Accts Receivable Accounts Receivable Reflects Credit That Essay

Accts Receivable

Accounts receivable reflects credit that has been extended to customers. The positive aspect is that it represents a sale that has been made; the negative is that it represents a sale that has not been paid for. There are a number of benefits to extending credit, but there also drawbacks. Thus, companies need to pay special attention to how they manage their accounts receivable.

Effectively management of accounts receivable can increase shareholder value; naturally the opposite is also true. By extending credit to customers, the company can gain more business. Trade credit induces more purchases from more people, by allowing the customers to better align their cash flows. The terms of the credit can also be used as a source of competitive advantage -- giving longer penalty-free terms than a competitor can help win business, for example. However, there are risks associated with accounts receivable that can lower shareholder value. The sale is only useful, for example, if it is eventually paid for. Thus, the company must take steps to limit bad debts from accounts receivable, and should also take steps to ensure that payments are made in a timely manner. If the latter does not occur, the company will carry too much value in accounts receivable, thereby increasing the risk of default. In addition, value held in accounts receivable represents future cash, which cannot be spent nearly as productively as actual cash.

In order to reduce the risk associated with accounts receivable, the company needs to set a credit policy that clearly defines which customers will receive credit, and how much credit they will receive, and under what terms. Assessing the ability of the customer to pay is critical to using trade credit wisely (Khanna, 2010). For potential clients, there may or may not be credit rating sources. The larger the customer is, the more likely it will have some sort of credit rating available. There are a number of credit rating agencies, and they will evaluate the long- and short-term debt capacity of some corporate entities, especially those that have issued paper. The current market yield-to-maturity of a company's paper can be used as a proxy for its credit rating. However, where credit reports are available, they are the easiest way to score a customer's credit, because somebody else has already done the work.

However, many…