Question

Please answer the following question, required 150-200 words Q: How may analyzing sales and receivables provide information about a firm's profitability?

Answer 1

Cash Sales are free from bad debt losses but still rely more on the credit-sale system as it possesses many advantages. Some of these are as follows:

Greater Sales and Profitability: Credit Sales help boost the volume of sales and improve the firm's competitiveness in the market. This in turn leads to higher profitability.

Absorbing Fluctuations in Demand: Credit sales not only bring greater sales but also absorb the shocks of fluctuations in demand.

Providing liquidity to the firm: Account receivable provide liquidity to the firm, especially, when there is sudden drop in liquidity. When there is a desired amount of liquidity, the firm can lend a part of its liquid resources directly to its customers in the form of trade credit for a specific period. During the period of shortage of liquidity, it can ask for repayment of credit.

Effecting Price discrimination: Account receivables are a tools for price discrimination. Since the credit term has an impact on the price of the product, the firm can use different credit terms for different market segment.

Despite of all such advantages of credit sales and accounts receivables, they have costs too, in form of administrative cost, financial cost, collection cost and bad debt losses.

Therefore, A firm's credit policy should be such that helps maximize corporate wealth. It can be determined through a cost benefit analysis or through preparing a proforma income statement. Any change in the credit standard or the period of the credit or in the discount policy must ensure that benefits exceed cost.