What You’ll Learn:
- Why investors look at AR as a key metric during business valuations
- Which AR data points look appealing to potential investors
- How to analyze your own AR data and leverage insights for potential growth
Before supporting a business, investors look at a wide variety of metrics, including accounts receivable records. AR valuation helps investors understand your sales processes, customer payment patterns, and cash flow.
If you want to partner with an investor to grow your business, you need to understand your AR data. Learn which aspects of AR and cash flow give insights into your overall company health and how you can optimize your processes to appeal to investors.
Why investors care about your AR
Money flowing into a company is good business, and AR is a significant asset in most companies. However, AR isn’t cash in your bank account. It represents money that is owed to the company. While this money will likely be paid to you, that doesn’t always happen. Clients may pay late or not at all.
With this in mind, investors don’t necessarily care about the raw AR numbers. They care about what AR represents for the overall viability of a company. Accounts receivable data can help them determine your creditworthiness and the risks of investing in your business.
Steps to valuation
When investors want to fund a company, they take a look under the hood, so to speak. They typically do this with the help of a valuation company, which takes steps to look at a company’s finances and processes to determine its value.
Valuation steps include:
- Gather relevant information like financial data, contracts, and assets.
- Perform analysis (both financial and nonfinancial) based on the available data.
- Assess company processes through site visits or interviews.
- Synthesize all information for a final valuation.
Standard valuation processes may take an income-based, asset-based, or market-based approach. AR valuation may be part of any one of these.
How investors analyze your AR
AR evaluation is a component of due diligence, aka how investors evaluate a business. When it comes to AR, potential investors analyze data points that give them insight into cash flow patterns. They look at:
Days sales outstanding
Days sales outstanding (DSO) is a metric that shows how fast you are getting paid on average. For a given period, use this formula:
(AR Balance / Total Credit Sales) x Number of Days = DSO
Generally, the lower your DSO, the better off your company is. A low DSO means your clients are paying you quickly and keeping your cash flow streamlined. A high DSO means that clients typically take their time fulfilling invoices—and may even regularly send in late payments.
AR aging schedule
An AR aging schedule puts invoices into categories based on how old they are. For a typical net-30 invoicing schedule, you may have three buckets of invoice types:
- 0–30 days: New invoices
- 31–60 days: Overdue payments
- 61+ days: Late payments
Most of your invoices should fall into the first bucket, as you wait for clients to pay their invoices on a regular schedule. A small percentage may fall into the other buckets as a part of normal business operations. A high percentage in the older buckets indicates an issue with collections, and is a red flag to potential investors.
Bad debt expense and reserve
Despite your best efforts, some clients may simply fail to pay their bills. In these cases, your business can write off these amounts as bad debt expenses, which are paid for with cash flow reserves. Potential investors will look at these numbers as they evaluate your company’s health.
How much do you historically write off? Is your reserve adequate to cover these expenses? In addition to these metrics, investors may examine why you write off bad debt. A one-time write-off due to a sharp market downturn or unexpected bankruptcy may be seen as the cost of doing business. Repeated write-offs from several different sources with low creditworthiness may be more of a red flag.
Customer concentration
Customer concentration looks at what percentage of your total AR is tied to specific customers or industries. While large accounts have their advantages, they also come with some risk. A high concentration—such as one client making up 20% or more of your receivables—is considered high risk. That risk can be somewhat mitigated, though not entirely eliminated, with clients who have good creditworthiness.
Think of it this way: If a single client makes up a large percentage of your AR and they suddenly stop paying their bills, you have a significant cash flow problem. On the other hand, if you have a more diverse income stream, it is more resilient to individual or market changes.
Collection policies and processes
In addition to hard data, potential investors are likely to examine how you handle your AR. How organized and effective are your collections? Written policies for credit and collections provide a solid foundation for operations. Clear follow-through and consistent enforcement signal your organization’s competency as well.
How to optimize your AR before soliciting new investors
When looking at your own company, you may realize you have high customer concentration or aging AR. A little active management can polish your processes before you present them to an investor for consideration.
To optimize your AR, you can:
- Review and document your invoicing processes, including bad debt processes.
- Examine and tighten credit policies to mitigate risk.
- Implement proactive, systematic collection procedures.
- Analyze DSO and aging reports to gain visibility.
- Address aged receivables through collections or write-offs.
- Evaluate customer concentration risk and take steps to diversify AR.
Leverage your current AR for growth and stability
Whether or not you partner with a new investor, your accounts receivable are a valuable financial asset. Clear records and internal analysis offer insight into your company’s overall health—and potential growth paths. Take a look at your DSO and AR aging schedule to see where your money sits and what your AR valuation might look like.
Ready to learn from those insights and grow your business?
Get approved for Flow to use your current AR for growth—no outside investors necessary.
Bret Lawrence
Writer
Bret Lawrence writes about invoicing and cash flow management at Hopscotch. Her previous roles include senior financial writer at Better Mortgage, where she covered lending and the home buying process. Her writing is not financial advice.
