Evaluating Collateral Value- The Effect of Past-Due Receivables on Loan Approval

Evaluating Collateral Value- The Effect of Past-Due Receivables on Loan Approval

The case shows that bad debts are one of the major problems facing businesses. Late payment by customers often exposes businesses to cash flow problems. One of the ways to manage bad debts is by monitoring and managing the accounts receivable turnover ratio. The ratio is calculated by dividing net sales by total account receivables (AR) due from debtors. The objective is to attain a high AR ratio which is desirable by lenders (Nurdiansyah & Manda, 2018). However, a low AR does not necessarily imply that customers are risky. There is a need to view AR relative to other players in the industry to sustain customers in the long run.

It is clear that debts are so high, and with the cost of collecting debt also being high, it is appropriate to write off some debts. Writing off toxic debts will make the business attractive to lenders, besides reducing its tax liability (Nurdiansyah & Manda, 2018). Estimating bad debt and writing it off will boost the AR ratio and reduce bad debt expense for the following fiscal year.

Since the recoverable debt that is due past 90 days stands at 80%, bad debt is estimated at 20%. The owner’s demand that bad debt be capped at 3% will be assessed based on debt payment history and recoverability. It will not be prudent to conclude bad debts at a flat rate of 3% without past data or payment surety. Besides, any bad debts that need to be considered must be subjected to internal estimates and specified reasons for every individual debt.

Therefore, it would be desirable to set bad debts at 20% to be on the safe side.  It is upon the business owner to set mechanisms and ensure the debt is collected timely. The request amounts to a falsification of documents, hence not ethical.

References

Nurdiansyah, D. H., & Manda, G. S. (2018). The Effect of Allowance for Bad Debt Loss to the Level of Profitability. ECONOMICS, 6(1), 125–139. https://doi.org/10.2478/eoik-2018-0005

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Historically, your company has calculated bad debts using an accounts receivable aging. Near the end of the fiscal year, the company is in a cash crunch and needs to borrow money from the bank, using accounts receivable as collateral. The company owner knows that many accounts receivable are more than 90 days past due, resulting in net receivables equal to only 80% of total receivables.

Respond to the following in a minimum of 175 words:

The owner asks you to change the method of estimating bad debts to a flat 3% of receivables. What should you do?