Computing cash collections from financial statements: why we don't take into account bad debt expense?
Hello!
I apologize for a bit lengthy text, but it's the only way I could explain my question. I will be truly grateful for your help.
Below I post an example on computing the cash collections based on the information in the company’s financial report, when we don’t actually have any more details. I wonder why we don’t have to deduct in this calculation bad debt expense (or provision for doubtful accounts), which appears on the income statement?
Here is how I understand it:
During the accounting period a company makes sales, and at the end of the period, when it prepares the income statement, it includes the bad debt expense (or provision for doubtful accounts) as an expense on the income statement. Within the accounting period this bad expense is recorded as a Credit to Allowance for Doubtful accounts account (contra asset account), and as a Debit to the Bad Debt Expense account.
So, simplifying a lot:
Gross Profit = Revenue - Bad Debt Expense, where
Revenue = Cash sales + Ending balance of Accounts Receivalbes
Ending balance of Accounts Receivalbes = Beginning balance of Accounts Receivalbes + Non-cash sales - Write-offs (which are net of recoveries)
Therefore, if a company included Bad Debt Expense in the Income Statement, it should mean that the company did not collect this amount in cash, nor it thinks it will collect it.
So, why, when we compute cash collections, we take the gross Accounts Receivable amount, and not the net one, which is minus Allowance for Doubtful Accounts, or why we at least don’t subtract the Bad Debt expense? Please, see example below for more details about my question.
Cash collections = Gross Accounts Receivable Beginning balance + Revenue - Write-offs - Ending balance
Example:
Accounts Receivable Beginning balance, net of Allowance of 220 = 7,826
Accounts Receivable Ending balance, net of Allowance of 1021 = 12,930
Provision for doubtful accounts in the income statement = 1,558
Revenue = 149,270
(1) Find write-offs:
Beginning balance of Allowance for DA + Provision for DA - Ending balance of Allowance for DA =
= 220 + 1,558 - 1021 = 757
(2) Cash collections (formula above) = Gross Accounts Receivable Beginning balance + Revenue - Write-offs - Ending balance =
= 8,046 + 149,270 - 757 - 13,951 = 142,608
It means that the company collected 142,608, but this amount completely** ignores the Bad Debt expense **reported on the income statement. Shouldn’t this cash amount be reduced by Provision for doubtful accounts in the income statement, namely 142,608 - 1,558?
Thank you very much!
