Help with a financial assumption regarding debtors

[richard256]

I am seeking to set up in business later. However, for the moment, I have need to put in some academic work dealing with financial matters.

I can see that although the fictitious business has a healthy trading situation there is a financial management problem.

Now, what I think I may have to do is make an assumption with regard to debtors. But I want it to be realistic. I'm wanting someone to give me a realistic assumption.

The business is a city florist, started in 2003, which has 20 contracts in addition to cash sales.

Here are some figures (£):

.........................Year 2011.............Year 2012

Sales................. 2,145,408.............2,127,265

Debtors/t.r.:........111,391................90,734

Bank overdraft:....24,286..................19,999

Okay, each year there is a debtors figure. I was thinking that perhaps it might be reasonable to assume that 95% of that figure was unpaid bills from the year in question and only 5% of the figure unpaid biils from the previuos year.

Anyhow, I just need a simple assumption/scenario about what is going on with unpaid bills that would tend to fit with the figures above. Particularly, what proportion of the debt may realisically be due to sales earned in an account year and what might be due to previous sales activity.

Not sure if it's calculatable from other figures I have.

Thanks if you can help. Rich

 

[richard256]

I've realised something:

Let's say 40% of sales were due to sales on credit and it was not seasonal.

That would mean for 2012 there was £858,163.2 of credit sales

Therefore monthly sales on credit would be £71,513.6.

If everybody paid within 30 days, there would always be a debt figure of around £71,513.

Therefore, the problem debt would be £111,391 - £71,513 = £39,878.

That £39,878 part of total debt in debtors is arising from some situation I have to dream up a realitic assumption for.

 

[richard256]

I wonder if folks see a problem. Let's first see if folks think there is a credit control problem, on first perusal I'd have said there was, but I'm nor sure now.

This is my thinking:

If we had perfection, everyone given credit would pay within 30 days. In this perfect scenario, where sales are not seasonal, at the end of the financial year, we might expect debtors figure to be no greater or less (on average) that one twelfth of annual (credit) sales earned.

What do you/folks think about that?

 

[Arch Stanton]

Have you allowed for VAT? Those sales figures will be net of VAT but trade debtors include VAT.

 

[richard256]

I might have been barking up the wrong tree a bit.

Instead of trying to make up assumptions about what is going on with debtors, as a way of showing how problemmatic the debtors situation may or not be, I might only need to work out relevant financial ratios.

But, if I did seek to make assumptions I believe it would be about debtor's day sales outstanding. I see that sales recovery is considered low under 55 days, average 55-85 days and high over 85 days.

As to the ratios: If I were simply to apply the liquidity ratio , then low risk is over 1.25, average risk 0.75-0.25 and high risk under 0.75.

Basically in my fictitious problem, I've been trying to come up with a way to explain whether unpaid debts are a problem. And I think I'm now in the zone on that.

 

[Tom McClelland]

It depends on the proportion of cash sales, which isn't stated. if the 20 contracts are worth £200k/year the debtor position is appalling. If the 20 contracts are worth £1800k/year the debtor position is wonderful.

 

[Zara Accountancy]

Do you know what percentage of the sales are cash?

Assuming that all the sales are credit then debtors days have gone down from 19 days to 15.6 days. This means that the business is collecting its debts quicker. The same would apply if the cash:credit ratio has not changed.

 

[richard256]

When I do the ratios and Debtors days outstanding I get reasonable figures.

But, I'm not taking into consideration what is credit sales and what is cash sales. And I think not doing that is painting too rosy a picture.

We are dealing with a florist business. As far as the sales breakdown is concerned sales are concerned, 60 % of sales were special occasion or gift purchases. Valentines, Mothers day, Easter, Christmas were busiest times of year. From that I assume that 40% will be credit sales because these would not be gifts or special occasions, they'd be for flowers for business offices and not seasonal.

So, I guees the sales breakdown is 60% cash, 40% credit.

I guess then this means when I do the debtors day outstanding I must take annual sales to be 40% of the figure in the income statement.

That would come out: 111,391 x 365 / 858395.60 = 47.6 days

Up from 18.9 days I calculated previously!

Actually I see that (47.6 days) would be about average, not in the high catagory.

I suppose the liquidity ratios are unaffected. That came out at as follows:

Current ratio: 4.32
Liquidity ratio: 2.26

Which I believe show low risk.