Trade receivables

Trade receivables
See also

Trade receivables are one of the components of the balance sheet’s current assets due to high liquidity. The subject of purchase on credit can be not only goods but also services. They arise when a company sells its products or services with prolonged payment date. Until the moment of payment, a record in trade receivables will be visible in the selling enterprise's balance sheet, equal to the value of the items or services sold, for which the customer has to pay. It means that trade receivables are the amount of money which has to be paid by the client who did not settle it in a given period of time. Trade receivables are created when the company allows a client to buy on credit. The credit time is the special period when a client should settle his debt arising from the enterprise. The given time depends on a relation between both of the engaged parties or the financial condition of the buyer. Usually, the time given to settle the debt is[1]:

  • 30 days,
  • 60 days,
  • or 90 days.

Bad Debt recognition[edit]

The selling company also performs aging procedures on trade receivables, which shows how many days the invoices have not been paid. Usually, if the debt has not been paid for a year (depends on the company’s policy), this amount of trade receivables become overdue and has to be recognized as a cost. This amount becomes, so called “Bad Debt” and is subtracted from the balance sheet’s current asset position and added to the cost section in profit & loss financial document[2].

Factoring business model[edit]

Settlement of bills by the client in a specific time gives the company the opportunity to better manage company's finances. On the other hand, the need of financial liquidity developed a type of business called “Factoring companies”. This business model focuses on purchasing trade receivables from the enterprises by external party – not involved in the transaction process between the buyer and the seller - for a lower price than its value. This option is used when an enterprise is at risk of losing financial liquidity. The factoring company earns on the difference between the amount of collected debt and the amount paid for the trade receivables. However, it also must bear the risk of uncollected debt. Thus, the company which sells its trade receivable to the factoring company also reduces the risk connected with bankruptcy or dishonesty of their customer which is a desirable phenomenon. If the enterprise is not at risk of losing financial liquidity, it is also important to control all of the trade receivables to accordingly react if necessary. However, the company should be patient towards its customers. Excessive haste and pressure to pay off debts can ruin the relation between the company and the client[3].

Footnotes[edit]

  1. A. Harssan Gorondutse, R. Abass Ali, A. Ali,2016, Effect of Tade Receivables and Inventory Management on SMEs Performance, British Journal of Economics, Management & Trade, no. 12(4)
  2. P. M. Griffin, (2015), How to Read and Interpret Financial Statements: A Guide to Understanding What the Numbers Mean to You, AMA Self-Study
  3. E.Piguła, M. Paduszyńska, (2015), Factoring as a Special Means of Financing, Jorunal of Finance and Financial Law, no. II(3)

References[edit]

Author: Justyna Piekorz