current-assets-part-ii

Many businesses have substantial dollars tied up in

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Unformatted text preview: dollars tied up in receivables, and corporate liquidity can be adversely impacted if receivables are not actively managed to insure timely collection. One ratio that is often monitored is the accounts receivable turnover ratio. That number reveals how many times a firm’s receivables are converted to cash during the year. It is calculated as net credit sales divided by average net accounts receivable: Accounts Receivable Turnover Ratio = Net Credit Sales/Average Net Accounts Receivable To illustrate these calculations, assume Shoztic Corporation had annual net credit sales of $3,000,000, beginning accounts receivable (net of uncollectibles) of $250,000, and ending accounts receivable (net of uncollectibles) of $350,000. Shoztic’s average net accounts receivable is $300,000 (($250,000 + $350,000)/2), and the turnover ratio is “10”: 10 = $3,000,000/$300,000 A closely related ratio is the “days outstanding” ratio. It reveals how many days sales are carried in the receivables category: Days Outstanding = 365 Days/Accounts Receivable Turnover Ratio For Shoztic, the days outstanding calculation is: 36.5 = 365/10 By themselves, these numbers mean little. But, when compared to industry trends and prior years, they will reveal important signals about how well receivables are being managed. In addition, the calculations may provide an “early warning” sign of potential problems in receivables management and rising bad debt risks. Analysts carefully monitor the days outstanding numbers for signs of weakening business conditions. One of the first signs of a business downturn is a delay in the payment cycle. These delays tend to have ripple effects; if a company has trouble collecting its receivables, it won’t be long before it may have trouble paying its own obligations. Download free ebooks at bookboon.com 17 Notes Receivable Current Assets: Part II 4. Notes Receivable A written promise from a client or customer to pay a definite amount of money on a specific future date is called a note receivable. Such notes can arise from a variety of circumstances, not the least of which is when credit is extended to a new customer with no formal prior credit history. The lender uses the note to make the loan more formal and enforceable. Such notes typically bear interest charges. The maker of the note is the party promising to make payment, the payee is the party to whom payment will be made, the principal is the stated amount of the note, and the maturity date is the day the note will be due. Interest is the charge imposed on the borrower of funds for the use of money. The specific amount of interest depends on the size, rate, and duration of the note. In mathematical form: Interest = Principal X Rate X Time. For example, a $1,000, 60-day note, bearing interest at 12% per year, would result in interest of $20 ($1,000 X 12% X 60/360). In this calculation, notice that the “time” was 60 days out of a 360 day year. Obviously, a year normally has 365 days, so the fraction could have been 60/365. But,...
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