When you invoice a company for products or services rendered, your customer’s payments become your business’s working capital. Unpaid invoices and late payments reduce your working capital and the available funds for operating expenses, payroll, and growth. This is when the Cross Age rule of accounts is important to be aware of.
Cross Age Rule
The cross age rule of accounts receivable financing is an effective way to identify delinquent accounts. Once a certain percentage of receivables for an individual account are overdue, then the entire account is considered overdue. The cross age rule has a significant impact on a business’s credit policies, valuation, and creditworthiness.
By using a formula that compares the dollar amount of past due invoices to the total amount of invoices due, it is easy to identify and take action to remedy past due accounts. When more than a certain percentage of an account balance is past due, the entire account is classified as cross aged.
Example of the Cross Age Rule
Application of the cross age rule starts with determining what constitutes an overdue receivable and what percentage of overdue receivables is acceptable. For example, if an account has $10,000 in total receivables and $5,000 is overdue, the account would have an overdue percentage of 50 percent. If a business decided its threshold for overdue receivables was 25 percent, this account would become subject to the cross age rule. The overdue age and the threshold percentage vary by industry, type of business, and the purpose of the valuation. Generally, the cross age limit is set to 25 to 33 percent after 90 days.
Allied Financial Corporation uses the 33 percent / 90 days equation. This means if more than 33% of the account is over 90 days old, then the account is cross aged.
Internal Credit Policies
Businesses often use the cross age rule to determine internal credit policies. By cross aging the account, the business can justify placing a hold on new purchases for that account to prevent further defaults. This rule also can act as a trigger to start internal collection proceedings or to send an account to an outside debt collector. Using this rule, a business can send the entire account into collections rather than just the overdue amount.
The cross age rule allows a business to declare an entire account uncollectable and write off the entire value of that account at tax time. That way, the business does not pay taxes on money it is owed but believes it will not ever collect. The rule also affects the valuation of a business, because it lets a business remove the value of an entire account that may prove too costly or impossible to recover.
Lenders look to the cross age rule to assess the true value of a business’s accounts receivable, which is a key indicator of whether the business will have the revenue needed to repay the loan. Lenders often apply their own cross age rule when evaluating creditworthiness rather than using the rule established by the business. Prospective borrowers implement the cross age rule to keep from using the value of an overdue account as collateral for a loan.
How Allied Financial Corporation Uses Cross Aging
When you receive a working capital line of credit from Allied Financial Corporation, we use cross aging to determine your borrowing base.
Contact Allied Financial Corporation for a free consultation about a working capital line of credit to help your business grow and prosper. Fill out our online contact form to get started with our easy and convenient application process.