In: Accounting
Aurora Corporation has annual credit sales of $1,200,000 with credit terms of 45 days and an average collection period of 40 days with no discount. In the current economy Aurora has fallen upon tough times and is looking for ways improve cash flow, so the company is considering a changing their collection policy to 1/10 net 30. They estimate 50% of customers will take advantage of the discount and the average collection period will be 28 days. With the change in cash, they are looking at an investment that provides an impressive 5% return.
a. Should the company adopt the policy? Support your answer by calculating the net change.
b. Besides offering a discount, how can Aurora improve their AR management process?
Answer A)
Current annual credit sales = $1,200,000
Collection period = 28days
Terms () = net/30
Rate of return = 5%
Current accounts receivable turnover: 360/45 = 8
Average accounts receivable balance = credit sales / turnover = $1,200,000 / 8 = $150,000
Average accounts receivable- balance—after policy change ($1,200,000/360*28) = $93,333.33
Reduction in average accounts receivable = $56.666.66
Rate of return x 0.05
Dollar return earned = $ 2833.33
Cost of discount: (0.50 x $12,000,000 x0.01)= $ 6000
Disadvantage of discount policy:($6000 – $2833.33)= $ 3166.67
Answer B) the following are few methods to improve Account receivables
A) CREATE AN A/R AGING REPORT AND CALCULATE YOUR ART
The first step to take control of your collections efforts is to determine the current payment status of all your accounts receivable.This is done by creating an accounts receivable (A/R) aging report, which will track and measure the payment status of all your customers.Accounts are broken out by the number of days since the invoice was issued, such as:
The report also lists the amounts due. If this report is updated and reviewed on a regular basis, it can help to address any potential problems before the bill becomes past due.
B) Improve Collections Efficiency can be achieved by implementing a lockbox service, pre-authorized checks, utilizing an automatic clearinghouse, or purchasing a cloud-based A/R management solution.