Receivables Management

Accounts receivables (also properly termed as

receivables) constitute a significant portion of the
total currents assets of the business next after
inventories. They are a direct consequences of “trade
credit” which has become an essential marketing
tool in modern business.
When a firm sells goods for cash, payments are received
immediately and, therefore, no receivables are credited.
However, when a firm sells goods or services on credit, the
payments are postponed to future dates and receivables are
created. Usually, the credit sales are made on open account,
which means that, no, formal acknowledgements of debt
obligations are taken from the buyers. The only documents
evidencing the same are a purchase order, shipping invoice or
even a billing statement. The policy of open account sales
facilities business transactions and reduces to a great extent
the paper work required in connection with credit sales.
 Meaning of receivables
• Receivables are assets accounts representing amounts owed to the
firm as a result of sale of goods / services in the ordinary course of
business.
• They, therefore, represent the claims of a firm against its customers
and are carried to the “assets side” of the balance sheet under titles
such as accounts receivables, customer receivables or book debts.
They are, as stated earlier, the result of extension of credit facility to
then customers a reasonable period of time in which they can pay for
the goods purchased by them.
• Accounts receivables are created because of credited sales. Hence the
purpose of receivables is directly connected with the objectives of
making credited sales.

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 MEANING & OBJECTIVES OF
RECEIVABLE MANAGEMENT
• Receivables management is the process of making decision relating to
investment in trade debtors.
• The objective of receivables management is to take a sound decision as regards
investment in debtors.
– Convert premium to cash as quickly and efficiently as possible
– Ensure an uninterrupted flow of services to your customers

“The objective of receivable management is to take a sound decision to

promote sales & profits until that point is reached where the return on
investment is to receivables is less than the cost of funds raised to finance
that additional credit”.

BOLTON
Benefits of Effective
Collections
– Increased investment income
from enhanced cash flow
– Higher underwriting capacity
from lower non-admitted
assets
– Reduced revenue
leakage/concessions on
disputed retro adjusted, loss
sensitive, etc. premium
– Increased subrogation and
reinsurance recovery
– Lower cost of collection
function
– Lower bad debt expense
Strategy – the Three Levels
• Corporate strategy for
receivables
– Financing customers as competitive
advantage
– Maximize cash flow
– Minimize bad debt
– Least cost to manage
– Undefined
• A Shared Corporate Vision for
Receivables
– Payment expected on due date
– Disputes are customer satisfaction
issues first
– Vision shared by C level management
• Portfolio Strategy
– Different approach for different
customer categories, just like the
Marketing segmentation approach
• Agents and Brokers vs. Direct
• Commercial vs. Personal
• Workers’ Compensation
• Major account vs. small account
• Government vs. private sector
• Credit risk rating
 DIMENSIONS OF RECEIVABLES
MANAGEMENT

3. FORMULATING
1. FORMING OF 2. EXECUTING THE & EXECUTING
CREDIT POLICY CREDIT POLICY COLLECTION
POLICY
• 1. QUALITY OF TRADE • A. COLLECTING CREDIT • STRICT COLLECTION
ACCOUNT OR CREDIT INFORMATION POLICY
STANDARD • CEDIT ANALYSIS • LENIENT COLLECTION
• 2. LENGTH OF CREDIT • CREDIT DECISION POLICY
PERIOD • FINANCING
• CASH DISCOUNT INVESTMENTS IN
• DISCOUNT PERIOD RECEVABLES &
FACTORING
 The objectives of credited sales are as
follows:
• Achieving growth in sales: If a firm sells goods on credit, it will
generally be in a position to sell more goods than if it insisted on
immediate cash payments. This is because many customers are either
not prepared or not in a position to pay cash when they purchase the
goods. The firm can sell goods to such customers, in case it resorts to
credit sales.
• Increasing profits: Increase in sales results in higher profits for the firm
not only because of increase in the volume of sales but also because of
the firm charging a higher margin of profit on credit sales as compared
to cash sales.

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• Meeting competition: A firm may have to resort to
granting of credit facilities to its customers because of
similar facilities being granted by the competing firms to
avoid the loss of sales from customers who would buy
elsewhere if they did not receive the expected output.
• The overall objective of committing funds to accounts
receivables is to generate a large flow of operating
revenue and hence profit than what would be achieved
in the absence of no such commitment.

