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)|
|6||Glass & Ceramics Products||97.9|
|11||Pulp & Paper||85.73|
|12||Nonferrous Metals Products||85.13|
|14||Iron & Steel||81.3|
|15||Wood & Wood products||75.7|
|19||Textiles & Apparels||69.34|
|22||Publishing & Printing||67.31|
|24||Oil & Gas Mining||60.29|
|28||Oil & Coal Products||54.99|
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.
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.
Can you guess what is the Accounts Receivable Days for MacDonalds?
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