Statement of Financial Position Cash 10,000 Accounts payable $15,000 Accounts receivable 70,548 Notes payable 35,548 Inventory 20,000 Current liabilities $50,548 Current assets $100,548 Long-term debt 200,000 Fixed assets 500,000 Equity $350,000 Total assets $600,548 Total liabilities & equity $600,548 Construct the Pro-forma Statement of Comprehensive Income and Statement of Financial Position based on the current credit policy and the two proposed credit policies. Calculate the average collection period, net profit margin, return on assets, and return on equity for both the current and the proposed policies. How does the company compare with the industry average in terms of its average collection period, profitability, and returns on assets and equity under the current and proposed policies? 4-Which credit policy should the Samuelsons choose? Provide reasons for your recommendation.
Reporting Cash Flows
Reporting of cash flows means a statement of cash flow which is a financial statement. A cash flow statement is prepared by gathering all the data regarding inflows and outflows of a company. The cash flow statement includes cash inflows and outflows from various activities such as operating, financing, and investment. Reporting this statement is important because it is the main financial statement of the company.
Balance Sheet
A balance sheet is an integral part of the set of financial statements of an organization that reports the assets, liabilities, equity (shareholding) capital, other short and long-term debts, along with other related items. A balance sheet is one of the most critical measures of the financial performance and position of the company, and as the name suggests, the statement must balance the assets against the liabilities and equity. The assets are what the company owns, and the liabilities represent what the company owes. Equity represents the amount invested in the business, either by the promoters of the company or by external shareholders. The total assets must match total liabilities plus equity.
Financial Statements
Financial statements are written records of an organization which provide a true and real picture of business activities. It shows the financial position and the operating performance of the company. It is prepared at the end of every financial cycle. It includes three main components that are balance sheet, income statement and cash flow statement.
Owner's Capital
Before we begin to understand what Owner’s capital is and what Equity financing is to an organization, it is important to understand some basic accounting terminologies. A double-entry bookkeeping system Normal account balances are those which are expected to have either a debit balance or a credit balance, depending on the nature of the account. An asset account will have a debit balance as normal balance because an asset is a debit account. Similarly, a liability account will have the normal balance as a credit balance because it is amount owed, representing a credit account. Equity is also said to have a credit balance as its normal balance. However, sometimes the normal balances may be reversed, often due to incorrect journal or posting entries or other accounting/ clerical errors.
Statement of Financial Position
|
||||||
Cash |
10,000 |
Accounts payable |
$15,000 |
|||
Accounts receivable |
70,548 |
Notes payable |
35,548 |
|||
Inventory |
20,000 |
Current liabilities |
$50,548 |
|||
Current assets |
$100,548 |
Long-term debt |
200,000 |
|||
Fixed assets |
500,000 |
Equity |
$350,000 |
|||
Total assets |
$600,548 |
|
$600,548 |
- Construct the Pro-forma Statement of Comprehensive Income and Statement of Financial Position based on the current credit policy and the two proposed credit policies.
- Calculate the average collection period, net profit margin, return on assets, and return on equity for both the current and the proposed policies.
- How does the company compare with the industry average in terms of its average collection period, profitability, and returns on assets and equity under the current and proposed policies?
4-Which credit policy should the Samuelsons choose? Provide reasons for your recommendation.
![Case 3: Credit Policy Management Case
Luvly Jubbly Inc., is a wholesaler of merchandise with a British flavour. The merchandise is
distributed to Canadian retailers in all provinces. Due to the rise in popularity in Canada of
British television shows such as Downton Abbey and Sherlock, the company's sales have
grown by an average of 15% per year over the last five years. The company's sales are
expected to grow by a more modest 10% next year, with all costs and expenses growing
proportionately with sales.
The company was started 10 years ago by Camilla and Phillip Samuelson, who emigrated
from Sweden to Canada 15 years ago. Camilla and Phillip and their three daughters are
huge fans of all things British. Before they started the company, they were avid collectors of
British memorabilia, particular those for the long-running British soap, East Enders. After
one particularly unsettling disagreement with an online retailer of British memorabilia
(concerning a misprint on a mug that said "West Enders rule!"), Camilla and Phillip decided
to combine their business acumen with their love of British memorabilia and started their
company. With profits from the business, they were able to put all three daughters through
university. One of their daughters, Margaret, now works for them as their office manager.
Margaret is responsible for sending out invoices and bills, checking on when these invoices
and bills come due, and calling customers if bills are still unpaid 60 days after sale.
Even with the recent growth in sales, the Samuelsons have noticed a steady decline in their
quarterly net profit in the last two years. They think that this may be due to their current
policy of giving trade credits. When they first started 10 years ago, to attract customers to
their new business they set their credit policy to net 50, which was more generous than the
wholesale industry average of net 30. Since then, the company has built up a steady
customer base, but has retained the net 50 credit policy. Unfortunately, the rising popularity
of British shows and their associated memorabilia in Canada has enticed more companies
into the business, including mega-companies such as Walmart.
In the midst of this increased competition, a severe financial crisis hit the world market two
years ago, forcing some of Luvly. Jubbly's customers to reduce their orders and forcing a few
into bankruptcy. As a result, bad debt increased to about 2% during the last two years. The
upcoming year is the first year that bad debt is forecasted to drop back down to its historical
level of 1%. Under the current net 50 policy, 85% of customers pay by Day 50, and the
remainder pay 10 days later. With the delays in collecting from customers, the Samuelsons
have had to use the company's line of credit to pay its expenses. Their bank, the United Bank
of Canada, sets both short-term and long-term debt interest rates for the company at 15%.
At this point, considering the company's lowered net profit, Camilla and Phillip are finally
ready to take a deeper look at their credit policy, and if necessary, to change it. They asked
their second daughter, Diana (who has an MBA degree), to take a look at their books. After
completing her analysis, Diana gave them two possible alternatives for their credit policy,
with suggested outcomes:](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F5f799239-bf75-4c8c-a88f-30febcc0c4a0%2F828cbd63-92f5-496c-8957-e4603d0afbe8%2Fizkq0ib_processed.png&w=3840&q=75)
![Alternative #1: 2/20 net 30
Lose 5% sales
50% of customers will pay at Day 20
40% of customers will pay at Day 30
10% of customers will pay at Day 60
Cash, inventory, fixed assets, accounts payable, long-term debt, and equity will
remain unchanged
Alternative #2: 2/25 net 45
No lost sales
60% of customers will pay at Day 25
35% of customers will pay at Day 45
5% customers will pay at Day 60
Cash, inventory, fixed assets, accounts payable, long-term debt, and equity will
remain unchanged
Industry average: 2/20 net 30
Average collection period
Net profit margin = 5%
Return on assets = 5.2%
Return on equity = 13%
The company's most recent statement of comprehensive income and statement of financial
position are presented below.
The Samuelsons will have to make a decision on the company's credit policy based on the
available information.
Cost of goods sold
Statement of Comprehensive Income
Sales
$500,000
300,000
$200,000
100,000
$100,000
Gross profit
Operating expenses
Earnings before interest
and taxes
Interest expense
=
Earnings before taxes
28 days
Income taxes (35%)
Net income
35,332
$64,668
22,634
$42,034](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F5f799239-bf75-4c8c-a88f-30febcc0c4a0%2F828cbd63-92f5-496c-8957-e4603d0afbe8%2Fy9wkkn_processed.png&w=3840&q=75)
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