Accounts Receivable Unit 1

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Questions and Answers

What is the primary concern with cash-in-advance (CIA) sales terms for sellers?

Few companies are willing to purchase under those terms. (correct)

They are preferred by all companies.

They guarantee immediate payment.

They lead to higher sales volume.

Which source should not be used to verify a small company's contact information?

Company-provided phone numbers. (correct)

Phone books.

Online business directories.

Personal connections.

Why is it important to verify trade references using independently sourced phone numbers?

To find out how many references the customer has.

To confirm the frequency of the customer’s purchases.

To identify the size of the companies referenced.

To prevent manipulation by fraudsters. (correct)

What is a common tactic used when checking trade references provided by a potential customer?

The customer tends to provide only favorable references. Signup and view all the answers

What can financial statements sometimes misrepresent?

The financial health of the company. Signup and view all the answers

How can industry groups assist credit professionals in assessing potential customers?

By sharing customer payment histories and reports. Signup and view all the answers

What should a credit professional do after contacting initial trade references?

Seek out other companies the customer has engaged with. Signup and view all the answers

Why is it advised to look up phone numbers independently rather than using those given by the company?

To prevent falling for scams and verify legitimacy. Signup and view all the answers

What constitutes an audited financial statement?

Compiled by an independent accounting firm from company records and conforms to GAAP. Signup and view all the answers

Which type of financial statement does NOT ensure that the accounting conforms to GAAP?

Compiled statements Signup and view all the answers

When are new financial statements typically available after the end of the fiscal year?

Six to nine months after the fiscal year-end. Signup and view all the answers

What might be a red flag for credit professionals regarding a company’s fiscal year-end?

The company changes its fiscal year-end frequently. Signup and view all the answers

What crucial information does the income statement provide?

The profit-and-loss summary for the current fiscal year. Signup and view all the answers

What is an example of an unusual or nonrecurring item to look for in an income statement?

A large tax credit. Signup and view all the answers

What does an unqualified audit report signify?

The financial statements are acceptable without any reservations. Signup and view all the answers

What should credit managers do if they encounter unusual items in an income statement?

Recalculate the income statement based on those items. Signup and view all the answers

What is one of the first steps companies should take when reviewing new accounts?

Assign one person to manage the entire process Signup and view all the answers

Why should companies standardize the credit approval process?

To ensure that all customers provide the same required information Signup and view all the answers

How often do recommendations suggest that credit reviews for existing accounts should occur?

At least once a year Signup and view all the answers

What is one reported drawback to ongoing credit reviews?

They often get postponed due to workload Signup and view all the answers

What is an essential component to include in the redesigned credit application?

Bank/trade references with the completed application Signup and view all the answers

What is a common practice for granting initial credit to new accounts?

Automatically assigning a small credit line Signup and view all the answers

What advantage does having a dedicated credit administrator provide?

More effective monitoring of the credit approval process Signup and view all the answers

What should a company do to enhance the visibility of a customer's financial status?

Review the completed credit application and access financial information online Signup and view all the answers

What should you be cautious of when a reference describes a customer using only superlatives?

The reference may not be reliable. Signup and view all the answers

What is a recommended step when verifying references for new customers?

Check the business listing of the reference company. Signup and view all the answers

Why is it risky to offer a credit line based solely on 10% of a customer's net worth?

It ignores the company's operational limits. Signup and view all the answers

What behavior could indicate potential trouble with a customer?

A normally prompt customer begins delaying payments. Signup and view all the answers

What might be a reasonable credit limit policy for a vendor with annual sales of $100 million?

Maintain a cap of $10 million for any customer regardless of their worth. Signup and view all the answers

Which method can help ensure that a reference is acting in good faith when verifying a potential customer?

Confirming the employee's position within the reference company. Signup and view all the answers

How can a small customer placing a much larger order than normal be perceived?

As a potential warning sign of trouble. Signup and view all the answers

What is a vital precaution when relying on references to evaluate new customers?

Seeking confirmation of their relationship with the customer. Signup and view all the answers

What is the primary responsibility of the credit department in a business?

To ensure sales are made to companies with both ability and willingness to pay. Signup and view all the answers

Why is finding the right credit policy considered a mixture of art and science?

