Financial Obligations Paid in Advance: Definition, Recording, and Evaluation Processes
In the business world, understanding accounts receivable (AR) is crucial for managing liquidity and assessing risk. AR, also known as trade receivables, represents the amount owed by customers for goods and services provided on credit. This amount can be found in the current assets section of financial statements.
The efficiency of a company's billing capabilities and its ability to collect short-term debt quickly is reflected in the accounts receivable turnover ratio. Calculated by dividing sales by the average trade receivables, a high turnover ratio indicates a healthy AR management. However, it's essential to compare this ratio with the company's sales growth and industry sales growth to determine if high ratios are due to strict policies or potential harm to future sales.
The days sales outstanding (DSO) ratio, calculated by dividing the number of days in a year by the accounts receivable turnover, shows how long it takes for companies to collect payments. Ideally, most AR should be short-lived, less than 30 days. Lower DSO is more desirable, as it means the company receives cash from credit sales faster, while higher DSO could lead to liquidity problems.
Companies often provide credit facilities to customers to increase transactions and maintain good relations. However, AR represents a potential liability, especially when customers pay in advance, receive refunds, or credits that have not yet been used. These customer credits (Kundenguthaben) impact liquidity management and risk assessment, as companies hold amounts owed back to customers, which can be significant depending on industry and company size. Comparing customer credits to other financial indicators helps evaluate liquidity risks and identify customers with unusually high credits that could pose payment delay risks.
To evaluate the level of a company's business debt, one should consider the concentration of AR (divided by customer, type of customer industry, or geographical area). AR is one of the liquidity indicators, measuring a company's ability to cover short-term liabilities.
If a company encounters difficulties in collecting receivables, it writes off the amount from the balance sheet and reduces both gross receivables and allowance for doubtful accounts. The total allowance for uncollectible accounts is calculated by multiplying probability values with amounts from each category. The calculation of net realizable value may involve categorizing receivables based on their level of collectibility, such as age categories of receivables. Companies report trade receivables based on net realizable value, which is the number of gross receivables reduced by uncollectible receivables (allowance for doubtful accounts).
In summary, understanding accounts receivable is vital for managing a company's liquidity and assessing its risk. By analysing accounts receivable turnover, DSO, customer credits, and AR concentration, businesses can make informed decisions to optimise their cash flow and mitigate potential risks.