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 Costs of maintaining receivables

The costs with respect to maintenance of receivables can be

identified as follows:
• Capital costs: Maintenance of accounts receivables results in blocking of
the firm’s financial resources in them. This is because there is a time lag
between the sale of goods to customers and the payments by them. The
firm has, therefore, to arrange for additional funds top meet its own
obligations, such as payment to employees, suppliers of raw materials,
etc., while awaiting for payments from its customers.
• Additional funds may either be raised from outside or out of profits
retained in the business. In both the cases, the firm incurs a cost. In the
former case, the firm has to pay interest to the outsider while in the latter
case, there is an opportunity cost to the firm, i.e., the money which the
firm could have earned otherwise by investing the funds elsewhere.

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• Administrative costs: The firm has to incur additional
administrative costs for maintaining accounts
receivable in the form of salaries to the staff kept for
maintaining accounting records relating to
customers, cost of conducting investigation regarding
potential credit customers to determine their
creditworthiness, etc.
• Collection costs: The firm has to incur costs for
collecting the payments from its credit customers.
Sometimes, additional steps may have to be taken to
recover money from defaulting customers.
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• Defaulting costs: Sometimes after making all
serious efforts to collect money from
defaulting customers, the firm may not be
able to recover the overdues because of the of
the inability of the customers. Such debts are
treated as bad debts and have to be written
off since they cannot be realized

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 Factors influencing the size of
Receivables.
• Size of credit sales.
• Credit policies.
• Terms of trade.
• Expansion plans.
• Relation with profits.
• Credit collection efforts.
• Habits of customers.
 Factors affecting the size of receivables

• The size of the receivable is determined by a number of factors. Some

of the important factors are as follows:

1. Level of sales:
• This is the most important factor in determining the size of accounts
receivable. Generally in the same industry, a firm having a large
volume of sales will be having a larger level of receivables as compared
to a firm with a small volume of sales.
• Sales level can also be used for forecasting change in accounts
receivable.

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 2. Credited policies:
• The term credit policy refers to those decision variables that influence
the amount of trade credit, i.e., the investment in receivables. These
variables include the quantity of trade accounts to be accepted, the
length of the credit period to be extended, the cash discount to be
given and any special terms to be offered depending upon particular
circumstances of the firm and the customer.
• A firm’s credit policy, as a matter of fact, determines the amount of risk
the firm is willing to undertake in its sales activities. If a firm has a
lenient or a relatively liberal credit policy, it will experience a higher
level of receivables as compared to a firm with a more rigid or
stringent credit policy.

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This is because of two reasons:
• A lenient credit policy encourages even the financially
strong customers to make delays in payments resulting in
increasing the size of the accounts receivables;
• Lenient credit policy will result in greater defaults in
payments by financially weak customers thus resulting in
increasing the size of receivables.

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 Changing Credit Standards

• Increase in sales and profits (if positive

Credit standards contribution margin), but higher costs
relaxed from additional A/R and additional bad
debt expense

Credit standards • Reduced investment in A/R and lower

tightened bad debt, but lower sales and profit

17
 Accounts Receivable Management:
Changing Credit Standards
• The firm sometimes will contemplate changing its
credit standards to improve its returns and generate
greater value for its owners.

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 Changing Credit Standards Example

Dodd Tool, a manufacturer of lathe tools, is currently selling a product

for $10/unit. Sales (all on credit) for last year were 60,000 units. The
variable cost per unit is $6. The firm’s total fixed costs are $120,000.

Dodd is currently contemplating a relaxation of credit standards that is

anticipated to increase sales 5% to 63,000 units. It is also anticipated
that the ACP will increase from 30 to 45 days, and that bad debt
expenses will increase from 1% of sales to 2% of sales. The
opportunity cost of tying funds up in receivables is 15%.

Given this information, should Dodd relax its credit standards?

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 Changing Credit
Standards Example (cont.)
Dodd Tool Company
Analysis of Relaxing Credit Standards
Relevant Data
Present Sales Level (units) 60,000
Proposed Sales Level (units) 63,000
Price/unit ($) $ 10.00
Variable Cost/unit ($) $ 6.00
Contributin Margin/unit ($) $ 4.00
Old Receivables Level (days) 30.0

New Receivables Level (days) 45.0

Present A/R Turnover (365/AR) 12.2
Proposed A/R Turnover (365/AR) 8.1
Present Bad Debt Level (% of sales) 1.0%
Proposed Bad Debt Level (% of sales) 2.0%
Opportunity Cost (%) 15.0%
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 Changing Credit
Standards Example (cont.)
• Additional Profit Contribution from Sales

