8.5 Managing Receivables Flashcards
what are the 4 key steps to amanging account receivables
1) determine who to extend credit to
2) establish a pay period
3) monitor collections
4) evaluate liquidity of receivables
what are the considerations when you are thinking about who to extend credit to?
THE CREDIT POLICY!!
1) if POLICY is too tight (denying too many people credit) than the company may lose revenue bc no one can do business w u
2) if POlicy is too lose, company may extend credit to shitty customers who dont pay
howc an companies minimize credit losses
- make risky customers provide letters of credit or bank guarantees
-make others pay deposits or cash on delivery
-reference checks from banks for payment history
-check credit score
how does a company establish a pay period for credit
1) match competitors (if you provide 30 day and opps provide 45 days you could lose the sale)
2) if your credit pay period is too long you may have to borrow more from th ebank
3) consider benefit of having discount for earlier pay
what ahppens is a customer does not pay in the credit term period
interest/finacning charge added to balance due
how can a company monitor colelctions?
1) companies should prepare and review an A/R aging schedule at least monthly (helps estimate the allowance for expected credit losses and other cool stuff)
what are the benefits of an a/r aging schedule
1) helps estimate allowance for expeceted credit losses
2) helps management estimate timing of future cash inflows
3) provides info about companys overall collection experience (identifies problem accounts)
what should credit policies alwawys thnk about?
economic envrionemnt!! if its a downturn in the whole ceonomy there will be larger scale impact (should we be kinder to makers?)
how do we evaluate the liquidity of receivables?
If sales increase, then what is expected to increase
accounts receivable are also expected to increase.
if a/r rises faster than sales?
this may indicate a collection problem
Perhaps the company increased its sales by loosening its credit policy,
what happens if receiveables are hard and impossibel to colelct?
lOWERS THEIR LIQUIDITY!!!
WHAT RATIO is used to assess the liquidity of receivables>
recievables turnover ratio (measures the number of times on avg that receiveables are collected throughout the year)
FORMULA= credit sales/ average gross accounts receivable during the year
FORMULA= credit sales/ average gross accounts receivable during the year
formula for receivables turnover
where do you find gross a/r
amount reported in the a/r account (before deducting allowance for expected credit losses)
how do you calculate average gross accounts receivable
adding otgether the beginning and ending balances and divide by 2 of all a/r
** but if seasonal factors are significant this is not correct
Unfortunately, companies seldom report the amount of credit sales in their financial statements. In such instances, sales (including both cash and credit sales) can be used as a substitute. As long as we consistently choose the same component to use in a ratio, the resulting ratio will be useful for period-to-period comparisons.
Unfortunately, companies seldom report the amount of credit sales in their financial statements. In such instances, sales (including both cash and credit sales) can be used as a substitute. As long as we consistently choose the same component to use in a ratio, the resulting ratio will be useful for period-to-period comparisons.
how do you measure the quotient of the receivables turnover formula
and what does it mean??
— times
higher the turnover ratio=the more liquid its recievables are
A popular variant of the receivables turnover is to convert it into an average collection period in terms of days. This is done by dividing 365 days by the receivables turnover.The average collection period is frequently used to assess the effectiveness of a company’s credit and collection policies. The general rule is that the collection period should not greatly exceed the credit term period (the time allowed for payment).
word?
if you are using receivable formula in days, what does this mean
shows how many days it takes you to collect recievables
Recall from earlier chapters that high receivables and inventory balances due to slow-moving accounts and goods can distort a company’s current ratio. In general, the faster the turnover, the more reliable the current ratio is for assessing liquidity.
In addition, in some cases receivables turnover and collection periods can be misleading. Some large retail chains that issue their own credit cards encourage customers to use these cards for purchases. If customers pay slowly, the stores earn a healthy return on the outstanding receivables in terms of interest income earned. Consequently, to interpret these ratios correctly, you must know how a company manages its receivables.
