Accounts Receivable Days Outstanding Analysis

About three years ago I wrote a series of three articles on ways to obtain low-cost cash. One of the articles was called 3 Low Cost Sources of Cash – Part 2 and concerned accounts receivable. In specific it discussed how the aging of accounts receivable might reveal an opportunity to generate additional cash, perhaps a significant amount. An alternative financial statistic to the accounts receivable aging that can help improve your cash position is the accounts receivable days outstanding. Let’s take a look.

A Working Example

I will use the same example I used in the earlier posting on accounts receivable aging.

accounts receivable aging exampleAs in the previous posting, assume the company is doing $1 Million in sales per month and assume the collection pattern has been the same for each month. At $1 million in sales per month, that is $12,000,000 per year. Bear in mind this is just for demonstration purposes, as I realize sales can fluctuate from month to month.

Calculation of Accounts Receivable Days Outstanding

The formula for accounts receivable days outstanding is:

(Total Accounts Receivable / Annual Sales) * 365

Note that for the sales number it should really just be for sales made on credit. Cash sales should not be in the sales number. For this example we will assume that all sales were on credit.

So, for our example, the calculation for days outstanding is:

($2,150,000 / $12,000,000) * 365 = 65 Days Outstanding. Actually it is slightly more than that, but this will work for our purposes.

The Significance of Reducing Days Outstanding

Now let’s see what happens when we reduce the accounts receivable days outstanding.

effect of reducing AR days oustandingFor our purposes I have looked at the impact of each 5 days of reduction in accounts receivable days outstanding. As you can see, just a 5 day reduction generates $164,385, a 10 days reduction generates $328,700 and so on up to $1,150,685 by reducing it by 35 days so that only 30 days are outstanding.

Now, getting to 30 days outstanding may be unrealistic, but probably 45 days (a reduction of 20 days outstanding) is reasonable if you have good practices for approving credit and are diligent in collection effort. Even this generates $657,540. Now think about it. Is it possible you may not really need a line of credit if you can control your accounts receivable days outstanding? Perhaps you’ll even be able to purchase equipment for cash. Wouldn’t it be nice not to have to take out a loan?

I believe you can see the significance of managing your accounts receivable well. If you’re not sure how to start controlling your accounts receivable, AimCFO would like to help you.

If you want to know more, contact AimCFO – Contact

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