxed at, depend on how the IRS classifies the asset. Section 1245 taxes filers at ordinary tax rates and applies to personal property such as manufacturing equipment and transportation vehicles. Section 1250 applies to real property such as warehouses, commercial buildings, and rental properties. Taxed at no more than 25 percent, Section 1250 depreciation recapture is indexed according to the filer’s ordinary tax rate.

Calculating Depreciation Recapture

This process looks at the discrepancy between the adjusted cost basis and what the asset sells for. It’s calculated as follows:

1. Determine the cost paid for the asset, plus additional costs for the asset’s fees
2. Calculate the asset’s adjusted cost basis. The section looks at both the impact of adding capital improvements to the asset, along with any potential loss accounts.
3. Is there any loss or gain? Assets sold by a business for a loss, or lower than the adjusted basis, don’t trigger the depreciation recapture. However, if an asset’s sale results in a gain that’s higher than the asset’s adjusted basis, the business incurs a depreciation recapture tax obligation. It’s important to distinguish timelines. For example, if it’s one year or less, it’s short-term. If it’s for more than one year, it’s long-term. 

Illustrating Section 1245 Depreciation Recapture Calculation

As an example, let’s say a company bought a truck for its business needs for $50,000 and owned it for five years. After five years, the company sold it for $30,000.

Accumulated depreciation over the life of the item is $25,000. The adjusted basis is $25,000. The $30,000 sales price, minus the $25,000 adjusted basis, results in a $5,000 gain. With the accumulated depreciation of $25,000 compared to the $5,000 gain, the depreciation recapture is $5,000, which is taxed at ordinary rates.

When it comes to ensuring a business’ tax compliance is adhered to, understanding how depreciation recapture works is one part of the tax code that companies need to understand fully to ensure taxes are filed accurately.

 

Liquidity looks at how well a company can handle paying wages, inventory, and lending repayments via measuring its cash or quasi-cash levels. Put another way, it looks at the health of a company’s cash flow to satisfy short-term financial obligations.

It’s important to be mindful of different sectors and what’s normal or healthy based on the time of year. For example, retail and manufacturing feature functionally focused companies, which means seasonality impacts their dynamic working capital requirements.

1. Current Ratio

The current ratio looks at the ratio of current assets divided by current liabilities. It measures how well a company is projected to pay its present obligations. If the result is 1.0 to 3.0, it’s considered financially well. However, if it’s higher than 3.0, suboptimal asset utilization may be incurred by the company, with a lower than industry average suggesting financial concern. It’s calculated as follows:

Current Ratio = Current Assets/Current Liabilities

The resulting current ratio can signal many things. For a growing current ratio, debt could be growing or cash levels falling. When the current ratio is falling, but not too low, and it’s a smooth downward trend, it can indicate the company is getting more efficient at moving inventory, collecting invoices, and reducing debt levels.

2. Quick Ratio or Acid Test

This is determined by taking the current assets and deducting inventory from them. Once that’s calculated, that number is divided by current liabilities. By looking at the business’ on-demand liquid assets without factoring in inventory, it’s calculated as follows:

Quick Ratio or Acid Test = (Current Assets – Inventory)/Current Liabilities

Resulting calculations above or equal to 1.0 show a company’s stable short-term fiscal health. It’s important to be mindful that a very high result can indicate there’s idle cash that’s not being reinvested, distributed to shareholders, or otherwise put to better use.

Defining Solvency

Solvency refers to the ability of a business’ complete assets to satisfy its complete long-term financial obligations and loan repayments. It’s especially helpful when the business is analyzed internally or externally to determine if the business can survive and thrive during challenging economic times (industry-specific or macro challenges). It helps determine the company’s creditworthiness, whether it’s a good bet for an investment, and/or the risk for companies to take on additional debt. It looks at not only the debt on the company’s financial statements, but also how it relates to equity, tangible assets, and EBITDA.

Debt to Equity

This measures how a company relies on debt versus its equity. It’s used when comparing one company against its industry competitors and how the company’s own ratio has trended over time. Looking at companies within the same industry, companies with a higher ratio indicate a riskier financial situation. Similarly, a ratio that’s too low can indicate a business not using debt to expand its operations effectively.

While liquidity and solvency are different, they are complementary for both owners and managers, along with external parties such as investors analyzing for the next potential investment.