302784 Flashcards
Selected data from Ostrander Corporation’s financial statements for the years indicated are presented below in thousands:
26.61 days.
17.83 days.
18.10 days.
18.36 days.
18.10 days.
Average collection period is days in the year divided by AR turnover. AR turnover = Net sales ÷ Average accounts receivable.
To compute accounts receivable turnover:
Find average accounts receivable ((Beginning + Ending) ÷ 2): ($210,000 + $204,000) ÷ 2 = $207,000.
Divide net sales by average AR to get accounts receivable turnover: $4,175,000 ÷ $207,000 = 20.17
Finally, divide 365 days by the AR turnover to get the AR collection period in days: 365 days ÷ 20.17 = 18.10 days.
Accounts Receivable
Accounts receivable are amounts the entity is entitled to receive that arise in the normal course of business (e.g., from the credit sales of goods or services). Receivables are claims against others for money, goods, or services, usually on “open” accounts after credit approval is granted. There is no formal written agreement, and they are usually classified as current assets. Normally, accounts receivable are expected to be received within 30 to 90 days. Accounts receivable are contrasted with notes receivable, which are of a longer term (e.g., 3 to 24 months) and accrue interest at a stated rate. Nontrade receivables are those that arise outside of the normal course of business (e.g., loans to employees or receivables from affiliated entities) and may be recorded net or gross. They are reported at net realizable value (i.e., the amount expected to be collected) and are offset by a valuation allowance account (a contra asset account).
Factors responsible for a net realizable value less than the amount billed are cash discounts, sales returns, and uncollectible amounts.
Accounts Receivable Turnover
Accounts receivable turnover (or receivables turnover) is an activity ratio that measures efficiency of credit and collection policies with respect to trade accounts. It confirms the fairness of the receivable balance and reflects the relationship between trade receivables outstanding and credit sales for the period. (Lenient credit policies and poor collection efforts will decrease this ratio.)
Computation: Net credit sales ÷ Average AR
Average AR used is: (Beginning balance + Ending balance) ÷ 2
Limitations on use of this ratio: It should be computed on credit sales only; if using total sales, a shift in the percentage of credit sales to cash sales will affect the ratio. It can be affected by significant seasonal fluctuations unless the denominator is a weighted average.
2161.01
Objectives: Short-term liquidity ratios and other measures provide information about how well a firm is able to meet its currently maturing obligations.
Creditor and management: This is of special interest to creditors, but also important for management to know in order for them to be able to avoid embarrassing last-minute scrambles. Liquidity refers to the composition of current assets and liabilities, primarily assets. A higher proportion of cash or marketable securities is more liquid than a low proportion.
Short-term liquidity: Operating activity and cash flow ratios are analyzed as part of short-term liquidity. Operating activity ratios measure how effectively and efficiently the firm is carrying out its business—making sales, collecting on sales, and managing inventory. Companies with slow turning inventory and slow paying customers are less liquid. Cash flow gives an indication of the liquidity of a company as does the speed with which noncash current assets convert to cash.
2161.02
Definitions
Current assets: These are cash and other assets that will be converted into cash, sold, or consumed within one year or the operating cycle, whichever is longer. Items are usually listed from highly liquid to less liquid. Increasing current assets is a use of short-term funds for a business. Typical categories are the following:
Cash and cash equivalents
Marketable securities (trading and available-for-sale classifications at fair value)
Notes and accounts receivable (at net realizable value)
Inventories
Prepaid expenses (at unexpired cost)
Current liabilities: Current liabilities are defined as liabilities to be paid within one year or the operating cycle, whichever is longer. Items are usually presented in order of their liquidation dates and reported at the amount to be paid. Increasing current liabilities are a source of short-term funds for a business. Typical categories are:
accounts payable arising from the acquisition of goods and services.
other accrued liabilities, such as wages payable and interest payable.
notes payable, such as but not limited to commercial paper, short-term bank credit loans, and factoring.
collections of amounts in advance (unearned or deferred revenues).
currently maturing portions of long-term debt.
Working capital: Working capital is simply the difference between current assets and current liabilities. Creditors are especially interested in working capital as it is the source from which they will be paid.