It requires a balance between subjective judgment and objective financial metrics. Signup and view all the answers

What does the term 'open account' refer to in business transactions?

A policy of selling goods and expecting payment at a future date. Signup and view all the answers

What might happen when credit is extended to a company that cannot or will not pay?

It can directly impact the seller's bottom line negatively. Signup and view all the answers

What is considered an unearned discount in credit transactions?

A discount taken when payment is made after the discount period. Signup and view all the answers

Which of the following terms indicates a common early payment discount?

2/10 net 30 Signup and view all the answers

What could be an example of policy factors to consider when extending credit?

Corporate culture and competition in the market. Signup and view all the answers

What impact does late payment by a seller have on their business?

It can negatively affect the seller's overall profitability. Signup and view all the answers

Study Notes

Importance of Business Credit

The credit department ensures sales are made to companies capable and willing to pay for goods.
A well-defined credit policy blends art and science, influenced by corporate culture, competition, inventory levels, and seasonality.
Extending credit to unqualified companies directly harms a seller's profitability, compounded by late payments and unauthorized deductions.

Open Account Sales

Businesses prefer selling goods on open account, enabling delayed payments (typically 30 days), unlike individual cash transactions.
Open account transactions shift the risk of payment delays to sellers.

Early Payment Discounts

Commonly, a 2% discount is offered for invoices paid within ten days, known as terms like 2/10 net 30.
If payment isn't received within the discount period, the full amount is due later, highlighting the importance of timely payment practices.
Buyers may take advantage of discounts without settling within the stipulated period, leading to unearned discounts.

Preferred Terms by Sellers

Cash-in-advance (CIA) is desirable for sellers but often rejected by buyers, necessitating careful risk assessment.
Credit staff must identify customers who can reliably pay under open account terms while also accommodating those who may not qualify.

Verifying Companies

Small and new businesses may lack credit reports; thus, verification processes should rely on reputable third-party sources, including independently sourced contact numbers.
Ensure references provided by potential clients are legitimate by cross-referencing phone numbers and calling independently.

Trade References Consideration

Companies check trade references to gauge potential customers' payment behaviors; references are typically selected by potential customers to provide favorable reviews.
Independent verification of references is crucial, and reaching out to additional contacts can provide insights into the customer's creditworthiness.

Financial Statements Evaluation

Analyzing financial statements reveals a company's financial health but recognizes the potential for manipulation.
The most reliable statements are audited by independent firms, which must conform to generally accepted accounting principles (GAAP).
A distinction is made among audited, reviewed, and compiled financial statements, with audited statements being the preferred form.

Current Financial Statements

The recency of financial statements impacts their reliability; statements can be up to 18 months old due to auditing processes.
Change in fiscal year-end may indicate underlying issues and warrants further inquiry.

Key Financial Documents

Financial statements encompass income statements, which reflect profit and loss for the current fiscal year; any anomalies should be thoroughly examined.
Profitability analysis is critical for determining creditworthiness and overall business viability.

New Account Review Processes

Companies should establish clear credit policies, streamline application processes, and require specific information uniformly from all customers.
Setting up new accounts should involve a standardized credit review, with small initial credit lines granted to encourage further evaluation.

Ongoing Credit Reviews

Annual credit reviews are recommended to manage ongoing exposure and identify potential risks from long-term customers.
Maintaining relevant documentation is essential for consistent credit evaluation.

Caution with New Customers

Verify references meticulously to prevent reliance on potentially deceptive information; superlative descriptions without deeper knowledge should raise red flags.

Setting Credit Limits

Companies may apply simplistic formulas for determining credit limits based on net worth but should ensure exposure does not exceed 10% of annual business.
Regulation ensures a balanced risk approach to customer credit extensions.

Warning Signs of Credit Risk

Signs indicating potential payment issues include delays in payment from typically prompt customers and uncharacteristically large orders from minor clients.
Close monitoring of these behaviors can aid in identifying and mitigating financial risk.

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Description

Explore the essential concepts of business credit, including the significance of credit policies and the impact of open account sales. Learn about the mechanisms like early payment discounts and their effects on cash flow management for businesses. This quiz uncovers the balance between risk and profitability in commercial transactions.