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RECEIVABLES MANAGEMENT IN A PUBLIC LIMITED
COMPANY - A CASE STUDY
Abstract
No business can be successfully run without adequate amount of working capital which is
concerned with two factors namely, current assets to be held and the type of assets and the
methods by which these assets are financed. This occupies much of the finance managers’ time in
taking decisions. Investment in current assets represents a very significant portion of the total
investment in assets. The finance managers have to be very careful, while making any investment
decisions especially short term i.e. working capital. Empirical results show that ineffective
management of working capital is one of the important factors causing industrial sickness.
There is a direct relationship between a firm’s growth and its working capital needs. As
sales grow, the firm needs to invest more in inventories and debtors. The finance manager should
determine levels and composition of current assets, which will help to run the business smoothly.
Account receivables are one of the major components of working capital. Receivables are a direct
result of credit sales. The sale of goods on credit is an essential part of the modern competitive
economic system. The objective of credit sales is to promote sales and thereby achieving more
profits. At the same time, credit sales result in blockage of funds in accounts receivable.
Moreover, increase in receivables will increase the investments and also increases chances of bad
debts. Hence, if the receivables is managed effectively, monitored efficiently, planned properly
and reviewed periodically at regular intervals to remove bottle necks if any, the company cannot
earn maximum profits and increase its turnover. With this as the primary objective of the study,
the study made an effort to assess the receivables management. This study concludes that the
efficiency of the receivables management of this company was satisfactory.
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INTRODUCTION
The major objective of any organisation is to make profits regularly. The objectives can
be achieved by making sufficient sales. This is possible only when there is no disruption in the
supply of required goods. The required goods may be supplied to the market, only if there is no
disruption in the production of these goods by the organization. There will be no disruption in the
production of goods only if there is sufficient machinery through permanent capital and if the
firm has enough working capital. Thus working capital forms the basis to make an organisation
successful by achieving its objectives.
Working capital is the life blood and controlling nerve of a firm. No business can be
successfully run without adequate amount of working capital. In ordinary parlance working
capital is taken to be the fund available for meeting day to day requirements of an organisation.
Working capital management is concerned with two factors namely, current assets to be held and
the type of assets and the methods by which these assets are financed. This occupies much of the
finance managers’ time in taking decisions. Empirical observations show that the financial
managers have to spend much of their time on the daily internal operations, relating to current
assets of the firm. As the largest portion of the financial manager’s valuable time is devoted to
working capital problems, it is necessary to manage working capital in the best possible way to
get the maximum benefit (Pandey, 2005). Thus, Investment in current assets represents a very
significant portion of the total investment in assets. The finance managers have to be very careful,
while making any investment decisions especially short term i.e. working capital. Empirical
results show that ineffective management of working capital is one of the important factors
causing industrial sickness (Yadav, 1986).
There is a direct relationship between a firm’s growth and its working capital needs. As
sales grow, the firm needs to invest more in inventories and debtors. The finance manager should
determine levels and composition of current assets, namely, Inventory, Receivables, Cash, and
Marketable securities, which will help to run the business smoothly. Account receivables are one
of the major components of working capital. The receivables are a result of credit sales which
helps to increase the profits. At the same time, credit sales result in blockage of funds in accounts
receivable and an increased chance of bad debts. In order to minimise the bad debts, it needs
careful analysis and proper management. Evaluating the credit worthiness of the customer is one
among the key factor in proper credit management. A mismatch can cause significant errors in
receivables management. Therefore the finance manager should always be careful and adapt the
proper evaluation before extending the credit facility to their customers.
Previously, the finance manager assessed the customers’ character such as, financial
position, liquidity position, collateral security offered and general economic conditions in which
business operates. Whereas, now a days, trade reference, credit bureaus, bank reference, balance
sheet information and direct information by sales men are the major indicators. However,
whatever may be method; it may not be proved hundred per cent fault free. In spite of this
problem, in the modern world, selling goods on credit is the most prominent force of the today’s
business. The purposes of adopting this method are achieving growth in sales, increasing profits
and meeting competition which many research studies have proved. However, on the other hand,
the longer the period of credit, the greater level of debt, and greater the strain on the liquidity of
the company. Hence it is necessary to have receivables management in any organization and the
need for this study.
Current Ratio: The current ratio is a measure of the firm’s short-term solvency. Current
assets represent those assets which could be converted into cash within a period of one
year to take care of current liabilities. A norm of 2:1 ratio represents a healthy trend in the
organization. As can be clear from the above table, though the company’s current ratio is
increasing trend which was lower than the conventional norm. The solvency of the firm
was considered satisfactory and it shows that the firm is in a position to meet its current
liabilities in time. On an average this company’s current ratio is 1.31 and the SD is 0.15.
The CR position is tested using the following hypothesis:
H0 = there is no significance difference between the 5 years average current ratio to the
standard
Since the calculated value (1.923) is less than the table value (2.13). Hence, Null
hypothesis is accepted at 5 per cent level and hence concluded that the mean current ratio
does not differs significantly for the standard.
