An accounts receivable reserve is a type of reserve account created to offset losses incurred when customers fail to remit payments on outstanding invoices.
An accounts receivable reserve is a type of reserve account created to offset losses incurred when customers fail to remit payments on outstanding invoices. The idea of the reserve is to prevent the company from experiencing serious financial difficulties due to non-payment. A reserve account of this type can be used to offset the impact of invoices that remain overdue when a customer declares bankruptcy, closes the deal, or simply fails to pay, and the balance is handed over to a collection agency.
There are several strategies that can be used to determine the amount of funds that are allocated to an accounts receivable reserve. One of the most common approaches is to make use of historical data that involves the percentage and actual amounts of invoice delinquencies that have occurred within a certain period of time. A slightly different approach calls for basing the amount on the due date of the invoices, with the reserve balance based on the sum total of invoices older than 90 days. Choosing the best approach often depends on the circumstances of the business and how easily the business can recover if older invoices are not paid in full.
The main benefit of establishing and maintaining an accounts receivable reserve is that the company is somewhat insulated from the harmful effects generated by customers’ failure to remit payments on outstanding invoices. By having reserves on hand, the company is able to offset these losses and continue to disburse payments to vendors and suppliers without fail. By having sufficient funds in reserve, it is possible to avoid late fees and other penalties on accounts payable that would only increase the company’s debt obligations, making financial stability even more difficult.
Guidelines on when to use funds from an accounts receivable reserve vary. Some companies require delinquent customer accounts to be sent for collection before the funds from the reserve can be used to make up for losses. Other companies adopt the practice of withdrawing funds from the accounts receivable reserve when invoices reach a certain level of aging, such as 120 days after issuance. In the event that funds are received due to collection efforts or the customer submits a payment after the account has reached the aging threshold, these payments can be used to replenish the reserve, allowing the company to maintain this type of savings. for the future .