Meena GorandleFinancial Management, ITM Institute of Management

DEBTORS TURNOVER DEBTORS TURNOVER RATIORATIO

Financing

Cash Considerations

Consists of: ü Currency and coins

on hand

Ø Most liquid of all assetsØ Central to operating cycle

ü Checks and money orders from customers

ü Deposits in checking and savings accounts

Cash may include a compensating balance—a minimum amount required

by a bank for a credit-granting agreement.

Credit Policies

The credit department: ü Examines the financial resources and debts of the

credit applicantü Asks for personal references ü Gets credit rating from credit bureaus ü Determines the extent to which the company can

grant credit, if any

To increase the likelihood of selling to customers who will pay on time, companies develop control procedures and

maintain a credit department

How Factoring Works

Assessing Management of Receivables

Accounts Receivable Turnover--A measure used to determine a company’s average collection period for receivables. Computed by dividing net sales (credit sales) by average accounts receivables.

• Accounts Receivable Turnover

• Number of Days in Receivables--A measure of the average number of days it takes to collect a credit sale. It is computed by dividing 365 days by the accounts receivable turnover.

Assessing Management of Receivables

The Wheeler Company had Net Credit Sales of $150,000 during 2009. The accounts receivables increased $5,000 to $40,000 during the same time. Calculate the Accounts Receivable Turnover and Number of Days in Receivables.

Accounts Receivable Turnover:

Net Sales $150,000 = 4.0Average Accounts Receivable $ 37,500

Example

Number of Days in Receivables:

Number of Days 365 = 91.25Accounts Receivable Turnover 4.0

The Wheeler Company had Net Credit Sales of $150,000 during 2009. The accounts receivables increased $5,000 to $40,000 during the same time. Calculate the Accounts Receivable Turnover and Number of Days in Receivables.

Example

Evaluating the Level of Accounts Receivable

How many times, on average, does a company turn its receivables into

cash during an accounting period?

How long, on average, does it take a company to collect its accounts receivables?

Receivable Turnover Days’ Sales Uncollected

Estimating Uncollectibles

ü There will always be customers who do not pay their accounts, called uncollectible accounts, or bad debts

ü Match these expenses of selling on credit to the revenues they help generate

Estimate the uncollectible expense in the fiscal year in which

the sales are made

Alternate Account Names

Allowance for Uncollectible Accounts

Uncollectible Accounts Expense

ü Allowance for Doubtful Accounts

ü Allowance for Bad Debts

ü Bad Debts Expense

Estimating Uncollectible Accounts

Estimated loss should be: ü Realistic ü Based on objective information ü Based on past experience ü Based on current economic conditions

Two commonly used methods for

estimating loss

1. Percentage of net sales method

2. Accounts receivable aging method

Percentage of Net Sales Method

How much of this year’s net sales will not be collected?

The answer determines the amount of uncollectible accounts expense for the year

ü The percentage amount is usually based on the company’s historic losses

ü It ignores the difference between last year’s estimated losses and the actual losses incurred during the year

Dec. 31, 2013: Account balances: Sales, $645,000; Sales Returns and Allowances, $40,000; Sales Discounts, $5,000; Allowance for Uncollectible Accounts, $3,600. Management estimates that uncollectible accounts will average about 2 percent of net sales.

$12,000 $5,000)– $40,000– ($645,000 x .02 expense accounts bleUncollecti

Allowance for Uncollectible Accounts

Dec. 31 3,600

Dec. 31 adj. 12,000

Dec 31 bal. 15,600

Percentage of Net Sales Method

After the above entry is posted, Allowance for

Uncollectible Accounts will have a credit balance of

$15,600

Dec. 31 Uncollectible Accounts Expense 12,000 Allowance for Uncollectible Accounts 12,000 To record the uncollectible accounts

expense at 2 percent of $600,000 net sales

Accounts Receivable Aging Method

How much of the ending balance of accounts receivable will not be collected?

The ending balance of Allowance for Uncollectible Accounts is determined directly through an analysis of accounts receivable

The difference between the amount determined to be uncollectible and the actual balance of Allowance for Uncollectible Accounts is the expense for the period.

Accounts Receivable Aging Method Dec. 31, 20x6: Management has estimated that $2,459 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a debit balance of $800.

