Analysis Of Accounts Receivabl Essay Research Paper

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Analysis Of Accounts Receivabl Essay, Research Paper Analysis of Accounts Receivable Analysis of accounts receivable involves two issues: the relative size of accounts receivable and the adequacy of the allowance for uncollected accounts (Murray, Neumann, & Elgers, 2000, p. 220). Size-The size of accounts receivable is usually assessed relative to the amount of credit sales. This seems appropriate because credit sales give rise to accounts receivable (accounts receivable earns no return after the discount period has expired). Most firms do not separately disclose credit sales, so net sales are usually used. This is figured using the following ratio: accounts receivable as a percentage of sales = accounts receivable gross sales Adequacy of allowance for uncollectible

accounts (an overall estimation of the accounts receivable amounts that will not be collected). These are presented as a contra-asset account that is subtracted from the accounts receivable. This is figured using the following ratio: Allowance for uncollectible accounts Accounts receivable gross The implication this has for managers is that management should attempt to maximize the return on accounts receivable. Managers must also decide which customers will be granted credit. Managers need to set a minimum credit rating for its customers so that profitability is maximized. Inventory-Inventory consists of products that are acquired for resale to customers. For many companies inventory is a major asset and a significant source of revenue. Cash flow-Cash flow is the amount of cash

a company generates and uses during a period calculated by adding non-cash charges to the net income after taxes. Cash flow can be used as an indicator of a company s financial strength. In essence, cash flow measures real money flowing into or out of a company s bank account (Equade Internet ltd, 2000). Cost flow assumptions-Most businesses purchase inventory items on an ongoing basis. Usually these purchases are not made at a uniform price. This, in some cases, causes an accounting problem when the inventory is sold (what is the cost of goods sold vs. cost of goods on hand). This can be determined by several different methods: a. Specific identification method-determines the cost of inventory by maintaining the identity and cost of each item. b. Average cost method-determines

the per unit cost of inventories by summing the beginning inventory cost plus all purchases and then dividing by the number of units available for sale. c. FIFO-First in first out method which values inventory that assumes the goods first in are those first out as they are sold or used in a production process. d. LIFO-Last in first out method which values inventory that assumes the last in purchases of inventory are those first sold or first used in the production process (Murray, Neumann, & Elgers, 2000, p. 714-721). Credit sales-Many companies make a large portion of their sales on credit. Credit transactions enable purchasers to use their cash for a longer period of time before paying the seller. Murray, Neumann, & Elgers, 2000, p. 216). Industry practices and

competitive pressures force many businesses to sell on credit therefore increasing the company s accounts receivable. There are several areas that must be dealt with in reference to accounts receivables and credit. These include: a. discounts-When selling on credit, many businesses offer discounts for early payment. Two reasons discounts are offered include 1) early payment enables the seller to have access to cash sooner and 2) the quicker an account is paid means there is less chance for non-payment. Typical discount terms are 2/10, net 30 (meaning a 2% discount if paid within 10 days, otherwise net 30). b. factoring accounts receivable-selling accounts receivables for a fee can be a valuable source of quick cash for growing companies. Factoring, converting accounts receivable