Accounts Receivable (AR) is one of your most valuable assets. It represents the money owed to you by your customers. However, as AR is susceptible to risk, unpaid invoices can cripple businesses, draining cash flow and hindering growth. Collecting invoices on time or early bears importance, as borrowing to float customer invoices will eat into margins. Collecting cash quickly to assist in self-financing with cash flow is imperative.

This article will guide you through a comprehensive risk assessment framework to help you identify and evaluate AR risks.  

Key Steps for Conducting an AR Risk Assessment

Analyze Your Aging Report:

• Identify Aging Trends: Use an aging report to pinpoint how long invoices remain outstanding. This helps you identify potential payment delays and assess the health of your receivables.
• Segment Your Customers: Categorize customers based on various factors such as industry, location, size, and payment history. This segmentation allows you to tailor risk mitigation strategies.

Identify Customers with Security Arrangements:

• These may include bonds, credit insurance, factoring, letters of credit, UCC lien, or guarantees.

Assess Your History of Unpaid Invoices:

• As explained by Atradius, looking at the history of losses incurred through insolvencies/bad debt allows you to draw conclusions about general default risks. Is there a pattern? For example, are the bad debts clustered in a particular sector or geography? Can you identify a group that has a greater need for security arrangements and guarantees than other customer groups?

Calculate DSO (Days Sales Outstanding):

• DSO represents the number of days it takes for a company to convert its accounts receivables into cash. Businesses will typically calculate their DSO on a monthly, quarterly, or annual basis.
• DSO calculation: DSO = (accounts receivables / total sales) x number of days
• Monitor DSO Trends: Track your DSO over time to identify any significant changes.
• Benchmark: Compare your DSO to industry averages to gauge your performance.
• Analyze Payment Patterns: Understand how many customers pay within the agreed credit period and how many don’t.

Monitoring your AR portfolio closely and generating regular reports to track performance is key. By following these steps and implementing effective risk mitigation strategies, you can significantly reduce the risk of non-payment and protect your business’s financial health.