What is the change in A/R between years 0 and 1 that is the responsibility of the Credit department?

a.	?$200
b.	?$180
c.	?$160
d.	?$140
e.	?$120

What is the cross-product term?

a.	$0
b.	$5
c.	+$10
d.	+$15
e.	+$20

What is the change in A/R between years 0 and 1 that is the responsibility of the Sales department?

a.	+$200
b.	+$180
c.	+$160
d.	+$140
e.	+$120

What is the cross-product term?

a.	?$50
b.	?$25
c.	$0
d.	+$25
e.	+$50

\fExhibit 1 Dperang Staments for Years Ending December 31, llEEIJS, and for First Quarter 2004 [thousands of dollars} Not solos Boot ol goods sold Boginning Inventory Purchasers Ending In'u'Bntl'y Tolal oost ol goods sold Gross profit Dparstlng expanse? lnlsrasi sxpsnss Not Income before toms Provlsion for Inoomo toms Not Inoomo 2am 51,59? 153 13TH $1,451 239 $1,222 475 425 13 S 3'? $31 snot: 524113 239 1.5211- $1353 326 51,43? STE 515 2G 5 41 S 34 First Quarter 2110! 5 HEEL 41E EEG $1 ,UTE 555 S 522 195 11"5 1D $11 $9 Cartwright Lumber Company Basic Information It's Spring 2004 Company founded in 1994 Partnership by Cartwright & Stark Brothers-in-law Stark sold in 2001 for $105 o Paid off in 2002, in part with a $70 loan, PMT = $7/yr over 10 years Good sales growth and profits, but short on cash Bank debt of $247; max = $250 per client Why do banks impose such limits? New bank willing to provide up to $465 Not all of this amount is \"fresh\" money Cartwright must sever ties with its current bank; i.e., must pay off $247 Is this amount enough to finance Cartwright's growth in 2004? Analysis of Accounts Receivable A Graphical Technique Analysis of Accounts Receivable In a growing company, it is quite common for Accounts Receivable to be one of the most important uses of funds Because an increase in A/R needs to be financed with costly sources, it is important to understand who is responsible for that change. While A/R spontaneously change as sales change, they may also change as the firm's average collection period (ACP) changes. This is apparent from rearranging the formula for ACP ACP = (A/R) / DCS Note: DCS is Daily Credit Sales Analysis of Accounts Receivable (Contd.) A/R = ACP x DCS This expression indicates that the A/R level of the firm results from the interaction between the ACP and the DCS. Thus, if either ACP or DCS grows, the A/R level of the firm also grows. While an increase in A/R due to sales growth is normally unobjectionable, an A/R increase resulting from a longer ACP is usually undesirable The following graphical technique is useful in ascertaining which portion of the change in A/R during a period is the responsibility of the Credit department and which portion is simply due to the change in sales Graphical Analysis of Accounts Receivable This technique is based on the simple observation that the product of any two variables may be visually represented as the area of a rectangle. Recalling some basic geometry, we have: Area = Base Height Therefore, letting DCS represent the base of the rectangle and ACP its height, and recalling that A/R = ACP DCS, we can interpret the A/R level at a given point in time as follows: ACP A/R DCS Graphical Analysis of Accounts Receivable (Contd.) By directly comparing the rectangle for the beginning of a period to the rectangle for the end of the period, we can graphically calculate the change in A/R that is the responsibility of the Credit and Sales departments over that period To begin, the following ACP and DCS values for 2001 and 2002 can be obtained from Cartwright's financial statements Assume there are 365 days per year A/R Sales 2001 171 1,697 2002 222 2,013 DCS ACP 4.65 36.78 5.52 40.25 Graphical Analysis of Accounts Receivable 2001 2002 A/R: 171 222 Sales: 1,697 2,013 A/R = ACP x DCS ACP 40.25 2002 +3.01 +16.15 36.78 2001 +31.84 0 4.65 5.52 DCS Interpretation of the Graphical Analysis of Accounts Receivable The total change of +$51 in A/R from 2001 to 2002 for Cartwright is represented in the previous graph by the difference in the corresponding areas. The analysis requires splitting that area change into three components: $16.15, $31.84, and $3.01. The first two amounts are the responsibility of the Credit and Sales department, respectively. The third amount, known as the crossproduct term, cannot be easily assigned to either department Fortunately, as in Cartwright, this term is usually the smallest of the three Notice that both the DCS and the ACP increased from 2001 to 2002. However, when one or both of these variables decrease, some confusion may arise To avoid confusion, the following general rules are useful: Rules for Determining the Three Components of the Change in Accounts Receivable There are ALWAYS three components when both the DCS and the ACP change during the period being analyzed Sometimes it may visually seem as if there are only two components, but that is not the case There are NEVER two components to the change in A/R! To find the Credit component, multiply the change in the ACP times the INITIAL value of DCS To find the Sales component, multiply the change in the DCS times the INITIAL value of ACP To find the cross-product component, multiply the change in the ACP times the change in the DCS Note that changes in the variables can be positive or negative Thus, any of the three components can be negative Exercise 2 Problem 1: Perform the graphical analysis of A/R for Cartwright over the period 2002 to 2003 Problem 2: Consider a company (not Cartwright!) whose A/R decreased from $660 to $550 between year 0 and year 1. During that period, the company's sales went from $4,000 to $5,000. Perform the graphical analysis of A/R for this company between year 0 and year 1 Notes: To minimize rounding errors, use four decimals in all intermediate steps Assume the year has 365 days When you finish the calculations for these problems, you may take the quiz