Domain IV − Financial Management − Section A.3 Current Assets Management Flashcards
Revenue cycle
is a group of business activities associated with providing products or services to customers and collecting cash for those sales. The revenue cycle begins with customer’s order for products or services and ends when either the invoice is paid in full, or
the account is written off the books.
Forecasts of Future Cash Flows
Forecasting future cash flows is an essential step in
managing current assets and liquidity.
If management finds that there would be a cash deficit (cash outflows for a period greater than the cash inflows) then management has the time to arrange for short term financing sources to avoid any insolvency.
On the other hand, if management finds that there would be a cash surplus, then management can utilize a portion of the surplus in additional investments to generate income.
Managing the Float
the float results from timing differences between the company’s cash balance and the bank account’s cash balance as there typically is a lag with customers, suppliers, and the banking system. The float can be collection float or disbursement float. The company can benefit from reducing collection float and utilizing the disbursement float.
Expediting Collections
which refers to taking measures to ensure that collections are made and deposited in the bank (i.e., made available) as quickly as possible. Collections
can be expedited by:
- Credit Policy – the first line of expediting collections is to ensure that credit is extended only to credit‐worthy customers who will pay and will pay on time.
- Prompt Billing – invoicing customers immediately after a sale can help reduce the payment cycle.
- Early Payment Discounts – offering customers a motive to pay early by offering them an additional cash discount if they pay within a specified period of time.
- Prompt Deposits – ensuring that customer collections are immediately made available in the bank account: electronic funds transfer, lockbox account, credit card
Delaying Payments
: using Payable Through Draft (PTD) – PTD is a payment tool that is, unlike a check, drawn against the writer not against the bank. After the PTD is presented to the bank, the bank must obtain the issuer’s approval before the amount can be paid by the bank.
Zero Balance Accounts (ZBA)
ZBA are bank accounts that are always at zero and replenished on a regular basis in the exact amount of the disbursements to be made out. This method provides control over account balances and allows the company to carry lower cash balances in its various disbursement accounts. The excess money is centered in the master account balance and can be used for short‐term investments.
Maintaining Overdraft Systems
In this case, the bank is financing the company’s disbursements because the company’s account will have a negative balance. Therefore, the company will need to pay interest on these negative amounts.
Compensating Balances
some banks offer customers a waiver from monthly service fees if a compensating balance is maintained. The compensating balance will therefore
save the company in banking costs.
Trade receivables
are amounts owed by customers for services rendered and/or goods sold, and they are further classified as either Accounts Receivable or Notes Receivable.
Accounts Receivable
are oral promises of customers to pay the company for goods and/or services received.
Notes Receivable
are written promises made by customers to pay a sum of money on a set date for goods and/or services received. Notes receivable would be classified as current on noncurrent on the balance sheet depending on their maturity date.
Uncollectible Accounts Receivable
uncollectible accounts receivable should be deducted from reported accounts receivable with an offsetting reduction to income.
Direct Write‐Off
Method under this method, an entry to write‐off the accounts receivable and record a Bad Debt Expense only when an account is deemed uncollectible.
- The direct write‐off method is NOT GAAP since it potentially violates the matching principle.
- The direct write‐off method is required for tax reporting, since the tax code allows for claiming a bad debt expense only when an account is deemed uncollectible.
Allowance Method
under this method, an estimate is made each period for uncollectible accounts receivable, and a charge to income is made during the period that the associated revenues were recorded.
- Percentage of Sales Approach (also referred to as the income statement approach) estimates the debit side of the entry by calculating a percentage of credit sales as bad debts.
- Percentage of Receivables Approach (also referred to as the balance sheet approach) estimates the balance of the contra account (Allowance for Doubtful Debts) and records any additionally required credit to the Allowance for Doubtful Debts as the Bad Debt Expense for the period.
Sale of Receivables
whereby receivables are typically sold to a factor or are securitized. Both factoring and securitization may be with recourse or without recourse.
- Factoring refers to selling the receivables to a finance company for a fee.
- Securitization refers to pooling receivables of some common nature together and issuing shares in these pools.
Raw materials
are inventory items that are processed further in a manufacturing process and are traceable into the final product.
Work‐in‐process
is the manufacturing cost of material that was incomplete as of year end.
Finished goods
are the completed manufactured units that are ready for sale in the ordinary course of business.
Materials and supplies
are items used in the manufacturing process that cannot be traced to the final product.
Periodic Inventory System
is an inventory management system that accumulates all purchases and related returns in a special “Purchases” account throughout the year. At year end, a physical inventory is performed, ending inventory is valuated, and the cost of goods sold is computed.
Perpetual Inventory System
is an inventory management system whereby updated inventory records are maintained for inventory on‐hand. Purchases and sales directly update the inventory records thus management always has an updated record of inventory. Annually, a physical inventory is made, and results are compared to the records. Significant differences are then investigated.
Specific Identification
is used to charge to cost of goods sold the historical cost of the particular item sold. The method is used when it is practical to physically separate inventory items.
Weighted Average
is used with a periodic inventory system whereby only one average for each inventory item is calculated every year.
First‐In First‐Out (FIFO)
assumes that inventory sold is from the earliest inventory purchases thus ending inventory is from the most recent inventory purchases.
- Cost of goods sold and ending inventory will always be the same.
- During a period of rising inventory costs, using FIFO will result in the lowest cost of goods sold and the highest net income.
Last‐In First‐Out (LIFO)
assumes that inventory sold is from the most recent inventory purchases thus ending inventory is from the earliest inventory purchases.
- Ending inventory and cost of goods sold may differ between using a periodic inventory system and a perpetual inventory system.
- During a period of rising inventory costs, using the LIFO method will result in the highest cost of goods sold and thus the lowest net income.
Supply chain management
is the active management of the flow of goods to maximize efficiency, create value for customers and shareholders, and achieve a sustainable competitive advantage in the marketplace.
Accounts payable (AP)
are liabilities due to suppliers resulting from the acquisition of goods or services without paying in cash up front.
Accounts Payable Management
refers to the policies employed by a company with respect to managing its trade credit purchases.
Cash Discount
suppliers may grant the company a cash discount to encourage early remittances. The cost of getting the discount may be calculated using the following formula:
=> Discount Annualized Percentage Rate = Discount Rate / (1 – Discount Rate) x 365/ (Net Payment Period – Discount Period)
