DEFINITION of 'Aging'
Aging is a method used by accountants and investors to evaluate and identify any irregularities within a company's accounts receivables. Aging is achieved by sorting and inspecting the accounts according to their length outstanding. By aging a company's accounts receivables, a person can get a better view of a company's bad debt and financial health.
BREAKING DOWN 'Aging'
An accounts receivable (AR) aging report lists unpaid customer invoices and credit memos by date ranges to determine which invoices are overdue. A typical report lists invoices in 30-day groups, such as 30 days old, 31-60 days old and 61-90 days old. The aging report is sorted by customer name and itemizes each invoice by number or date.
Importance of Aging Report
Management uses the aging report in determining the effectiveness of the company’s credit and collections functions and for estimating potential bad debts. Management revises the allowance for doubtful accounts and determines the historical percentage of invoice dollar amounts per time period that often become bad debt, then applies the percentage to the most recent aging report. Management knows which customers need sending to collections, which need targeting with follow-up invoices and whether the company is collecting receivables too slowly and taking on too much credit risk. If money flows in too slowly, the company’s bills are not paid on time, possibly leading to insolvency.
Example of Aging Report
Company A typically has 1% bad debts on items in the 30-day period, 5% bad debts in the 31 to 60-day period and 15% bad debts in the 61+ day period. The most recent aging report has $500,000 in the 30-day period, $200,000 in the 31 to 60-day period and $50,000 in the 61+ day period. Based on the calculation ($500,000 x 1%) + ($200,000 x 5%) + ($50,000 x 15%), the company has an allowance for doubtful accounts of $22,500.
Issues with Aging Report
Management may extend particularly long credit terms to specific companies or invoices, which may appear extremely overdue on the aging report when they are not. Since many companies bill at month end and run the aging report days later, outstanding accounts from a month prior show up. Even though payments for some invoices are on the way, receivables falsely appear in a bad state. Running the report prior to month-end billing includes fewer accounts receivable and shows little cash coming in, when in reality much cash is owed. The company’s credit terms must match the time periods on the report for an accurate representation of the company’s financial health. For example, credit terms of 10 days showing up in time periods of 30 days make invoices appear current when they are not. Unapplied credits on the report need cleaning up by finding which invoices they are applied against and reducing the amount of overdue receivables on the aging report.