Week 7 Flashcards
Define the following terms:
- Accruals
- Accounts receivable
- Accounts payable
- Inventory
Accruals - Sales and expenses are recognised in the period which the transaction takes place. Not when the money is exchanged.
Accounts receivable - A customer who has received goods but not yet paid for them.
Accounts payable - A supplier who has provided goods but has yet to be paid for them.
Inventory - Goods manufactured or bought for resale.
Fill the gaps within the Working Capital Cycle
- Cash
- Accounts payable
- Inventory
- Accounts receivables
- Profit
A. Pay suppliers
B. Assemble units
C. Sell units
D. Collect debts
What five factors add to the cost of holding inventory.
- Rent of warehouse
- Security staff
- Obsolescence
- Pilferage
- Opportunity cost
Why should a business hold stock/inventory?
A firm may hold stocks/inventories for various reasons
Most common: to meet the immediate daily requirements of customers and production
Some businesses may hold more stock/inventory than is necessary for this purpose if it is believed that future supplies of stock may be interrupted or scarce
Similarly, if the firm has reason to believe that the cost of stocks will rise in the future, it may decide to stockpile the goods
What are the key factors that influence the level of debtors/receivables
The Terms of Sale
The Firm’s Pricing Policy
The Firm’s Debtor/Receivable Follow-up Procedures
Explain why firms should make a credit management policy and what things should be considered when making one.
A firm’s credit management policy should help the firm to maximise its expected profits
The firm will need to take into account its current and desired cash position, as well as its ability to satisfy the expected demand
Key factors influencing the level of debtors/receivables are:
- The Terms of Sale
- The Firm’s Pricing Policy
- The Firm’s Debtor/Receivable Follow-up Procedures
The debtor/receivable management system should seek to balance the benefits to be gained from offering credit to customers against the costs of doing so
Longer credit terms may increase turnover, but they will also increase the risk of bad debts
Shortening the credit terms to customers will help reduce the risk of bad debts, but this will mean less turnover
What are the 5 C’s of credit
Capital
Capacity
Collateral
Conditions
Character
Define capital in terms of credit
The customer/firm should appear to be financially sound before any credit is extended
Financial statements should be examined as part of this process
Particular emphasis should be placed on the firm’s/customer’s likely future profitability
Any major financial commitments of the firm/customer should be taken into consideration
Define capacity in terms of credit
The customer must appear to have the capacity to pay amounts owing
The payment record of the customer to date (if available) should be examined If the customer is a business, then their type of business operated and their physical resources will be relevant as well
Define collateral in terms of credit
On certain occasions, it may be necessary to ask the firm/customer for some kind of security for the goods supplied on credit
When this occurs, the business must be convinced that the customer is able to offer a satisfactory form of security
Define conditions in terms of credit
Consideration should be given to the state of the industry in which the customer operates, especially the general economic conditions of the region or country
This may have an important impact upon the ability of a customer to pay the amounts outstanding on the due date
Define character in terms of credit
The business should make an assessment of the customers/firms’ character
The willingness to pay depends on the honesty and integrity of the individual with whom the business is dealing
For firms, this may mean assessing the characters of its directors
The firm offering credit should feel satisfied that the customer will make every effort to pay any amounts owing
Fill in the blanks for calculating the operating cash cycle
- Average inventories holding period
- Average settlement period for receivables
- The average payment period for payables
