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Are Your Receivables Over or Understated?

written by: •edited by: Ronda Bowen•updated: 6/6/2011

Whether you’re a business owner or an investor looking to buy an existing business, you need to take a close look at accounts receivables (A/R) to find out what those numbers really represent. Often AR can be manipulated, posted incorrectly or even uncollectible yet still shown as an asset.

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    How Much Is Your A/R Worth?

    Dice Accounts receivable valuation is an important tool for many things including:

    Net Worth – The A/R on your books is essentially an asset and helps to determine the company’s net worth or value. Over-valuing A/R that can’t be collected can be detrimental if exposed to investors or banks.

    Collateral – Often businesses use their A/R to help gain a business loan and use them as a guarantee or collateral for the loan.

    Real Value – All businesses need to develop a way to track their A/R and be able to find, upon a quick glance, how many are current or past due and past due by how many days such as 30, 60 or 90 or even more. This is also known as proper aging of account receivables.

    Best Practices – Once valued and tracked, you’ll need to utilize some best practices in collecting accounts on time as well as finding ways to reach out to customers and recover old receivables.

    Cash Flow – If your A/R isn’t coming in on a regular basis, you’re losing cash flow and cash is king in every business.

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    Hiding the Truth

    Due Diligence As a business owner, I have been involved in the takeover of existing businesses and part of the acquisition process is to find out the real value of the company. If you determine the best way to buy the existing company is to purchase assets and not stock, you’ll most likely take a look at the balance sheet and income and expense statements.

    Beware of stated accounts receivables on the balance sheet and take the time to perform some due diligence. The numbers you see on the balance sheet on the asset side, may show a high number but of that number how many are uncollectible or come with caveats?

    By caveats I mean if you do buy the A/R, what if some of them are indeed collectible but come with issues or problems from past customers—real or imagined? For example, one account I took on once I was the new business owner, the customer complained they were overcharged, repairs weren’t as promised and demanded an immediate remedy or they threatened a lawsuit. If you do indeed buy an existing company’s A/R, you’re buying the whole package so keep that in mind.

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    Due Diligence

    So, how do you go about accounts receivable valuation? Actually it’s more complicated than looking at the balance sheet, you need to see journals or schedules offering up the detail of those receivables.

    Again, let’s take the example of one existing business I purchased. I chose to purchase assets, not stock or liabilities. The owner’s balance sheet showed accounts receivables in the amount of $120,000—not bad as an asset right? Wrong!

    My next step was to ask to see the A/R journal with detail—without the detail the accounts receivable valuation was as useless as the bland number on the balance sheet. Upon my review of the detailed journal I found that of the $120,000 of receivables, only $30,000 were actual receivables that I would be able to realize upon the purchase of the company. The journal detail was something like the screenshot below (click to enlarge).

    Screenshot Accounts Receivable Detail Journal 

    And, the detail of the A/R went on and on where most accounts were 120 days or more past due, meaning the chances of collecting those assets were slim to none—so in essence the buyer of the business overstated these assets and without due diligence on my part I would have purchased uncollectible assets.

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    When It’s Bad

    Ideas for Best AR Practices If you do find you have purchased A/R assets and find they are falsely stated or if you find yourself over-valuing your A/R, what can you do?

    If you do purchase account receivables and find their not truly stated and likely uncollectible, there’s probably not much you can do except to write these off as bad debt expenses at tax year end. If you feel you can collect on some of these past due accounts, consider the cost of collection compared to the expense deduction you’ll gain at year end—weigh both options and choose the best one. Close any customer accounts that aren’t current and offer a truthful explanation.

    If you know the receivables listed on your balance sheet aren’t true dollars you can collect, consider using a balance sheet that shows the total number of A/R plus an additional column showing past due amounts in days (30, 60, 90, 120+). This way, if an investor or lender looks at your balance sheet they will see right away you’re being upfront and honest about your actual A/R without looking at the detail (although they may ask for it anyway).

    Follow some best practices when it comes to collecting on receivables to ensure you’re paid on time and get that much needed cash to keep your cash flow positive, not negative. Even if you must implement late fees or interest on past due payments, do so. Once an A/R customer is faced with fees the first time, they’ll be more likely to pay on time.

    Finally, invest in accounting software to track your receivables. Keeping figures in your head or in an unorganized format will only result in missed payment, posting mistakes and debts owed to your company not paid in full.

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    References

    The author has been a business owner for over 17 years and has experience with receivables, payables, and financial statements.

    Image Credits:

    Dice - MorgueFile/Alivmann

    Magnifying Glass - MorgueFile/ariadna

    Screenshot courtesy of author

    Idea - MorgueFile/ppdigital