Page 393 - Accounting Principles (A Business Perspective)

9. Receivables and payables

Interest-Bearing Notes Non interest-Bearing Notes
2009 2009
Dec. 1 Cash (+A) 10,000 Dec. 1 Cash (+A) 9,775
Notes Payable (+L) 10,00 Discount on Notes Payable (-L) 225
0
To record 90-day bank loan, Notes Payable (+L) 10,000
To record 90-day bank loan.
31 Interest Expense (-SE) 75 31 Interest Expense (-SE) 75
Interest Payable (+L) 75 Discount on Notes Payable (+L) 75
To record accrued interest on To record accrued interest on a
a note payable at year-end. note payable at year-end.
2010 2010
Mar. 1 Notes Payable (-L) 10,000 Mar. 1 Notes Payable (-L) 10,000
Interest Expense (-SE) 150 Interest Expense (-SE) 150
Interest Payable (-L) 75 Cash (-A) 10,000
Cash (-A) 10,22 Discount on Notes Payable (+L) 150
To record note principal and 5 To record note payment and
interest payment. interest expense.
Exhibit 79: Comparison between interest-bearing notes and noninterest-bearing notes
Analyzing and using the financial results—Accounts receivable turnover and number of
days' sales in accounts receivable
Accounts receivable turnover is the number of times per year that the average amount of accounts

receivable is collected. To calculate this ratio divide net credit sales, or net sales, by the average net accounts
receivable (accounts receivable after deducting the allowance for uncollectible accounts):
Netcredit salesnetsales
Accounts receivableturnover=
Averagenetaccounts receivable
Ideally, average net accounts receivable should represent weekly or monthly averages; often, however, beginning
and end-of-year averages are the only amounts available to users outside the company. Although analysts should
use net credit sales, frequently net credit sales are not known to those outside the company. Instead, they use net
sales in the numerator.
Generally, the faster firms collect accounts receivable, the better. A company with a high accounts receivable
turnover ties up a smaller proportion of its funds in accounts receivable than a company with a low turnover. Both
the company's credit terms and collection policies affect turnover. For instance, a company with credit terms of
2/10, n/30 would expect a higher turnover than a company with terms of n/60. Also, a company that aggressively
pursues overdue accounts receivable has a higher turnover of accounts receivable than one that does not.

For example, we calculated these accounts receivable turnovers for the following hypothetical companies:
Accounts Receivable
Net Sales Average
(millions) Net Turnover
Abercrombie & Fitch $ 1,238 $ 14 88.43
The Limited, Inc. 10,105 1,012 10.00
We calculate the number of days' sales in accounts receivable (also called the average collection period
for accounts receivable) as follows:
Number of daysper a year 365
Numberof days'sales per accountsreceivable=
Accountsreceivable turnover
This ratio measures the average liquidity of accounts receivable and gives an indication of their quality. The

faster a firm collects receivables, the more liquid (the closer to being cash) they are and the higher their quality. The
longer accounts receivable remain outstanding, the greater the probability they never will be collected. As the time
period increases, so does the probability that customers will declare bankruptcy or go out of business.

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