52 weeks ÷ 6.34 (Accounts receivable turnover ratio) = 8.21 weeks Hasbro’s accounts receivable turned over at a rate slightly faster than Mattel’s.
Is that an improvement or a step backward for Hasbro? Using the 2006 numbers, you find that Hasbro took 8.91 weeks to collect from its customers.
That means that the company experienced an improvement in its accounts receivable collection.
What do the numbers mean?
The higher an accounts receivable turnover ratio is, the faster a company’s customers are paying their bills. Most times, the accounts receivable collec- tion is directly related to the credit policies that the company sets. For exam- ple, a high turnover ratio may look very good, but that ratio may also mean that the company’s credit policies are too strict and that it’s losing sales because few customers qualify for credit. A low accounts receivable turnover ratio usually means that a company’s credit policies are too loose, and the company may not be doing a good job of collecting on its accounts.
According to its balance sheets, Mattel wrote off $21.5 million in bad debt in 2007 and $19.4 million in 2006. Hasbro wrote off a lot more: $30.6 million in 2007 and $27.7 million in 2006. Hasbro not only has slower-paying customers but also writes off more to bad debt.
Hasbro’s customers took an average of 8.21 weeks to pay their bills in 2007.
Mattel’s customers took a bit longer at 8.4 weeks. Both companies wait about two months to get paid. The amount sitting in accounts receivable for Mattel increased by about $50 million between 2006 and 2007. Hasbro experienced an increase in accounts receivable of almost $100 million.
As an investor, you may want to call Hasbro’s investor-relations department to find out about its longer accounts receivable collections period and its bad-debt write-offs, as well as what the company is doing to improve these numbers.
Taking a Close Look at Customer Accounts
If you work inside a company and have responsibility for customer accounts, you get an internal financial report called the accounts receivable aging sched- ule. This schedule summarizes the customers with outstanding accounts, the amounts they have outstanding, and the number of days that their bills are outstanding. Each company designs its own report, so they don’t all look the same. Check out Table 16-1 to see an example of an accounts receivable aging schedule.
Finding the right credit policy
Setting the right accounts receivable policy can have a major impact on sales. For example, a company could require customers to pay within ten days of billing or close the accounts. That may be too strict, and customers could end up having to walk out of the store because they can’t charge to the account. Another common credit policy that may be too strict is one that requires too high a salary level to qualify, forc- ing too many customers to go elsewhere to buy the products they need.
Looking at the other side of the coin, a credit policy that’s too loose may allow customers 60 days to pay their accounts. By the time the com- pany realizes that it has a nonpaying customer, the customer may have already charged a large sum to the account. If the customer never pays the amount due, the company has to write it off as a bad debt.
Table 16-1 Accounts Receivable Aging Schedule for ABC Company, as of March 31, 2008
Customer 30–45 Days
46–60 Days
61–90 Days
Over 90 Days
Total DE
Company
$100 $50 $0 $0 $150
FG Company
$200 $0 $0 $0 $200
HI Company
$200 $100 $100 $50 $450
JK Company
$300 $150 $50 $50 $550
Total $800 $300 $150 $100 $1,350
Looking at the aging schedule, you can quickly see which companies are sig- nificantly past due in their payments. Many firms begin cutting off customers whose accounts are more than 60 or 90 days past due. Other firms cut off customers when they’re more than 120 days past due. No set accounting rule dictates when to cut off customers who haven’t paid their bills; this decision depends on the accounting policies the company sets.
In the aging schedule example for ABC Company, the JK Company looks like its account needs some investigating. Although a company can carry past-due payments because of a dispute about a bill, after that dispute goes beyond 90 days, the company awaiting payment may put restrictions on the other company’s future purchases until its account gets cleaned up. HI Company seems to be another slow-paying company that may need a call from the accounts receivable manager or collections department.
Many times, a company salesperson makes the first contact with the cus- tomer. If the salesperson is unsuccessful, the business initiates more severe collection methods, with the highest level being an outside collection agency.
Companies with strong collection practices place a gentle reminder call when an account is more than 30 days late and push harder as the account is more and more past due.
When a business decides that it probably will never collect on an account, it writes off the account as a bad debt in the Allowance for Bad Debt Account.
Each company sets its own policies about how quickly it writes off a bad debt. A company usually reviews its accounts for possible write-offs at the end of each accounting period. I talk more about accounts receivable and their impact on cash flow in Chapter 17.
Finding the Accounts Payable Ratio
A company’s reputation for paying its bills is just as important as collect- ing from its own customers. If a company develops the reputation of being a slow payer, it can have a hard time buying on credit. The situation can get even more serious if a company is late paying on its loans. In that case, the business can end up with increased interest rates while its credit rating drops lower and lower. I discuss the importance of a good credit rating in Chapter 21.
You can test a company’s bill-paying record with the accounts payable turn- over ratio. In addition, you can check how many days a company takes to pay its bills by using the days in accounts payable ratio. Keep reading to find out how to calculate these ratios.
Calculating the ratio
The accounts payable turnover ratio measures how quickly a company pays its bills. You calculate this ratio by dividing the cost of goods sold (you find this figure on the income statement) by the average accounts payable (you find the accounts payable figures on the balance sheet).
Here’s the formula for the accounts payable turnover ratio:
Cost of goods sold ÷ Average accounts payable = Accounts payable turn- over ratio
I use Mattel’s and Hasbro’s income statements and balance sheets for 2007 to compare their accounts payable turnover ratios.
Mattel