 Definition

 Credit Policy
 Credit Standard
 Credit Terms
 Example: Credit Terms
 Collection Policy
 Past Semesters Questions Related To
This Topic.
Account Receivable
 Is a debtor’s account: the balance due from customers when goods are
sold on credit.
 Account receivable increases when:
- More sales are made on credit
- The Average Collection Period is longer
- Lenient credit and collection policies
- Nature of business such as supermarket sell on cash or manufacturer
sells on credit.
Objective of Account Receivable Management
I. As a sales strategy – To increase the company’s sales and market
share.
II. To establish a long-term relationship with the customer – To crease
customer’s loyalty.
III. To generate higher profit – Normally credit sales generate higher
profit margin.
 Credit policy is a system for managing accounts receivable that
includes credit standards, credit terms and collection policy.
 The selling process providing services to customers and increment in
sales are part of the factors that must be taken into consideration
when setting up the credit policy.
 Therefore, the firm must conduct proper cost-benefit analysis in
ensuring the success of the credit policy, regardless whether giving
credits to customers worthwhile or not.
 Factor that need to be considered in formulating credit policy:-
I. Credit Standard
II. Credit Term
III. Collection Period
 Credit policy is a system for managing accounts receivable that
includes credit standards, credit terms and collection policy.
 The selling process providing services to customers and increment in
sales are part of the factors that must be taken into consideration
when setting up the credit policy.
 Therefore, the firm must conduct proper cost-benefit analysis in
ensuring the success of the credit policy, regardless whether giving
credits to customers worthwhile or not.
 Factor that need to be considered in formulating credit policy:-
I. Credit Standard
II. Credit Term
III. Collection Period
 It is the minimum financial strength and moral standard of
acceptable credit customers.
 It represents the acceptable credit risk that the firm is willing to
absorb. The credit risk involved the determinations of the willingness
to pay and ability to pay of the applicants.
 The credit risk of customers, willingness and ability to pay can be
evaluated by using the five C’s below:
a) Character
b) Capacity
c) Capital
d) Collateral
e) Conditions
Purpose: To assess the creditworthiness of a client and help to reduce
default risk.

a) Character
- Willingness to pay that is the probability that customers will try to
make an honest effort to honor their obligations.
- The factor can be based on business and social reputations, past
payment records, and other that may affect the moral judgement.

b) Capacity
- It is a judgment of the customer’s ability to pay.
- It refers to the management ability to effectively manage the firm to
generate revenue and the availability of financial resources to pay.
c) Capital
- It is a measure of ability to pay by looking at the general financial
position of a firm.
- The focus is on working capital of the firm as it is directly available
for payments of obligation.

d) Collateral
- It represents tangible or intangible assets offered to creditors as
security to obtain credit facilities.
- The assets must have value, liquid and transferable to be accepted as
collateral.

e) Conditions
- It refers to the impact of general trends or other specific conditions in
the market lace that may affect a customer’s business operations and
the ability to meet the obligations.
 It is the conditions under which the credit facilities are granted such
as cash discounts for early payments, discount period, credit period
and financial charges for the late payments.
 The opportunity cost must be high, interesting enough to motive a
financially strong credit customers to accept the discounts offered.
 The most common terms are:
1) Open terms : A credit granted normally involves 10-days period to
allow customers to send in payment after receipt of invoice.
2) Cash before delivery (CBD) : A firm must receive cash before
deliveries can be made. No risk involved, as no credit is granted.
3) Cash in advance (CIA) : similar to CBD
4) Cash with order (CWO) : similar to CBD
5) Cash on delivery (COD) : Customer will pay for shipment or goods
when it is received. Some risk involves as customer may refuse to
accepts the shipments or give bad checks.
6) Net 30 : Payment in full is due full within 30 days after date of
shipment.
7) Net 10 EOM : EOM stands for end of month. A payment in full is due
before the tenth day of the month following shipment or before the
tenth day at the end of the month
8) 2/10 net 30 : Means the customer has to pay within 30 days, but 2%
discount is given if the payment is made within 10 days.
9) 2/10 prox, net 30 : A 2% discount is earned if payment is made by
the 10th of the month following shipment. The full, undiscounted
amount is due by the 30th of the month following shipment.
10)2/10 EOM, net 40 : Means the client has to pay within 40 days, but
2% is given if the payment is made at end of 10 days.
11)2/10 ROI, net 40 : If invoice is paid within 40 days of receipt of
invoice, a 2% discount is permitted. Thus, cash discount is offered to
induce prompt payment from credit customers.
Trade credit term at 2/10 net 30

a = 2%, b = 10, c = 30

Formula :-
Annualized opportunity cost = a% x 360 x 100%
of forgoing discount 1 − a% c−b

= 0.02 x 360 x 100%

( 1−0.02) (30−10)

= 36.73%
 Effective collection procedures are needed in order the firm to be
able to convert its receivable to cash in time.
 Collection policy provide guidelines on what actions should be taken
if established credit terms are violated or when accounts are
overdue.
 The actions in trying to solve problem accounts involve three stages:
a) Reminder
- First stage of the process that is to remind a customer that the
account is overdue without payment by sending duplicate invoice or
statement with reminder phrases or stickers, brief, courteous letter,
printed card and aging schedule for the account with reminder notes.
b) Follow Up
- If the reminder notes fail and may last several months.
- Actions such as sending successive follow up letters with increasing
firmness, telegram, telephone and most effective method personal
visits.

c) Drastic Action
- Last unfriendly stage that includes drawing a draft on a customer,
collection by attorney or agency.
- Risk because a firm may lose these customers and increasing future
sales.
1. June 2019, Part B (Question 4b)
Briefly explain the criteria used to measure on the applicants’ capital
and collateral in the credit application process.
(5 marks)
2. December 2018, Part B (Question 5b)
State the five (5) elements of 5C’s in the account receivable
management.
(5 marks)
3. June 2018, Part B (Question 1b)
Identify the three (3) stages in collection policy.
(3 marks)
5. January 2018, Part B (Question 4b)
Explain any two (2) elements of 5C’s in the account receivable
management.
(6 marks)

6. March 2017, Part B (Question 4b)

Collection policy provides guidelines for appropriate actions to be
taken when established credit terms are violated, or when accounts
are overdue. Briefly explain the three (3) stages involved in the
collection activities that contribute to efficiency in managing
receivables.
(6marks)