Accounts Receivable and Credit Evaluation Essay
Accounts receivable is defined as a record or asset on the balance sheet that represents the existing amounts due to the chosen business (Viney & Phillips, 2015). This term is usually shortened to “receivables” (Kennon, 2017). It represents all money that may be owned by customers to a company regarding products or services. Still, the payment on these products or services is not received at the moment.
Notes Receivable and Their Differences
In addition to receivables, companies and customers have to recognize notes receivable. This note is a kind of a promise given in a written form according to which certain cash should be sent from one party to another in the future. In some cases, overdue accounts receivable may be converted into such notes so that a debtor can have more time to pay for products or services offered (“Notes receivable accounting,” 2017). However, it is impossible to convert notes into accounts. In addition, notes receivable require a formal instrument that may be used as proof of the debt. Accounts are mentioned on a balance sheet, and notes are separate legal documents.
How Creditors Extend Credits to Their Customers
The extension of credit to customers is a crucial step in any business relationships and operations. It is not enough to ask for an extension or have enough reasons for it. It is necessary to understand when creditors may give this extension and when the situation does not allow taking this step. Certain considerations should be identified before extending credit to a customer, including the evaluation of the worthiness of credit to the customer and the business, the identification of such factors as liquidity and the presence/absence of collateral, and the ability to repay (“Considerations before extending credit to a customer or client,” n.d.).
Credit extension also depends on such factors as possible risks, the existing policies, and review of credit history with the help of which it is possible to identify credit limits and consider customers’ requests (Carbajo, n.d.). Each customer is free to introduce personal reasons, explanations, and promises to prove the appropriateness of an extension.
Process of Credit Evaluation
Credit evaluation is an important business process in terms of which a customer is proved to be eligible for a loan and payment for goods or services in a certain, extended period of time. As a rule, credit managers have to take several steps to evaluate new customers and understanding their credit abilities. The main steps include the identification of creditworthiness when a moral character of a creditor should be evaluated (“Credit evaluation and approval,” n.d.).
Then, loan size and frequency of credit requests should be identified. Finally, social considerations should be gathered to understand if customers are connected with some risks or social projects. Finally, it is necessary to learn that every approval and evaluation procedure may have some new characteristics in new organizations. Therefore, it is wrong to follow and use one certain plan. Certain corrections and adjustments are possible.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is defined as a balance sheet account with the help of which it is possible to reduce the amount of the already reported accounts receivable. It is a possibility to introduce a clear picture of how accounts can be turned into cash with time. It is usually introduced as a contra asset account because of a reduction of the total amount of accounts that the company has on its balance sheet.
For example, the company cooperates with more than 10,000 customers and states sales in more than $1,000,000. It is hard to make sure how many customers may default. Therefore, 1% is defined as bad debt. So that $100,000 is used as a credit to the allowance for doubtful accounts and reserved. Another example may be observed while developing a weekly financial statement when the company indicates that 0.1% of its sales can hardly be collected during this period and doubtful accounts are allowed.
Carbajo, M. (n.d.). Factors to consider before extending credit to customers. AllBusiness. Web.
Considerations before extending credit to a customer or client. (n.d.). Web.
Credit evaluation and approval. (n.d.). Web.
Kennon, J. (2017). Accounts receivable on the balance sheet. The Balance. Web.
Notes receivable accounting. (2017). Web.
Viney, C., & Phillips, P. (2015). Financial institutions, instruments and markets (8th ed.). New York, NY: McGraw-Hill Education.