DEMYSTIFYING THE BALANCE SHEET - Understanding Accounts Receivable

Welcome to blog 4, in this sales training series on Demystifying Financial Statements.

If you are new to our blog – thank you for joining us – it’s great to have you here.

You can read previous blogs at our blog page: https://www.castcommercialacumentraining.blog/blog

A new training blog in this series is released every Monday, which includes a structured exercise to build your knowledge and embed your learning by incorporating it into your customer engagement planning.

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Today's blog focuses on Accounts Receivable.

Accounts Receivable or Trade Receivables (if you are in the UK), refers to the amounts owed to a company by its customers. In essence it relates to amounts invoiced for services or products sold, not yet been paid for.

What type of asset is accounts receivable?

Accounts receivable is classified as a current asset.

Remember, a current asset is a short-term asset that is cash or can be turned into cash within 12 months.

Every month, companies receive payments from their customers for outstanding invoices. When the payment is received it is recorded as cash received in the company bank account, reducing amounts owed as shown in accounts receivable – this is why accounts receivable is classified as a current asset.

Here’s how to do a quick and dirty review...for accounts receivable.

I recommend the following quick and dirty (Q&D) approach, which is purposefully similar to the approaches for tangible assets and inventory, to help embed your learning of a new skill.

When you review and hypothesise about accounts receivable, you are brainstorming ideas and gathering insights about a company’s sales revenue, cash flow and cash collection. This review could also reveal potential cash pressures, and issues around cash control, or cash management all of which your products or services may be able to ease and help resolve.

Here are the steps in order for the Q&D review:

Step 1

Download the financial statements for one of your favourite customers. From the contents page, turn to the balance sheet. If possible, I would recommend using the same customer’s balance sheet as you did for your review in our last blog as it helps to build familiarity and understanding of your customers business.

Step 2

Scroll down to current assets until you find the words Accounts Receivable (AR) or Trade Receivables (TR) – see image 1.

Image 1.

Step 3

To start and complete your Q&D review for accounts receivable, answer the following four questions:

i. Compare the current year AR or TR number with the prior year. Ask yourself, has the number gone up, gone down, or stayed close to the same? Make a note of the movement.

ii. What can you hypothesize about the movement.

If it’s gone up, what could this mean? Here’s a couple of ideas:

- Sales revenue has also gone up indicating growth. You would need to check the income statement to confirm this.

- It could also mean that despite sales going up, the company is experiencing slower cash collection.

- The company has extended it payment terms with customers e.g., from 45 days to 60 days, meaning it takes customers longer to pay. If so, why?

- Better cashflow, supported by stronger credit worthiness. If so, what are the company’s plans for the increased cashflow and stronger credit score? Investment? Expansion? Acquisition?

Similarly, if AR or TR has gone down or stayed close to the same, what could the reasons be for this?

- Is there a reduction in sales revenue?

- Is the company collecting its cash quicker? If so, why? Have they recruited new credit controllers?

- Customers are paying faster because the company has shortened its payment terms e.g., from 60 days to 30 days.

- Customers are not financially viable or credit worthy. If so, why is this happening? Is it because the company has inadequate or bad credit policies?

Remember - You don’t need to have the exact answers, you just need to be curious about ‘why’ the movement could have happened, and brainstorm ideas to explore further.

iii. What questions could you ask your customer based upon your hypothesis and ideas to learn more about their business?

iv. Finally, based upon your hypothesis and questions, how could your products or services help your customer?

So, how long should this Q&D review take?

The first time you do an AR review, it’s likely to be clunky, bumpy, and slow. Allow 20 minutes. With repetition, you will be able to do the review in just 5 minutes.

It’s now time to practice and play...

Repetition is mastery of all skill...so practice! practice! practice!

Download the financial statements for your top five favourite customers, who businesses you are familiar with. Then play and practice each of the above steps. Using your top five customers will mean you can apply the above steps to five different businesses. This will give you different perspectives, different questions, new insights, and fast track to mastery.

Remember to trust your instincts...

When doing a Q&D review remember to trust your instincts. If something doesn’t feel right, or doesn’t make sense, you are probably right. Make a note of it and ask your customer questions about it. Use it as an opportunity to learn more about their business. Curiosity is key, and they will love your interest in them and their business.

What's next weeks blog in the series?

Next week our training blog focuses on the importance of cash which is the most important blog in the series to date. Cash is the lifeblood of a business. You may have heard the saying 'Cash is King', well next week's blog we explore why this IS the case. You will realise that everything you sell to your customers will have an impact on their cash, whether it be to help increase sales revenue, reduce costs to free up cash for investment or simply to build cash balances. Like our previous blogs, we will highlight signs to look out for and questions to ask your customers.

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