Copyright © Cengage Learning. All rights reserved. Chapter 7 Cash and Receivables.

Copyright © Cengage Learning. All rights reserved.

Chapter 7

Cash and Receivables

Copyright © Cengage Learning. All rights reserved. 7-2

Management Issues Related to Cash and Receivables

• Objective 1– Identify and explain the management and ethical issues

related to cash and receivables.


Key Issues In Dealing With Short-Term Financial Assets

• Management must address five key issues: – Managing cash needs

– Setting credit policies

– Evaluating the level of accounts receivable

– Financing receivables

– Making ethical estimates of credit losses


May include a compensating balance -- a minimum amount that a bank requires a company to keep in its bank account

as part of a credit-granting arrangement

Seasonal cycles of businesses require them to carefully plan cash inflows, cash outflows,

borrowing, and investing.

Cash Management

• Cash– Currency and coins on hand

– Checks and money orders from customers

– Deposits in checking and savings accounts


Accounts Receivables and Credit Policies

• Companies sell on credit to be competitive and increase sales.

• To increase the likelihood of selling to customers who will pay on time, companies develop control procedures and maintain a credit department.


Evaluating the Level of Accounts Receivables

• Two common measures of the effect of a company’s credit policies are – Receivable turnover

• Reflects the relative size of a company's accounts receivable and the success of its seasonal conditions and interest rates

– Days’ sales uncollected (Average Collection Period or Daily Sales Outstanding)

• Shows, on average, how long it takes to collect accounts receivable


Nike’s Receivable Turnover =

Receivable Turnover = Net Sales

Average Net Accounts Receivable

$16,325.9

($2,494.7 + $2,382.9) ÷ 2

= 6.7 times

Receivable Turnover

Reflects the relative size of a company’s accounts receivable and the success of its credit and collection policies


Receivable Turnover for Selected Industries


Nike’s Days’ Sales Uncollected =

Days’ Sales Uncollected =

(ACP)

365 days

Receivable Turnover

365

6.7

= 54.5 days

To interpret a company’s ratios, take into consideration the industry in which it operates.

Days’ Sales Uncollected

Days’ Sales Uncollected

• Suppose the company can reduce collection period to 45 days w/o changing sales.

• What effect will this have on A/R and Cash?• RTO = 365/45 = 8.111…• Avg A/R = S/RTO =16,325.9/8.1111 = $2012.78• Old A/R = $2438.80• Assuming everything but cash stays the same• Change in Cash = 2438.80 – 2012.78 = $462• So a decrease in A/R is a source of cash.



Financing Receivables

• Companies with significant amounts tied up in accounts receivable may not be willing or able to wait until cash is collected

• Solutions– Set up financing companies

– Borrowing funds using receivables as collateral

– Factoring

– Securitization


Examples:–Ford Motor Credit Company (FMCC)–General Motors Acceptance Corp. (GMAC)–Sears Roebuck Acceptance Corp. (SRAC)

Financing Companies

Companies set up by corporations to help their customers pay for the purchase of their products


Borrowing

• Some companies borrow funds using their accounts receivable as collateral.

• If the company does not pay back its loan, the creditor takes possession of the accounts receivable and converts them to cash to satisfy the loan.


A credit card sale is an example of factoring without recourse because the credit card issuer accepts the risk of nonpayment

Factoring

The sale or transfer of accounts receivable with or without recourse.

• With recourse– The seller of the receivables is liable to the purchaser if a

receivable is not collected.

• Without recourse– The factor that buys the accounts receivable bears any

losses from uncollectible accounts.


Factoring (cont’d)

• The factor charges a fee for its service.– Usually about 1 percent for sales with recourse.

– Higher fees for sales without recourse because of increased risk.

• Selling receivables with recourse creates a contingent liability.– A potential liability that can develop into a real liability if

a particular subsequent event occurs, which should be disclosed


Securitization

The sale of batches of a company’s accounts receivables at a discount to companies and

investors.

• The buyer receives the full amount when the receivables are paid.

• The revenue is the amount of the discount.


Since estimations are involved, earnings may be easily manipulated…

earnings are understated. If the amount of losses from uncollectible accounts are

overstated,

earnings are overstated. If amount of losses from

uncollectible accounts are understated,

Ethics and Estimates in Accounting for Receivables


Cash Equivalents and Cash Control

• Objective 2– Define cash equivalents, and explain methods of

controlling cash, including bank reconciliations.


Cash Equivalents

Short-term, highly liquid investments that will revert to cash in 90 days or

less from the time of purchase.• Include:

– Money market accounts

– Commercial paper

– U.S. Treasury bills

• These funds revert to cash so quickly they are regarded as cash on the balance sheet.

Copyright © Cengage Learning. All rights reserved.

Fair Value of Cash and Cash Equivalents

• Cash and cash equivalents are financial instruments that are valued at fair value.

• Companies often invest these funds in money market funds to earn interest with cash when they don’t need cash for current operations.

7-20


Notes Receivable

• Objective 4– Define promissory note, and make common calculations

for promissory notes receivable.


Unconditional promises to pay a definite sum of money on demand or at a future date.

Promissory Notes

• The signer of the note is called the maker.• The entity to whom payment is to be made is called

the payee.• The payee regards all promissory notes it holds that

are due in less than one year as notes receivable in the current assets section of the balance sheet.

• The maker regards them as notes payable in the current liability section of the balance sheet.


Computations for Promissory Notes

• Several terms are important in accounting for promissory notes

1. Maturity dateThe date on which the note must be paid

2. Duration of noteThe length of time in days between a promissory note’s issue date and its maturity date

3. Interest and interest rateThe cost of borrowing money or the return for lending money.

Usually stated on an annual basis

4. Maturity valueThe total proceeds of a note at the maturity date


Ways in which maturity date may be stated:

Due “November 14, 2010”

Due “three months after November 14, 2010”

Due “60 days after November 14, 2010”

Exclude the date of the note when computing the maturity date:A note dated May 20 and due in 90 days would be due on August 18, determined as follows:Days remaining in May (31 – 20) 11Days in June 30Days in July 31Days in August 18

Total days 90

Maturity Date


Interest is calculated on this basis

If maturity date is stated as a specific number of days from date of note… duration is easy to

calculate. Duration is the same as number of days.

If maturity date is stated as a specific date… number of days must be

calculated.

Duration of a Note

Why is duration of a note important?


Interest and Interest Rate

Amount of interest is based on: Principal

Rate of interest

Loan’s length of time

What is the interest on a three-month, 8 percent, $1,000 note?

Principal x Rate of interest x Time = Interest

$1,000 x .08 x 3/12 = $20


90-day 8 percent

$1,000 loan proceeds

= Principal + Interest

= $1,000 + ($1,000 × 8/100 × 90/365)

= $1,000 + $19.73

= $1,019.73

The maturity value of a non-interest-bearing note is the principal amount. In this case, the principal includes an

implied interest cost

Maturity Value

Total proceeds of loan


$1,000 note, 90-day, 8 percent note was received on Aug. 31. The fiscal year ends on Sept. 30.

30 days interest, or $6.58 ($1,000 × 8/100 × 30/365 = $6.58), is earned in the fiscal year that ends on Sept. 30

Accrued Interest A promissory note received in one accounting

period may not be due until a later period Accrue the interest applicable to the note at the end

of the accounting period

Copyright © Cengage Learning. All rights reserved. Chapter 7 Cash and Receivables.

Documents

copyright cengage learning

accounts receivable

companys accounts receivables

days receivable turnover

level of accounts receivables

days sales uncollected

disclosed slide

nikes receivable turnover