Unit V

Receivable Management
 Content
• Objective of Receivable Management, Credit Policy: Nature
and Goals
• Credit Policy Variables: Credit Standards, Credit Analysis
• Credit Terms and Collection Policies and Procedures.
• Factoring: Definition, types & Mechanism.

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 Receivable Management - Introduction
• Receivables is defined as ‘debt owned to the firm by
customers arising from sale of goods or services in the
ordinary course of business’.

• Receivables management is also termed as trade credit

management.

• No formal obligations. Receivables and Trade credit also act

as a marketing tool.
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 Receivable Management – Introduction (cont.)
Cost associated with accounts receivables are:
i. Collection Costs (salary, accounting records, stationary,
postage)
ii. Capital Costs (additional capital to support credit sales)
iii. Delinquency Costs (cost arising out of failure of
customers to pay on due date)
iv. Default Costs (amount not recovered)

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 Receivable Management – Introduction (cont.)
Benefits:
i. Increased sales (because of liberal policy)
a) Existing customers
b) Attracting new customers
ii. Protect its current sales against emerging competition

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 Credit Policy
• Credit policy is the determination of credit standards and
credit analysis.

• Two things are involved:

The profits on addition sales that arises due to credit
The cost of carrying those debtors and bad debt losses (additional
funds, administrative costs, collection costs and default costs)

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 Credit Policy (cont.)
• Credit standards are the basic criteria for extending credit
to a customer.

a) Credit rating or credit worthiness

b) Credit reference
c) Average payment period

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 Credit Policy (cont.)
• Credit standards could be categorised as
a) Restrictive or tight
b) Non-restrictive or liberal

These will affect the following four factors:

a. Collection Cost (credit, receivables, collection costs)
b. Average collection period
c. Bad debt expenses
d. Sales volume
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 Credit Policy (cont.)
Question: A firm is currently selling a product Rs. 10 per unit.
The most recent annual sales (all credit) were 30,000 units.
The variable cost per unit is Rs 6. The total fixed cost is Rs.
60,000. The average collection period may be assumed to be
30 days. If the firm is relaxing the credit standard to 45 days
then the sales (in units) would have increases by 15%. The
additional net working capital required would be Rs. 10,000.
Should the firm relax the credit standard?

10-04-2019 Nikhil Kaushik, IMS Ghaziabad, PGDM Faculty 9

 Credit Policy (cont.)
Solution: Proposed Plan (based on profit)
Sales revenue
Less: Variable cost
Less: Fixed cost
Current Plan
Sales revenue
Less: Variable cost
Less: Fixed cost
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 Credit Policy (cont.)
Solution: Proposed Plan (based on profit)
Sales revenue (34,500 * 10) 3,45,000
Less: Variable cost (34,500 * 6) 2,07,000
Less: Fixed cost 60,000
Current Plan
Sales revenue (30,000 * 10) 3,00,000
Less: Variable cost (30,000 * 6) 1,80,000
Less: Fixed cost 60,000
10-04-2019 Nikhil Kaushik, IMS Ghaziabad, PGDM Faculty 11
 Credit Policy (cont.)
Solution: Proposed Plan (based on marginal investment)
Turnover of account receivables
Variable cost
Fixed cost
Average investment in account receivables
Current Plan
Turnover of account receivables
Variable cost
Fixed cost
Average investment in account receivables
10-04-2019 Nikhil Kaushik, IMS Ghaziabad, PGDM Faculty 12
 Credit Policy (cont.)
Solution: Proposed Plan (based on marginal investment)
Turnover of account receivables 360/45
Variable cost (34,500 * 6) 2,07,000
Fixed cost 60,000
Average investment in account receivables 2,67,000/8
Current Plan
Turnover of account receivables 360/30
Variable cost (30,000 * 6) 1,80,000
Fixed cost 60,000
Average investment in account receivables 2,40,000/12
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 Credit Policy (cont.)
Suppose a firm is contemplating an increase in the credit
period from 30 to 60 days. The average collection period will
increase from 45 days to 75 days. The bad debt expenses will
also increase from 1% to 3% of sales. Total credit sales are
expected to increase from 30,000 to 34500 units. The present
average cost per unit is Rs. 8, the variable cost per unit Rs. 6
(this cost is only applicable to increased unit in sales) and sales
per unit is Rs 10. Cost of additional investment is 15%.
Should the firm relax the credit standard?

