Question

Question 1

Provide responses to the following questions:

Explain why the accounts receivable turnover ratio is helpful in evaluating the liquidity of a company?

Why is the amount reported on the balance sheet for receivables usually not the same as the sum of the amounts that customers have promised to pay? (hint: Explain bad debt expense / ADFA)

Answer 1

Liquidity refers to an enterprise's ability to pay short term obligations or company's capability to sell assets quickly to raise cash.

The receivables turnover ratio is used to analyse the effectiveness of a firm in extending credits and in collecting debts on that credit.

Companies that convert faster their receivables into cash are always more liquid.

It helps in identifying how efficiently a firm uses its assets.

On the company;s balance sheet accounts receivable are the money owed to that company by entities outside the company.

Whatever amount is received from the customers is deducted from the receivable balance and the same is reported in balance sheet.

But the cash received is only one adjustment. There are other adjustments too needs to be made from accounts receivable.

Like badebts , allowance for baddebts, sales returns,discount etc,

In balance sheet the amount of accounts receivable is recorded after making all these adjsutments no only of cash that is why the sum does not matches.

These adjustments are made by following the two methods:

1.Write off method

2.Allowance method.