GRADE 11 ACCOUNTING MODULE 7 LESSON 4 DEBTORS

GRADE 11 ACCOUNTING MODULE 7 LESSON 4

DEBTORS COLLECTION PERIOD & PAYMENTCREDITORS PERIOD Increase OR decrease in STOCK, DEBTORS or CASH will have an impact on the level of working capital In order to calculate whether a Business is handling their capital effectively – need to calculate: The period of stock on hand Debtors collection period Creditors payment period

DEBTORS COLLECTION PERIOD & CREDITORS PAYMENT PERIOD Stock on hand Debtors pay after: JJ Stores 4 months 2 months 1 month KK Stores 2 months 1 month JJ will require more Working Capital than KK Stores WHY? To finance the additional stock they holding To compensate for the slower rate debtors are paying JJ Stores are paying their Creditors after 1 month BUT allowing debtors to take 2 months to pay How would they fix this? Reduce stock levels Control payments of debtors more effectively

DEBTORS COLLECTION PERIOD & CREDITORS PAYMENT PERIOD Useful to calculate these time periods as they indicate the efficiency of the utilisation of working capital Can be compared to: Previous periods OR Pre-determined objectives

DEBTORS COLLECTION PERIOD & CREDITORS PAYMENT PERIOD 2006 2005 R 720 000 R 660 000 480 000 440 000 Trading stock at end of year 90 000 150 000 Debtors at end of year 39 000 55 000 Creditors at end of year 80 000 60 000 Sales (half cash, half credit) Cost of Sales DEBTORS COLLECTION PERIOD = Debtors X Credit Sales 365 1 NOTE: Debtors may be avg debtors or closing debtors depends on circumstances On avg: (39 000 + 55 000)/2 x 365 = 47. 6 = 48 days (720 000/2) 1 This means debtors take 48 days to pay us

DEBTORS COLLECTION PERIOD & CREDITORS PAYMENT PERIOD 2006 2005 R 720 000 R 660 000 480 000 440 000 Trading stock at end of year 90 000 150 000 Debtors at end of year 39 000 55 000 Creditors at end of year 80 000 60 000 Sales (half cash, half credit) Cost of Sales CREDITORS PAYMENT PERIOD = Creditors X Cost of Sales 365 1 NOTE: Debtors may be avg creditors OR closing creditors depends on circumstances Assume all Creditors are stock related purchases – stock was purchased on credit On avg: (80 000 + 60 000)/2 x 365 = 480 000 1 This means we take ___ days to pay our creditors

DEBTEQUITY Give an indication of how a business is financed CAPITAL provided by owners (own capital) LOANS – funds borrowed from outside institutions (borrowed capital) If making significant use of borrowed capital – business is put under great financial risk If profits drop – still need to pay back interest on loan If relying mainly on owners’ equity (own capital) to fund the operations - regards as low risk business Own capital doesn’t have to be repaid even when profits drop – they will just lose out on profits

DEBTEQUITY Debt : Equity ratio indicates the extent to which the business is financed by borrowed capital The degree of financial risk Influence the ratio has on the bottom-line figure If loans are high then so is interest expense High interest could turn favourable OP profit into net loss. On other hand it is often favourable to make use of loans – despite the risk – as is could lead to possible increased profits Profits would outweigh the interest expense This is termed ‘Positive Gearing’ (benefits of borrowing outweigh the cost

DEBT EQUITY DEBT : EQUITY = Non-current Liabilities: Owners’ Equity Consider the following: Owners’ Equity Non-current Liabilities R 950 000 200 000 Debt : Equity = 200 000 : 950 000 = 0. 2 : 1 It is financed mainly by equity (own capital) Long term liabilities are 20% of equity Indicates a low degree of financial risk – closer it gets to 1: 1 the higher the risk No correct or incorrect level depends on nature of business Compare to past/desired objectives