Question

Max can now see how both these systems work and can see the net sales method is much simpler to apply. He has asked you to explain why anyone would bother going to the trouble of analysing the ageing data for accounts receivable.

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1. Answer Max’s question for him.

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Max is still a little overwhelmed by the concepts involved in dealing with accounts receivable and wants to know why they are such a big deal. “I just give my good clients credit and they pay me back as soon as they can. Occasionally some take a little bit too long or can’t pay their entire bill, but that’s just the way business works.”

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2. Try and convince Max that proper management of accounts receivable is crucial to business survival.

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Answer 1

1. Allowance for Uncolletible Accounts can be made using percentage of Net Sales or using the ageing analysis method. It is very easy and simple to understand and compute as well. However the draw back of net sales is that it's a rough estimate of sales that includes cash and even those credit sales of which cash have been received and not. But the ageing analysis classifies the outstanding at the end of the accounting period and then a portion ie percentage of such outstanding based on varied periods are expected to be not collectible and allowances are made. Thus the latter is more scientific and accurate than the former.
2. Accounts Receivables is the life blood of the business. Thus managing it is crucial for any business. The system of credit surely helps in expansion of business, but it may cause problems pertaining to liquidity and then solvency and hence lead to death of the business. Hence managing receivables such that they are recovered early is important for the business. In case of non-payment or late payment from receivables, the business resorts to either short term credits from banks or avail extended credit period from payables. Thus it increases costs and hence causing business disruption. Hence