CREDIT WHERE DUE
Solving the New ADA Puzzle
Calculating credit loss in a way that complies with recent regulations may seem daunting, unless you take a step-by-step approach. BY C. ROBIN SZABO
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ou may find yourself scratching factors and a reasonable forecast of future determine which ones have similar risk charyour head these days over how economic conditions. These components, acteristics. Pool similar customers together to calculate your company’s Al- when combined, will yield a more accurate and assign a loss percentage for each pool. lowance for Doubtful Accounts estimate of credit loss. It’s in use now by Se- This is where working closely with salespeo(ADA). It’s an estimate of the amount of curities and Exchange Commission (SEC) ple is vital as they pursue additional revenue accounts receivable that will not be paid by filers and will be for non-SEC filers by 2023. opportunities by either expanding existing customers and is used to improve the accuraWith the new CECL model, credit man- advertiser segments or exploring new ones. cy of accrual financial statements and aid in agers will need to create additional data Since you are modeling for the future, the forecasting of cash collections. Account- points and may need the help of other de- staying abreast of trends in your customer ing departments calculate the ADA, and the partments within their organization. Work- base and the industries they belong to is task is usually assigned to the credit extremely important. Keep an esmanager, since they are most fapecially close watch on those cusmiliar with the customers in their tomers that represent the biggest accounts receivable portfolio. dollars or are a high concentration When ADA is recorded at the risk. time of the credit sale, it’s listed If you have credit-scoring modin the current asset section of the els in place or subscribe to an orbalance sheet below cash and is ganization that provides one (like generally presented like this: “AcBCCA), this can be a big benefit. counts receivable, net of allowAs your customer base evolves, ance of $66,324, $5,197,456.” these tools supply quick decisionIn the past, many companies making information. relied solely on historical bad After completing your risk analThis new modeling is not an exact science; it will ysis, debt data using an incurred loss factor in current economic model to calculate their ADA. take time to implement and require tweaking conditions locally, nationally and This method, while widely used before a truly functional template is in place. globally. Take into consideration a for many years, had its shortcomgrowing economy versus a slowing ings. It did not allow for the probability of ing more closely with sales departments will economy; qualitative factors; severe weather; suspected future losses to be included in the be a must to track new types of customers. supply shortages; pandemics; reasonable allowance, since those losses had not yet If the data needed is not readily available, forecasts of future economic conditions; inbeen realized. managers may need to seek enhancements flation; interest rates; and employment. ComThis has resulted in issues for users of from IT. This new modeling is not an exact bining these new data points and applying the financial information who need deci- science; it will take time to implement and their influences to historical percentages sion-useful information about the credit require tweaking before a truly functional provides an adjusted overall percentage risk inherent with financial assets measured template is in place. So, begin now before that can be used to calculate the CECL alat amortized cost, which includes trade deadlines approach. lowance for trade accounts receivable. accounts receivable. The global financial Where to start? With a little of the old CECL implementacrisis magnified the shortcomings, result- and plenty of the new. First the old: credit tion may seem daunting in the Financial Accounting Standards managers historically have used previous loss ing, but by taking a Board (FASB) issuing new guidance in 2016 data from their aging buckets to calculate an step-by-step planned through ASC 326, “Measurement of Credit overall percentage for the incurred loss model approach, t his new Losses on Financial Instruments,” and the ADA. This historical information will be modeling will provide introduction of the Current Expected Credit part of the new model, but with adjustments. more accurate and deciLoss (CECL) model. Now the new: credit managers are re- sion-useful information. This model calculates the credit loss over quired to perform a risk analysis of their C. Robin Szabo is president of Szabo Associates the life of the receivable and has several accounts receivable portfolio. This involves Inc., media collection professionals, in weighted components: historical loss data, taking a deeper look at their current, past Atlanta, GA. He can be contacted at robin@szabo.com or (404) 266-2464. current economic conditions, qualitative and future portfolio of credit customers to
8 The Financial Manager • January/February 2022
