Net accounts receivable formula and how to calculate it

A business owner wears multiple hats. Juggling between tasks like marketing, employee management, and operations isn’t an easy feat. While there’s still some margin of trial and error in others, you can’t afford to make mistakes when managing accounts receivable. It’s basically the lifeblood of a business and managing it well is highly important to ensure healthy business functioning.

As per the 2024 survey from Revelwood, 75% of the finance leaders said that accounts receivable have become more strategic than ever before¹. The survey digs further and discovers that Days Sales Outstanding (DSO) is expected to increase for 55% of the respondents. Customer-specific dynamics, inflationary economic landscape, and supply chain issues are the main drivers behind unexpected DSO fluctuations.

In this guide, we’ll explore some fundamental information about net accounts receivable and how a UK business can make the process smooth and accurate.

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What is net accounts receivable?

Net accounts receivable is one of the key performance indicators (KPIs) of business finances. It refers to the amount a business is likely to receive from its customers. It is calculated after deducting allowances, bad debts, and discounts from the potential sum or gross accounts receivable. Imagine it as a realistic estimate of how much cash you'll actually receive from your accounts receivable once all customer payments come through.

Knowing the net accounts receivable formula is the initial step in maximizing the power of this metric. Once you’ve got a clear idea of what net accounts receivable of your business are, you can leverage its power to improve your collection efforts.

Why is net accounts receivable important?

Almost 90% of UK businesses deal with late payments. For about half (52%), delays happen in less than 10% of their transactions. However, nearly one in five (18%) see late payments in 25% of their invoices. These late payments can seriously impact cash flow, especially for smaller businesses that don’t have much financial cushion.

What’s more concerning is that 1 in 10 businesses don’t even know how often they receive late payments, which puts them at risk of financial trouble by not keeping a close eye on their cash flow².

Figures like these bring us to the underlying question – how does the net accounts receivable formula help? Here are some reasons that could answer this query:

Measure their Performance

Businesses can track their net receivables over time or compare them with industry peers to assess how well they manage credit. For example, looking at receivable turnover ratios along with net receivables can provide useful insights into how efficiently they collect payments.

Improves Cashflow Management

Cash keeps a business running. Without it, everything can come to a halt. Net accounts receivable helps you estimate how much money will be coming in and going out, and when you'll have it available to cover wages, rent, inventory, and other expenses.

Reduces Reliance on Credit

If businesses don’t accurately predict their cash flow, they often end up relying on credit to stay afloat. When this need arises unexpectedly, they’re more likely to make rushed decisions, which can lead to higher interest rates. On the other hand, with better cash flow predictions, companies can explore other ways to cut costs, like postponing investments in product development.

Strengthens Relations with Suppliers

When a business doesn’t have full control over its cash flow, its relationships with suppliers can take a hit. By calculating the net value of receivables, companies can better predict their incoming payments and plans. This not only strengthens supplier relationships but also gives businesses more confidence when negotiating prices and discounts.

All in all, when you regularly calculate net accounts receivable, you find your business in better financial health. It signals the upcoming red flags and pushes you to take mitigation steps before things go beyond your control.

How to calculate net receivables?

For starters, let’s take a closer look at each component that composes net accounts receivable:

Calculate Gross AR

This is the total amount owed by customers for the goods or services they got on credit. It doesn’t consider any bad debts, allowances, or discounts. It’s simply the total amount of unpaid invoices.

Subtract Discounts and Allowances

This is a common method companies adopt to improve their customer relationships and offer an incentive for quick payments. But it can significantly cut down the receivables.

For example, you might give a refund or credit if an item is faulty, gets damaged during shipping, or arrives late. Discounts, on the other hand, are often used to encourage quicker payments. A customer might get up to 2% off if they pay within 10 days instead of waiting the full 30 days.

Estimate Bad Debts

Bad debts are inevitable when your business relies on credit. When you get an accurate amount of bad debts, you have an idea about the portion of your gross accounts receivable that is realistically collectible.

