# Accounts Receivables

Accounts Receivables is money that is owed to the company by the customers (credit to the customers). The company has provided services / delivered the product to the customer but it has not collected the cash yet (that goes into cash and cash equivalents).

## Gross Accounts Receivables vs Net Accounts Receivables

Gross Accounts receivables are the total receivables (open invoices) that are due to the company. This does not take into account a scenario where the customer may default.

Net Accounts Receivables on the other hand takes into account the probability of default from the customers. To prepare for some nonpayment’s, the company estimates that a proportion of its credit sales will go bad. This term is usually called as “allowance for bad debt”.

The estimate shows up on the income statement as a bad debt expense. This expense is usually charged to SC&A in the income statement.

#### Colgate: Gross Accounts Receivables and Net Accounts Receivables Example

In Colgate, we note the following –

• 2014 – Net receivables is \$1,552 mn, allowance is \$54 mn; This implies Gross Receivables are \$1,552 + \$54 = \$1,606 mn
• 2013 – Net receivables is \$1,636 mn, allowance is \$67 mn; This implies Gross Receivables are \$1,636 + \$67 = \$1,703 mn

## Accounts Receivables flow – Financial Statements

Let us take one case study and see how it works. ToysforU sales and receipts from customers are shown below.

• All customers buy on credit and pay cash the following year if they are not bankrupt. Any uncollected receivables are then written off
• Based on its experience, ToysforU books 10% of its receivables outstanding at the end of the period as an allowance for bad debts
• There are no other costs, i.e. the cost of goods sold (COGS) is \$0
• The actual write-offs differ from expectations as show in the table below.

Please create the Income Statement, Balance Sheet and Cash Flows at the end of Year 1 and Year 2

#### Accounts Receivables – Year 1

Income Statement for the 1st Year

• \$100 sales will be booked due to “Accrual Accounting” concept (introduced in 1st chapter Kartik’s case study)
• COGS is \$0 as given in the case study
• Bad Debt Expense is 10% of the Sales = 10% of \$100 = \$10
• Net Income Reported in 1st Year is \$90

Cash flow for Year 1

There is no cash received in Year 1, Cash Flow = \$0

#### Accounts Receivables – Year 2

Income Statement for the 2nd Year

• Sales will be booked due to “Accrual Accounting” concept (introduced in 1st chapter Kartik’s case study)
• COGS is \$0 as given in the case study
• Bad Debt Expense is 10% of the Sales = 10% of \$150 = \$50
• Net Income Reported in 2nd Year is \$135

Cash flow for Year 2

Actual cash collection during the year was \$90. Cash Flow = \$90

## Colgate Accounts Receivables Example

Below is the Colgate account receivables policy suggests a shorter credit policy of less than 60 days

## Industry Wise Average Accounts Receivables

Let us now have a look at the industry average accounts receivables

 Rank Industry Accounts Receivables (Days) 1 Banks 331.9 2 Machinery 109.93 3 Construction 107.88 4 Metal Products 103.36 5 Chemicals 98.27 6 Glass & Ceramics Products 97.9 7 Precision Instruments 97.8 8 Electric Appliances 96.46 9 Rubber Products 92.09 10 Other Services 89.74 11 Pulp & Paper 85.73 12 Nonferrous Metals Products 85.13 13 Other Products 83.87 14 Iron & Steel 81.3 15 Wood & Wood products 75.7 16 Communication 74.19 17 Wholesale Trade 73.78 18 Transportation Equipments 70.65 19 Textiles & Apparels 69.34 20 Leather Products 69.23 21 Air Transportation 68.22 22 Publishing & Printing 67.31 23 Agriculture 61.59 24 Oil & Gas Mining 60.29 25 Other Transportation 58.85 26 Insurance 56.89 27 Foods 55.44 28 Oil & Coal Products 54.99 29 Forestry 54.38 30 Coal Mining 48.24 31 Fishery 42.81 32 Metal Mining 41.66 33 Gas 36.26 34 Movie 33.49 35 Road Transportation 32.41 36 Retail Trade 28.23 37 Hotel 27.47 38 Electric Power 27.28 39 Railway 24.68 40 Warehousing 23.81 41 Marine Transportation 23.72 42 Amusement 18.78 43 Real Estate 10.64 44 Securities 6.86

source: ediunet

As you can see from above, industries like Banks have a very long receivables period (in excess of 300 days), however, for capital goods and heavy asset industries like machinery, construction, metals etc, it is around 100 days.

## How to generate cash from Accounts Receivables?

Since Accounts Receivalbles are company’s assets, the company can approach a bank to provide them with a loan against these accounts receivalbles as security. This is fairly common practice adopted by companies for liquidity.

## Credit Card Payments and Accounts Receivables

Credit card sales from customers are technically accounts receivables for the company, but only for 1-2 days. This one to two days time is what it takes for the bank to reconcile and deposit the amount in the company’s account.

## Conclusion

Accounts receivables is the amount that is due to the company by its customers. It is important to consider the default probability of the customer and therefore look at the Net Receivables numbers. Each industry has different set of credit policy and hence, account receivable days differ by wide measures.

## What Next?

Can you guess what is the Accounts Receivable Days for MacDonalds?

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