Happy Tuesday Folks!

Welcome back to another edition of The Contractor Finance Playbook.

Last week I broke down how Fortune 500 companies manage their accounts receivable and what you can take and implement in your own company. If you missed it you can read it here.

The AR Aging report is a key component of effectively managing AR. And while I broke down at a high level how these Fortune 500 enterprises manage their Accounts Receivable as a whole, I didn’t breakdown how you should specifically analyze the aging that provides that visibility that is needed.

So today I want to a little more technical and expand on what I wrote last week and breakdown how to analyze your AR Aging report like a CFO would.

Plus, we have a new From The Feed this week that every contractor had to deal with at some point.

Let’s dive on in!

Most contractors take a quick glance at their AR aging at a glance and then move on about their day. But when reviewed correctly, this report gives one of the earliest warning signs for cash flow issues.

Accounts Receivable doesn’t come into play nearly as much with residential work because a lot of times payment is due immediately upon completion of work. If your contractor that does a lot of commercial work, it’s a completely different ball game.

You likely have multiple contacts for multiple things and invoices have to be processed through the company’s Accounts Payable department. And if everything falls in line and they do their job well, you get paid on time

One of the biggest unlocks for a contractor is to fully understand what makes up their AR aging and truly understand the ins and outs of their portfolio.

Here are the steps:

The AR Aging Summary tells you the total amount of AR outstanding by customer. Don’t only focus on the total amount of AR standing, the report also defaults to show current, 0-30, 31 - 60, 61-90, 90+days past due aging buckets. QuickBooks default aging buckets stop at 90+ days but you can add more buckets or customize to your business

For example: if most of your invoices are due upon receipt or are net15 terms you can customize the report to show the aging buckets how you want to see them.

Divide the dollar amount for each aging bucket by total AR to get your percentages of the AR total.

Bucket percentage = (Total amount specific aging bucket / Total AR) * 100

Percentages let you compare month to month and track whether collections are improving, getting worse and where you should prioritize your collections efforts.

For example: Say you currently have $125K in open receivables. That number could be alarming if you look at it on its own. But if out of the $125K, if 80% of the open receivable balance is current then it’s not as scary. On the flip side if 80% of open receivables are past due, especially 60+ days old then that’s where it becomes alarming.

Analyze which customers has the highest AR and which ones have the most invoices past due? Those should be your top priority to collect. For the past due balances, is it a small group of customers making up these balances or is spread out across the portfolio? If it’s between a small concentration of customers, the reason could be customer specific. If it’s spread out between many customers then the reason could be more system driven or lack thereof.

Flag any customer that shows up in the 60+ days bucket frequently and track it. This is where you will need to make customer specific decisions like requiring deposits, tightening credit terms or even dropping them all together.

For the customers that have balances that are 60+ days past due, evaluate why they aren’t paying. Did they actually receive your invoices? Are they in a cash crunch? We’re they fully satisfied with the service that was provided? Are they on the verge of bankruptcy (hopefully not)? Whatever a customer’s reason is, its best to understand why they aren’t paying you and using that info to make decisions.

In this case you need to take that feedback (or lack there of) and evaluate what are the chances that I don’t get paid for this work and what you can do to prevent that from happening.

In situations where there is a high likelihood that invoices are uncollectable, its best practice to go ahead and put a reserve on the books in case they are deemed uncollectable and need to be written off. This is especially important if your books are using accrual accounting even if its just for management reporting purposes.

The Days Sales Outstanding (DSO) is one of the most important metrics you can track.

DSO = (Total AR / Total credit sales) * number of days in the period

DSO tells you on average how long it takes you to get paid. Tracking it each month gives you insight into how fast you are collecting and be an early warning sign for potential cash flow issues.

If your invoices say Net 30 and your DSO is sitting at 52, that 22-day gap is telling you either your terms aren't being enforced, your follow-up process is too passive, or certain customers are taking advantage by not paying on time.

This is where last week's follow-up guide comes in. When your DSO starts slipping and aged receivables are increasing, you need a structured follow-up system to collect on those invoices instead of a wait and see approach. If you haven't grabbed that guide yet, it walks through exactly when to escalate and what to do at each stage. The link is below

The Link: AR Follow-up Guide

That’s all this week folks!

Til next time, cheers!

Preston