7.4 Receivable Management Flashcards
A retail company analyst is comparing North Company to South Company. The analyst notes that receivables for both companies’ private label credit cards have significantly increased balances in the current year. North’s customers’ monthly payment averaged 15% of their balances, while South’s customers’ monthly payment averaged 22% of their balances. What should the analyst conclude?
A. North’s customers may be having a hard time paying down their credit card debt than South’s customers.
B. South Company has likely increased its prices higher than North Company.
C. Both North Company and South Company have increased their prices in the current period; however, South Company has a higher gross margin than North Company.
D. North Company sells more high-volume, low-margin goods than South Company.
A. North’s customers may be having a hard time paying down their credit card debt than South’s customers.
Define the cash conversion cycle and describe how it relates to the operating cycle.
The cash conversion cycle is the time that passes, on average, between the firm’s payment for a purchase of inventory and the collection of cash from a customer on the sale of that inventory. The cash cycle is part of the operating cycle. The operating cycle is the cash cycle plus the time between purchases and payment.
An aging of accounts receivable measures the
A. Ability of the firm to meet short-term obligations.
B. Average length of time that receivables have been outstanding.
C. Percentage of sales that have been collected after a given time period.
D. Amount of receivables that have been outstanding for given lengths of time.
D. Amount of receivables that have been outstanding for given lengths of time.
The purpose of an aging of receivables is to classify receivables by due date. Those that are current (not past due) are listed in one column, those less than 30 days past due in another column, etc. The amount in each category can then be multiplied by an estimated bad debt percentage that is based on a company’s credit experience and other factors. The theory is that the oldest receivables are the least likely to be collectible. Aging the receivables and estimating the uncollectible amounts is one method of arriving at the appropriate balance sheet valuation of the accounts receivable account.
A company believes that its collection costs could be reduced through modification of collection procedures. This action is expected to result in a lengthening of the average collection period from 28 days to 34 days; however, there will be no change in uncollectible accounts. The company’s budgeted credit sales for the coming year are $27,000,000, and short-term interest rates are expected to average 8%. To make the changes in collection procedures cost beneficial, the minimum savings in collection costs (using a 360-day year) for the coming year would have to be
A. $30,000
B. $36,000
C. $180,000
D. $360,000
B. $36,000
If the change is adopted, the company’s average balance in receivables will increase by $450,000 {$27,000,000 × [(34 days – 28 days) ÷ 360 days]}. The minimum savings that the company must experience to justify the change is therefore $36,000 ($450,000 × 8%).
Which one of the following statements is most likely to be true if a seller extends credit to a purchaser for a period of time longer than the purchaser’s operating cycle? The seller
A. Will have a lower level of accounts receivable than those companies whose credit period is shorter than the purchaser’s operating cycle.
B. Is, in effect, financing more than just the purchaser’s inventory needs.
C. Can be certain that the purchaser will be able to convert the inventory into cash before payment is due.
D. Has no need for a stated discount rate or credit period.
B. Is, in effect, financing more than just the purchaser’s inventory needs.
The normal operating cycle is the period from the acquisition of inventory to the collection of the account receivable. If trade credit is for a period longer than the normal operating cycle, the seller must be financing more than just the purchase of inventory.
The average collection period for a firm measures the number of days
A. After a typical credit sale is made until the firm receives the payment.
B. For a typical check to “clear” through the banking system.
C. Beyond the end of the credit period before a typical customer payment is received.
D. Before a typical account becomes delinquent.
A. After a typical credit sale is made until the firm receives the payment.
The average collection period measures the number of days between the date of sale and the date of collection. It should be related to a firm’s credit terms. For example, a firm that allows terms of 2/15, net 30, should have an average collection period of somewhere between 15 and 30 days.
A company is considering a change in its credit terms from n/30 to 2/10, n/30. The company’s budgeted sales for the coming year are $24,000,000, of which 90% are expected to be made on credit. If the new credit terms are adopted, the company estimates that discounts will be taken on 50% of the credit sales; however, uncollectible accounts will be unchanged. The new credit terms will result in expected discounts taken in the coming year of
A. $216,000
B. $240,000
C. $432,000
D. $480,000
A. $216,000
The company can calculate expected discounts taken under the new credit policy as follows:
Total sales 24,000,000 x percentage on credit 90% = $21,600,000 credit sales
Credit sales 21,600,000 x subject to discount 50% = $10,800,000
Subject to discount 10,800,000 x discount percentage 2% = expected discounts taken $216,000