Allowance for Uncollectible Accounts

A credit adjustment of $3,259 will bring the account to its target balance

Dec. 31. 800Dec. 31 adj. 3,259

Dec. 31 bal. 2,459

The target balance for the account is $2,459

Dec. 31 Uncollectible Accounts Expense 3,259 Allowance for Uncollectible Accounts 3,259 To bring the allowance for uncollectible

accounts to the level of estimated losses

Estimates Differ from Write-Offs?

Accounts receivable written off during a period will rarely equal the estimated uncollectible amount

Shows a credit balance when the total of

accounts written off is less than the estimated uncollectible amount

Shows a debit balance when the total of

accounts written off is greater than the

estimated uncollectible amount

Allowance for Uncollectible Accounts

Financing ReceivablesMoney tied up in receivables is something that many

companies seek to avoid

Companies may use one or more of these methods so that they can receive cash faster:

Set up a separate finance company

Borrow money and pledge A/R

In case of default on loan, A/R (collateral) can be taken and converted to cash to satisfy the loan

FactorA/R

Sale or transfer of A/R; the buyer may bear risk of collection (factoring without recourse) or the seller may bear risk of collection (factoring with recourse)

Ford Ford Motor Credit CompanyGM General Motors Acceptance Corp. Sears Sears Roebuck Acceptance Corp.

Securitization A company may sell a group of receivables in a batch at a discount to another company or to investors

When receivables are paid, buyer gets full amount, thus their profit depends on the amount of discount they negotiated

DiscountingThe sale of promissory notes held

as notes receivable

Company AHolds $10,000 note

payable to Company B; Note will pay $600 in

interest ü If Company B pays, bank will receive $10,600 and realize a $1,000 profit

ü If Company B defaults, Company A is liable for the note

ü Company A should disclose the contingent liability (in the amount of note plus interest) in notes to its financial statements

BankBuys the note for

$9,600

Notes Receivable

A written promise that allows someone to pay a certain amount of money on or before a specific future date.

Notes are classified as current or long-term assets, depending on the due date.

Key Components of Promissory Notes

Total proceeds of a note at maturity date (face value plus interest)

Maturity Value

Cost of borrowing money or the return for lending money, usually stated on an annual basis

Interest and Interest Rate

Length of time in days between the note’s issue date and its maturity date

Duration

Date on which the note must be paidMaturity Date

Computing Interest

Principal Principal (amount)(amount)

Principal Principal (amount)(amount)

Interest Interest Rate (%)Rate (%)X

Computing Interest

Principal Principal (amount)(amount)

Interest Interest Rate (%)Rate (%)

Time Time (years)(years)X X

Computing Interest

Principal Principal (amount)(amount)

Interest Interest Rate (%)Rate (%)

Time Time (years)(years)

Interest Interest OwedOwed

X X

Equals

Computing Interest

Example: Interest

The ABC Company signed a 90-day, $5,000 note payable to the XYZ Company in settlement of existing accounts payable. The interest rate of the agreement is 14 percent. Calculate the interest cost.

The ABC Company signed a 90-day, $5,000 note payable to the XYZ Company in settlement of existing accounts payable. The interest rate of the agreement is 14 percent. Calculate the interest cost.

Principal x Interest Rate x Time = Interest

$5,000 x 0.14 x 90/365 = $172.60

What journal entries are required for the ABC What journal entries are required for the ABC Company? For the XYZ Company?Company? For the XYZ Company?

Example: Interest

A Promissory Note

Accept Note: Accounts Payable............ 5,000.00 Note Payable............. 5,000.00

Pay Note Plus Interest: Note Payable................... 5,000.00 Interest Expense.............. 172.60 Cash.......................... 5,172.60

The ABC Company--Maker

Journalizing Notes Receivable

Accept Note: Note Receivable............... 5,000.00 Accounts Receivable.. 5,000.00

Collect Note Plus Interest: Cash................................. 5,172.60 Note Receivable......... 5,000.00 Interest Revenue........ 172.60

The XYZ Company--Payee

Journalizing Notes Receivable

Selling or Factoring Receivables

Receivables are sold to factoring companies for cash.

The factoring companies charge a percentage of the receivable as a service cost.

Factoring allows companies to receive cash now, instead of waiting to collect on the receivable.