Quick Ratio (LR): Quick ratio establishes a relationship between quick, or liquid, assets
and current liabilities. An asset is liquid if it can be converted into cash immediately or
reasonably soon without a loss of value. Cash is the most liquid asset. Other assets,
which are considered to be relatively liquid and included in quick assets, are debtors and
bills receivables and marketable securities. A quick ratio of 1:1 is usually considered
adequate. In during the study period, this company maintained a satisfactory financial
position in this regard.
Working Capital Turnover Ratio (WTR): A firm may also like to relate net current
assets (or net working capital gap) to sales. It may thus compute net working capital
turnover by dividing sales by net working capital. It indicates the efficiency of the
company in utilising the working capital in business. High ratio denotes more efficient
use of working capital in the business and vice versa. From the table 1 indicates that the
ratio varies 9.16 to 24.55 and was fluctuating every year. On an average, this company’s
working capital turnover ratio was 16.104 which is less than the desired level. The
correlation coefficient of working capital and sales of this company was positive (0.714).
It implies that as the amount of working capital increases, the amount of sales also
increases which was tested with the help of the following hypothesis.
H0 = Correlation between working capital and sales of this company is not significant.
Since the calculated value (1.78) is less than the critical value (2.132), Null hypothesis is
accepted and hence concluded the correlation between the working capital and sales is
insignificant.
Credit Sales to Total Sales (CSTS): This ratio portrays the impact of credit system
followed by the organization in its total sales. It is safe for the organization, if it
maintains 50: 50 ratios as for as cash and credit sales are consider. A higher ratio of
credit sales is a result of improper credit management. Form the above table shows the
ratio between sales to credit sales. It is found that credit sales range from 75 percent to 85
percent. Latest, it was 85 percent which implies that the company increases the credit
sales and its affects liquidity.
In addition to mean and SD, an effort has also been made to measure the consistency
among all eight parameters of receivables management more precisely by applying the coefficient
of variation (CV). The variable for which the CV is greater that indicates the variables is to be
more fluctuating or conversely less consistent, less stable or less uniform. On the other hand, the
variable for which the CV is less that indicates the variables is to be is regarded as less
fluctuating, more consistent, more stable or more homogenous. Table 1 reveals that out of the
eight different parameters of receivables management of the sample company, the CSTS is most
consistent and stable followed by LR, CTR, APP, CR, WTR, ACP and DTR respectively.
Amongst the eight variables, DTR and ACP are the highest variable and inconsistent.
Here the financial position concept means only the short-term position of finance. The
company has a satisfactory financial position; Short-term financial position indicates the ability of
the company to pay off the current liability within a short-span of time. This company maintained
satisfactory level of current position and more than the optimum level throughout the five years.
Liquidity position is satisfactory and the current assets and liabilities have positive
correlation. The current ratio position of the company is tested and concluded that the
mean current ratio does not differ significantly from the standard.
On an average, this company’s working capital turnover ratio was 16.104 which is less
than the desired level. The correlation coefficient of working capital and sales of this
company was positive (0.714) which was tested and concluded the correlation between
the working capital and sales is not significant.
This company increases the credit sales every year. The company debtors’ level of
turnover is somewhat satisfactory. The correlation coefficient of debtors and sales was
positive, tested through the hypothesis and concluded that the correlation between debtors
and sales is significant.
On an average, the company was maintaining the credit period of 35 days; the collection
effort of this company was satisfactory.
As this business firm is a profit seeking one, it has to utilise all of its resources to achieve
this goal. This company is trying to enhance the value of its own and thereby that of its
shareholders. While searching for Profitability, the liquidity and solvency position are crucial
elements to be watched carefully. On the basis of the analysis and observation, an attempt is made
to offer some suggestions as below.
¾ The average collection period should be maintained the same level because the debtor’s
collection period is found to be satisfactory. At the same time, this company payable period is
found to be very high, this will affect the liquidity position positively and it may be call for
low fewer investments in receivables will arrives. So the company should maintain a
proportional changes in collection policies in order strengthen the collection department.
¾ There was decrease in trend in the net profit it is because of investment in all receivables
increased substantially. So the company should increase the sales level in order to achieve the
impressive profit.
CONCLUSION
It could be inferred from the above analysis that, the efficiency of the receivables
management of this company was satisfactory. The competition is a major challenge that every
finance manager encounters during their working capital decision making process for optimum
utilisation of scarce resources. To examine the effects of receivables management, it is important
to note the difference between liberalised credit period and the profitability. It is the change in the
investments in receivables level and costs involved in that creates crucial difference between
these two. Therefore, the finance manager should take into cognizance the effect of credit policy
to manage effectively, monitor efficiently, plan properly and review periodically to remove bottle
necks to reap maximum profits and increase its turnover.
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