Net accounts receivable formula

The main net AR formula is as follows:

Net Receivables = Gross Accounts Receivable - Allowance for Doubtful Accounts - Sales Returns and Allowances

Below, I’ve illustrated how the net AR formula works:

Suppose that a UK-based company has £200,000 in total accounts receivable. It estimates £8,000 as doubtful accounts and records £5,000 in sales returns. The net accounts receivable are calculated as:

Net Accounts Receivable = £200,000 − £8,000 − £5,000 = £187,000

This means the company realistically expects to collect £187,000 from its customers after accounting for potential losses and returns.

The company realistically expects to receive £187,000 rather than the full £200,000, after adjusting for potential losses and discounts. A larger-than-expected amount set aside for doubtful accounts suggests ongoing issues with late payments, signaling a need for tighter credit policies. To speed up collections, the finance team recommends offering discounts for early payments and being more selective with customer credit approvals.

Keeping a close eye on net accounts receivable helps the business manage cash flow more effectively and rely less on outside funding.

Common errors and challenges when calculating net accounts receivable

Some potential challenges your business may encounter when calculating net accounts receivable are:

Overdue Invoices and Risky Customers

Dealing with high-risk customers and their overdue invoices significantly increases DSO, which puts pressure on cash flow. Managing these late payments requires extra time and resources, forcing teams to closely monitor and follow up on unpaid accounts. This process can create inefficiencies in operations and add financial strain to the business.

Tracking Payments

Keeping track of payments is essential in accounts receivable. If payments are mismanaged, it can lead to errors like double charges or missed payments, causing delays and cash flow issues. Manually matching payments to invoices is not only time-consuming but also prone to mistakes, especially for businesses handling a high volume of transactions.

Difficulty in Managing Deductions

Handling deductions takes up a lot of time and effort, making it harder to recover the full amount owed. The process is slow and prone to mistakes, which can delay resolving disputes and result in financial losses.

Bad Customer Communication

Clear communication is key to ensuring timely payments, especially when starting a business relationship. It is even more vital when you’re dealing with overseas customers. Setting clear payment terms and signing agreements could help with financial management.

The points discussed here make it clear that it isn’t difficult to calculate net accounts receivable. It’s the collection process and communication methods that hinder the process. Steps like using automation tools and setting clear policies can help deal with those issues.

How to improve net accounts receivable?

A business needs strategic plans to streamline collections and cut down its outstanding balances. The following tips might come in handy when making those plans:

• Strengthen credit policies: Before offering credit, set clear terms and check the customer’s financial stability. Regularly review their payment history and adjust credit limits as needed to manage risk. To encourage timely payments, consider offering discounts for early payments and using automated reminders to keep customers on track.
• Run background checks carefully: Before offering credit, carefully check a customer's financial stability to ensure they can make timely payments. Set clear credit terms and make sure customers fully understand them from the start.
• Integrate tech tools: Use accounting software or AR management systems to automate invoicing, payment reminders, and reports. AI can help prioritize collections and handle exceptions more efficiently. These tools simplify the process and make managing receivables easier and more effective.
• Predict cashflows accurately: Using AI-driven exception management and keeping AR data and forecasts updated can also improve cash flow predictions. This allows businesses to make smarter decisions about growth and other key operations, ensuring financial stability.
• Reduce allowances and sales returns: Enhance product quality and customer service to lower the chances of returns and disputes. Make sure refund and return policies are clear and easily understood by customers.

Accounts receivable teams carry a heavy responsibility of making the right decisions at the right times. Sometimes, a single error could lead to irreversible damage.

It’s therefore essential to stay in the learning loop and discover new methods of making the AR calculation process a breeze. Work on the steps mentioned above and make a cohesive plan to deal with cashflow issues effectively.

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FAQs - Net Accounts Receivable Formula

Here are some commonly asked questions about net accounts receivable formula:

What is the formula for net accounts receivable?

The formula for net accounts receivable is:

Net accounts receivable = total accounts receivable – allowance for doubtful accounts

How does net accounts receivable differ from gross accounts receivable?

Gross accounts receivable is the total amount customers owe, while net accounts receivable account for potential losses due to unpaid invoices.

What type of account is net accounts receivable?

In accounting, accounts receivable are considered a current asset. Assets are things a business owns or controls that have financial value. Current assets are those expected to turn into cash within a year.

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Sources used:

1. Unlocking the Potential of Accounts Receivables in 2024
2. Frequency of late payments reported by UK businesses

Sources last checked on date: 12-May-2025