Problem 19 - Accounting

Question

Office Mate Supplies Inc. has "cash and carry" customers and credit customers. Office Mate estimates that \(25 \%\) of monthly sales are to cash customers, while the remaining sales are to credit customers. Of the credit customers, \(20 \%\) pay their accounts in the month of sale, while the remaining \(80 \%\) pay their accounts in the month following the month of sale. Projected sales for the first three months of 2010 are as follows: \(\begin{array}{lr}\text { August } & \$ 250,000 \\ \text { September } & 290,000 \\ \text { October } & 270,000 \\ & \\ \text { nce on July 31, 2010, was } \$ 200,000 .\end{array}\) The Accounts Receivable balance on July 31, 2010, was \(\$ 200,000\). Prepare a schedule of cash collections from sales for August, September, and October.

Step-by-Step Solution

Answer

Cash collections: August - $260,000; September - $266,000; October - $282,000.

Step 1: Identify the Types of Sales and Their Payment Timing

Office Mate has two types of customers: cash customers and credit customers. Cash customers account for 25% of the sales and pay immediately. Credit customers account for 75% of the sales. Of these, 20% pay within the sale month and 80% pay in the following month.

Step 2: Calculate Cash Collections from Credit Sales on July 31

The accounts receivable balance on July 31, 2010, was \(200,000. 80% of this will be collected in August (since these are credit sales from the previous month). To find this: \[ \text{July Credit Sales Collected in August} = 0.8 \times \\)200,000 = \$160,000 \]

Step 3: Compute August Cash Collections

Sales for August are \(250,000. Calculate cash collections as follows:- Cash sales: 25% of August sales, \[ 0.25 \times \\)250,000 = \\(62,500 \]- Credit sales collected in August (20% of total credit sales for August):\[ 0.20 \times 0.75 \times \\)250,000 = \\(37,500 \]- Total for August (including July carryover):\[ \\)62,500 + \\(37,500 + \\)160,000 = \$260,000 \]

Step 4: Compute September Cash Collections

Sales for September are \(290,000. Calculate cash collections as follows:- Cash sales (25% of September sales):\[ 0.25 \times \\)290,000 = \\(72,500 \]- Credit sales collected in September:\[ 0.20 \times 0.75 \times \\)290,000 = \\(43,500 \]- Collections from August credit sales (80% of August’s credit sales):\[ 0.80 \times 0.75 \times \\)250,000 = \\(150,000 \]- Total for September: \[ \\)72,500 + \\(43,500 + \\)150,000 = \$266,000 \]

Step 5: Compute October Cash Collections

Sales for October are \(270,000. Calculate cash collections as follows:- Cash sales (25% of October sales):\[ 0.25 \times \\)270,000 = \\(67,500 \]- Credit sales collected in October:\[ 0.20 \times 0.75 \times \\)270,000 = \\(40,500 \]- Collections from September credit sales:\[ 0.80 \times 0.75 \times \\)290,000 = \\(174,000 \]- Total for October:\[ \\)67,500 + \\(40,500 + \\)174,000 = \$282,000 \]

Key Concepts

Cash Collections

Cash collections refer to the process of accumulating and managing the cash that flows into a business from its sales operations. This process is crucial because it directly impacts the liquidity of a business. Having a clear understanding of how cash is collected from different types of sales can help a company plan its finances more effectively. Office Mate Supplies Inc., for example, experiences cash collections from two primary sources: cash customers and credit customers. Cash customers provide immediate inflow, contributing to a steady flow of cash. This is an advantage as it allows the business to immediately utilize this cash for operational needs or investments. For credit customers, however, the timing of collections is dependent on payment agreements. In the exercise, it is specified that 20% of credit sales are collected in the month of sale, which helps improve monthly cash flows, while the remaining 80% is collected the following month. Understanding this pattern is key to making accurate cash flow projections, which in turn help in managing expenses and planning for future growth.

Credit Sales

Credit sales occur when a company allows customers to purchase goods or services now, and pay later. While this approach can increase sales by attracting more customers, it requires careful management of accounts receivable. In the case of Office Mate Supplies Inc., 75% of total sales are made on credit. Once these sales are recorded, they become accounts receivable until the cash payment is made. It's important for a business to track and manage these receivables to ensure they are collected promptly. Moreover, credit terms are crucial. For Office Mate, 20% of credit customers pay within the same month, and the rest, or 80%, pay in the following month. Setting these terms helps balance customer relationships with the business's cash flow needs. Monitoring credit sales and their subsequent collections can also trigger refined credit terms if payments are consistently delayed, ensuring the company's financial health is not adversely impacted.

Financial Projections

Financial projections involve estimating future revenues, expenses, and cash flows to help guide business decisions. They are an essential part of strategic planning, enabling companies to anticipate future financial needs and make informed decisions. For Office Mate Supplies Inc., accurate financial projections are dependent on understanding both cash and credit sales. By predicting when cash from sales will be collected, the company can better plan its expenditures, identify potential financial needs in advance, and avoid cash shortfalls. Projections based on past sales data, like those outlined in the exercise, offer insight into future cash collections. Businesses can thus align their sales, marketing, and administrative efforts to ensure they are prepared for various outcomes. For instance, knowing that a significant portion of September's credit sales will result in cash inflows in October can influence inventory purchases and staffing decisions.

Sales Analysis

Sales analysis involves examining a company's sales figures to understand the causes behind success or decline in sales. This understanding can be used to improve future sales strategies and forecasts. For Office Mate Supplies Inc., sales analysis not only includes evaluating the proportion of cash versus credit sales but also understanding the payment patterns of credit customers. By analyzing how quickly accounts receivable are being converted into cash, the company can assess the effectiveness of its credit policies and identify any areas needing improvement. Additionally, sales analysis can identify trends or seasonal patterns in sales, helping companies to adjust their marketing strategies and stock levels accordingly. In context, analyzing sales from August to October highlights patterns in cash and credit collections, providing a clear picture of how sales are likely to perform in future months. By using such analytical insights, Office Mate can make informed decisions to enhance sales performance and financial stability.