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 Credit Policy (cont.)
• Credit Analysis involves obtaining credit information and
evaluation of credit applications.

• Obtaining credit information

a) Internal (Filled forms and documents)
b) External (Financial statements, bank reference, trade reference)

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 Credit Policy (cont.)
• Credit Analysis (cont.)

• Analysis of credit information

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 Credit Policy (cont.)
Credit Terms

• Credit Period
• Credit discount (Solve problem of Khan and Jain, Page 15.9)
• Credit discount period

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 Factoring
1

5 6
3

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 Factoring Numerical 1
Question: A firm has total credit sales of Rs. 80 lakh and its
average collection period is 80 days. The past experience
indicates that bad debt losses are around 1% of credit sales.
The firm spends Rs. 1,20,000 per year on administering its
credit sales. A factor is appointed to buy the firm’s receivables.
He will charge 2% commission. He will advance against
receivables to the firm at 18% after withholding 10% as
reserve. What is the cost of factoring? Should the firm avail
factoring service?
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 Factoring Numerical 1
Solution
𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 ∗𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑
a) Receivables
360
b) Reserve against receivables by factor
c) Factoring commission
d) Advance payable by the factor
e) Interest on advance by factor
f) Net amount of advance
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 Factoring Numerical 1
Solution (cont.)
g) Cost of Factoring
i. Sum of (c) and (e)
h) Net incremental cost
Annualized Cost of Factoring
Less: Savings in bad debts
Less: Administrative cost

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 Factoring Numerical 1
Solution
𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 ∗𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑
a) Receivables: (17,77,778)
360
b) Reserve against receivables by factor: 17,77,778*10%
c) Factoring commission: 17,77,778 * 2%
d) Advance payable by the factor: a–b–c
e) Interest on advance by factor: 15,64,444 * 18/100 * 80/360
f) Net amount of advance d–e
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 Factoring Numerical 1
Solution (cont.)
g) Cost of Factoring
i. Sum of (c) and (e) 98,134
h) Net incremental cost
Annualized Cost of Factoring 98,134 * 360/80
Less: Savings in bad debts 80,00,000 * 0.01
Less: Administrative cost 1,20,000

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 Factoring Numerical 2
Question: The turnover of ABC Ltd. is Rs. 100 lakh of which
72% is on credit. Debtors are allowed one month to clear off
the dues. A factoring company is willing to advance 80% of
the bills raised on credit for a fee of 1% a month plus a
commission of 5% on the total amount of debts. As a result
this will save Rs 48000 annually in management costs and
avoid bad debts at 1% on credit sales (monthly).
A bank has come forward to make an advance equal to 80% of
the debts at an annual interest rate of 15%. However, its
processing fee will be at 1% on the debts monthly. Would you
accept factoring or the offer from the bank?
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 Factoring Numerical 2
Solution:
Annual sales turnover: Rs 100 lakhs
Credit sales:
Debtors balance (one month credit):

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 Factoring Numerical 2
Solution:
Annual sales turnover: Rs 100 lakhs
Credit sales: Rs 100 * 72/100
Debtors balance (one month credit): Rs 72 * 1/12

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 Factoring Numerical 2
Solution (cont.): Factoring
Factoring commission
Factoring fee
Less: Management cost
Less: Bad Debts
Net cost of factoring

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 Factoring Numerical 2
Solution (cont.): Factoring
Factoring commission 6,00,000 * 5/100
Factoring fee 6,00,000 * 80/100 * 1/100
Less: Management cost 48,000/12
Less: Bad Debts 6,00,000 * 1/100
Net cost of factoring 24,800

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 Factoring Numerical 2
Solution (cont.): Bank
Interest
Processing fee
Less: Bad debts
Less: Management Cost
Net Cost

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 Factoring Numerical 2
Solution (cont.): Bank
Interest 6,00,000 * 80/100 *1/12 * 15/100
Processing fee 6,00,000 * 1/100
Less: Bad debts 6,00,000 * 1/100
Less: Management Cost 48,000 * 1/12
Net Cost 2,000

10-04-2019 Nikhil Kaushik, IMS Ghaziabad, PGDM Faculty 30