For plenty of companies, an important line item on the balance sheet is accounts receivable (AR). The question is, can you take the amount reported at face value, or is there more to it than meets the eye?
It’s critical to dig deeper into your numbers to understand the true quality of your AR. Your balances might include stale invoices, bad debts, or even fictitious entries.
Benchmarking receivables
A good place to start with evaluating the quality of receivables is the days sales outstanding (DSO) ratio.
This number represents the average amount of days it takes you to collect payment after booking sales. Find it by dividing the average AR balance by your yearly sales and multiplying this number by 365 days.
Companies that are on the ball when it comes to managing receivables usually have lower DSO ratios than those that are a bit more lax about collections. Businesses with high DSO ratios may have accounts on the books that could be overdue by 31 to 90 days or even longer.
If a company has more than 20% of stale receivables, this could indicate less-than-stellar collection habits, a poor-quality customer base, or other troubling issues.
Your percentage of delinquent accounts is another important number, and you might decide to outsource these accounts to third-party collectors to do away with the troublesome process of wrangling overdue payments or threatening legal action just to collect the money you’re owed.
Diagnosing fraud symptoms
AR can also be a common place to hide fraud due to the high volume of transactions involved. Some warning signs of fraud to be on the lookout for in your receivables are:
- Increases in stale receivables
- A larger amount of write-offs compared to previous periods
- An increase in receivables as a percentage of sales or total assets
Aside from creating false invoices or fictitious customers, a dishonest employee may engage in lapping scams. This is when a receivables clerk assigns payments to incorrect accounts to obfuscate systematic embezzlement.
In addition to creating phony invoices or customers, a dishonest worker may engage in lapping scams. This happens when a receivables clerk assigns payments to incorrect accounts to conceal systematic embezzlement.
Additionally, a fraudster may send out inflated invoices to customers and proceed to “skim” the difference after applying the correct amount to the customer’s account. Using multiple employees for invoicing and recording payments can reduce the likelihood of skimming (unless multiple employees work in concert to defraud the business).
Have questions? Smolin can help.
Like any valuable asset, accounts receivable needs to be managed and safeguarded. Evaluating receivables is standard procedure for auditors, and this process includes performing ratio analysis, sending confirmation letters, and reconciling customer receipts with bank deposits.If you have concerns about your AR trends, contact the professionals at Smolin. In addition to conducting surprise audits, our team can customize procedures engagements or forensic accounting investigations that will dig deeper into your books to ensure everything is above board.