Despite your best efforts, an unavoidable part of doing business is the occasional uncollectible account. Although every business owner wants to avoid this and does her or his best to do so, uncollectible accounts are inevitable. These accounts are receivables or debts with either little chance of being repaid or none at all and are also known as doubtful accounts or uncollectible receivables. The job of a credit manager — or one in the accounts receivables management role — is to minimize the number of unpaid lines of credit. However, when the inevitable happens, credit managers need to have methods for estimating these uncollectible amounts. Keeping an estimate of the amount of money you’ll be unable to collect for your business helps you fiscally plan with more accurate profit and loss details.
Estimating uncollectible accounts
There are a variety of methods you can use to estimate these unpaid debts. The best way may depend on your particular business model. The majority of company leaders employ either a percent of sales or aging method.
Percent of sales
This method involves looking over past accounts to determine what average percentage of total sales went unpaid in the past.1 Credit managers can use this average percent to estimate the amount they can expect in doubtful accounts for current and future business.
For example, Bob, the credit manager at ABC Company, knows his company has an average 5% of net sales that are never paid. Bob applies that percentage to his current net sales to estimate his company’s projected uncollectible accounts for the present period. Bob can more accurately forecast what his profit will be, figuring in the amount of payment he likely won’t receive based on his percent of sales calculation.
Another common method credit managers use to estimate doubtful accounts is the aging method. While similar to the percentage of sales method, the aging method differs in that this calculation takes more than current account sales numbers into consideration.
This method, also known as analysis of receivables, is used when a credit manager studies the company’s uncollectible accounts but takes the process a step further than percent of sales by considering the age of past due accounts.2 Usually, the longer an account goes uncollected, the higher chance a credit manager will never collect. This fact is considered in the aging process, which makes this method more complex but slightly more accurate than the simple percent of sales method.
For example, Bob at ABC Company uses a spreadsheet to help him sort accounts based on how long they’ve been overdue with columns for current accounts, those 30 days past due, 60 days past due, and so on. Even if the accounts owed are from the same customer, he will break apart the amount due by date, according to the length of time overdue. If a customer owes ABC Company a grand total of $20,000 but part of that amount has been overdue longer, Bob will split apart the money due according to the past-due date.
Bob then sums all columns with the idea that the longer an account goes unpaid, the more likely it is that he will never collect. Sorting his collections data this way gives Bob a fairly good idea of which doubtful accounts will not be collected. He can then use this information to fiscally plan his business’s future.
Professionals at your local commercial credit bureau will not only help you maximize your collections but also aid you in estimating your uncollectible accounts. When you have a complete financial understanding of your organization, you can make better credit lending, planning, and growth decisions.
1 Credit Research Foundation. 1999. “Estimating Uncollectable Accounts.” Accessed October 13, 2016. Source.
2 Averkamp, Harold. 2016. “Q&A: How do you estimate the amount of uncollectable accounts receivable?” AccountingCoach. Accessed October 13. Source.