538 Accounting: Business Reporting for Decision Making
systems), accessing an accounts receivable ageing schedule is easy, as such schedules are standard in
accounting packages. Ageing schedules identify which accounts are unpaid and overdue. Additionally, these
overdue accounts are classified by the period overdue, for example, 30 days, 60 days, 90 days and so on.
Entities may judge the effectiveness of their collection policies and procedures by making use of ratio
analysis, as discussed in chapter 8. The most useful ratio is the days debtors turnover, which is the ratio that
indicates how long on average it takes for the cash to be collected from accounts receivable. When calculating
this ratio, ideally the credit sales figure rather than total sales should be used, as accounts receivable arise only
from credit sales. The ratio gives the number of days of the sales value that remain outstanding. This number
may then be compared with those of previous periods for the same entity and industry benchmarks.
A decreasing average collection period (ACP) may indicate more effective collection processes —
which is good, but may also indicate that too much time and effort is being put into collections, or that
credit policy has become so restrictive that the entity is missing out on sales. Conversely, an increasing
ACP may indicate less effectiveness in collections, too little expenditure, or too lenient a credit policy.
Another measure of the success of collection policies is the percentage of bad debts — bad debts
divided by sales for the same period. As above, an entity may compare this value with the values
computed for previous periods or against industry benchmarks. The same comments relate to either
decreasing or increasing values, as was noted above for decreasing or increasing ACPs.
The level of credit sales
Now that we have examined sales revenue, credit policies, and collection policies and procedures, we
can review all of the determinants of the level of accounts receivable. Credit policies to some extent
impact on total sales; and total sales, when considered in conjunction with credit policies, determine
the value of credit sales. Credit sales increase the value of accounts receivable at any point of time, but
efficient collection policies decrease the value of accounts receivable.
VALUE TO BUSINESS• The benefits to entities of granting credit include:- increasing sales, because of
- attracting new customers from other cash-only suppliers
- encouraging customers to bring planned purchases forward
- attracting impulsive purchasers
- attracting customers who would not otherwise have purchased at all
- reducing the cost of making sales, such as by having counter staff merely fill out delivery dockets
and specialist pricing people calculate actual charges.
• But, granting credit has costs, which include: - the opportunity cost of the funds tied up, as there is no direct return to the funds
- the cost of the (hopefully small) proportion of slow payers and bad debts, as, even with the best
of credit rating and collection systems, normally there will be a small percentage of accounts
receivable who will be slow to pay or who will not pay at all - the cost of administering the system, including office staff, stationery, postage, telephone and,
possibly, specialist collection services.
• The level of accounts receivable is determined by total sales, credit policies and collection policies.
13.4 Managing inventories
LEARNING OBJECTIVE 13.4 Identify the issues with respect to the management of inventories.
Inventories or stock are normally a component of current assets for entities involved in manufacturing or the
sale of goods. Manufacturers hold raw material inventory so that production can be carried out without undue
hold-ups should there be any disruption in the normal course of supply. A manufacturing company such as
BMW Group has 20.4 per cent of current assets in the form of inventories. Retail entities hold inventory to