Question
Write a short research paper about how accounts receivables arise and how they accounted for, including the use of a subsidiary ledger and an allowance account. Also explain the options a company has to convert its receivables to cash. Identify what the consequences are if a company fails to collect on receivables. Please use MLA format with citations, and a minimum of 825 words.
Solution
Accounts Receivables
Raising and Accounting Receivables
Receivables are the money owed by entities to a business from the sales of its products and services on credit, and represent future cash collections. The accounts receivable increase when there is credit sale, and decrease when the customer makes a payment on their account (Purwanti 3). A business accounts receivable department uses a ledger to record the sales made, the amount of money paid for goods and services, and the amount owed to the business at the end of a payment term.
Subsidiary ledger provides prompt, and accurate receivables information to the management. The document ensures that organized internal control procedures are maintained by updating the account’s transaction backup. Account receivables are booked in a journal entry as current assets when they are due within one year (Lessambo 55). When a sale is made, the receivable account is debited, and the revenue account is credited. If a customer pays off their account, the cash account is debited, and the receivable account credited. The trial balance debits the accounts receivable at the end.
An Allowance Account is an asset account with a credit balance, due to customers failure to repay their debts. Therefore, businesses estimate the amount, and then record an allowance for doubtful accounts. This record is booked on the balance sheet as a contra account to offset the receivables account balance (Kuznetsova 96). At the end of an accounting period, the percentage of the accounts receivables is used to calculate, and estimate the expense of bad debt, and allowance for doubtful accounts. For instance, a small scale business has an ending accounts receivables balance of $20,000 and it estimates that 2% of receivables are doubtful. To adjust the business’s allowance account, the Bad Debt expenses are debited for $400 (20,000*0.02), and the Allowance Account debited for the same amount.
Converting Receivables To Cash
To maintain healthy cash flow, a company needs to convert its account receivables into cash. However, collecting payments from customers requires an active process of accounts receivable management. The less the collection period a business takes to complete its accounts receivable cycle, the less capital gets tied up in its operational process (Purwanti 6). Therefore, a business needs to evaluate its credit terms, and limit any outstanding accounts receivable to no more than 10 to 15 days after the payment date is due.
Another option is by developing highly efficient Sales and Accounts Receivables Management. The management should have an intelligent team working on the whole credit and collection process to reduce the exposure to bad debt. They must have insight into the clients’ credit history, financial strengths, and previous credit repayment trends (Hill 1). The management’s prompt ability to make a well-informed credit decision enables the business to not only maintain a good cash flow, but also be able to penetrate new markets, and build a wider customer base.
A business could also opt for accounts receivables financing to acquire capital relatively equal to the Accounts Receivables balance, and the process is known as factoring. The factoring companies usually structure the receivables agreement as either an asset sale or a loan. Moreover, with the development of accounting technology, companies are finding it easier to integrate their accounts receivable records with factoring company platforms (Tuovila 1). Once the sale of the accounts receivables is done, the financier company takes charge of the receivables invoice and commences with collections. In addition, a financier usually audits the accounts receivable records to determine its collectability.
Furthermore, a company should calculate its Average Collection Period Ratio (ACP), which is the time the company takes to convert its non-cash assets to cash. If the company has a high ACP, it implies that it is too liberal to its credit customers, and weak on the payment collection process. Nevertheless, the company could be too restrictive if its collection period has very few numbers of days, and this can affect its sales. The company’s Accounts Receivables Turnover Ratio (ART) should also be calculated to quantify its effectiveness to extend, and collect credit sales. A high ART implies that the company either operates on a cash basis, or its Accounts Receivable Management is efficient (Hill 1). However, a low ART implies that the company should re-evaluate its credit policies, and ensure a prompt receivables collection process
Consequences of Failing to Collect Receivables.
Account receivables are the lifeline of a business cash flow, therefore a company’s operation processes would suffer if it fails to collect on its accounts receivables. A company’s failure to manage its receivables closely may lead to an accumulation of bad debt write-offs. The write off could affect a company’s profitability, as well as marketing, and payroll budget (Purwanti 4). Also, there is a relationship between the accounts receivables and payables, therefore pending payments from customers mean that the business could have pending payments to its suppliers and vendors that have a payment time frame. Consequently, the problem should be handled by narrowing down the receivables payment terms to run the business smoothly.
For a company to achieve its desired growth and upgrade, it must have an adequate cash inflow as compared to any cash outflow. Therefore, a company needs to keep an eye on its receivables by devising an accurate method of payment collection or invoice factoring. Another consequence a company might face for failing to collect on receivables is the accumulation of collection and tax charges. A company might have tax charges from the documented purchase orders irrespective of whether they have been paid. Besides, if the company does not have a good A/R management, it is necessary to hire a third-party collection agency to recover the payments (Belyh1 ). The agencies usually charge on the collection, and any other costs that may occur.
Works Cited
Lessambo, Felix I. “Financial Statements: Accounts Receivables.” Palgrave Macmillan, 2018, pp. 53-67.
Purwanti, Titik. “An Analysis of Cash and Receivables Turnover Effect Towards Company Profitability.” International Journal of Seocology, 2019, pp. 1-8.
Tuovila, Aliciac. “Accounts Receivable Financing Definition.” Investopedia, www.investopedia.com/terms/a/accountsreceivablefinancing.asp Accessed 30 July 2019
Belyh, Anastasia. “Accounts Receivable and Bad Debts Expense.” Cleverism www.cleverism.com/accounts-receivable-and-bad-debts-expense/ Accessed 30 July 2019
Hill, Terry H. “Converting Accounts Receivable into Cash.” SG & Singapore Map! Powered by Streetdirectory.com, www.streetdirectory.com/travel_guide/193168/accounting/converting_accounts_receivable_into_cash.html Accessed 30 July 2019
Kuznetsova, O. N. “Accounting and Control of Doubtful Debts Reserves.” Financial Journal, no. 4, 2019, pp. 88-101.
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