Dodd Tool Company

Analysis of Rexaxing Credit Standards
Additional Profit Contribution from Sales
Old Sales Level 60,000 Price/Unit $ 10.00
New Sales Level 63,000 Variable Cost/Unit $ 6.00
Increase in Sales 3,000 Contribution Margin/Unit $ 4.00
Additional Profit Contribution from Sales (sales incr x cont margin) $ 12,000

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 Changing Credit
Standards Example (cont.)
Dodd Tool Company
Analysis of Rexaxing Credit Standards
Cost of Marginal Investment in Accounts Receivable
Cost of Marginal Investment in A/R = Total VC/Turnover of A/R
Total VC = VC/Unit X # of Units
Total VC Under the Present Plan $ 360,000
Total VC Under the Proposed Plan $ 378,000
Average Investment Under Present Plan $ 29,508
Average Investment Under Proposed Plan $ 46,667
Marginal Investment in Accounts Receivable $ 17,158
Opportunity Cost 15.0%
Cost of Marginal Investment in Accounts Receivable $ 2,574
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 Changing Credit
Standards Example (cont.)
Dodd Tool Company
Analysis of Relaxing Credit Standards
Cost of Marginal Bad Debt
Cost of Bad Debt = Bad Debt % x Total Sales
Total Sales under Present Plan $ 600,000
Total Sales under Proposed Plan $ 630,000
Bad Debt % under Present Plan 1.0%
Bad Debt % under Proposed Plan 2.0%

Cost of Bad Debt under Present Plan $ 6,000

Cost of Bad Debt under Proposed Plan $ 12,600
Cost of Marginal Bad Debts $ 6,600
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 Changing Credit
Standards Example (cont.)

Dodd Tool Company

Analysis of Relaxing Credit Standards
Making the Credit Standard Decision
Additional Profit Contribution from Sales $ 12,000
Cost of Marginal Investment in Accounts Receivable (2,574)
Cost of Marginal Bad Debts (6,600)
Net Profit From Implementation of Proposed Plan $ 2,826

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 3. Terms of trade:
The size of the receivables is also affected by terms of
trade (or credit terms) offered by the firm.
The two important components of the credit terms are:
• Credit period: The term credit period refers to the
time duration for which credit is extended to the
customers.
• Cash discount: Most firms offer cash discount to
their customers for encouraging them to pay their
dues before the expiry of the credit period.

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 Changing Credit Terms Example
MAX Company has an average collection period of 40
days (turnover = 365/40 = 9.1). In accordance with the
firm’s credit terms of net 30, this period is divided into 32
days until the customers place their payments in the mail
(not everyone pays within 30 days) and 8 days to receive,
process, and collect payments once they are mailed.

MAX is considering initiating a cash discount by changing

its credit terms from net 30 to 2/10 net 30. The firm
expects this change to reduce the amount of time until the
payments are placed in the mail, resulting in an average
collection period of 25 days (turnover = 365/25 = 14.6).
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 Changing Credit
Terms Example (cont.)

Insert Table 14.3 here

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 • Terms of sale for customers
– Net 30: Payment in full due in 30 days
– Cash discounts
• Example: 2/10 net 30
– 2% discount if payment made within 10-day cash discount
period
– Otherwise, full payment due within 30-day credit period

28
 Credit Monitoring:
Collection Policy
• The firm’s collection policy is its procedures
for collecting a firm’s accounts receivable
when they are due.
• At a minimum, the company should generally
suspend further sales to the customer until
the delinquent account is brought current.
• The effectiveness of this policy can be partly
evaluated by evaluating at the level of bad
expenses.
• As seen in the previous examples, this level
depends not only on collection policy but also
on the firm’s credit policy.
13-29
 Collection Policy

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 Collection Policy
• Reminders, form letters, telephone calls, or
personal visits may initiate customer payment.
• At a minimum, the company should generally
suspend further sales to the customer until
the delinquent account is brought current.
 Credit Monitoring
• The ongoing review of a firm’s accounts
Credit receivable to determine if customers are
monitoring paying according to stated credit terms

Techniques • Average collection period

for credit • Aging of accounts receivable
monitoring • Payment pattern monitoring

Average collection period: The average number of days

credit sales are outstanding
Accounts receivable
Average collection period 
Average sales per day

Aging of accounts receivable: Schedule that indicates the

portions of total A/R balance outstanding
32
 Credit Monitoring

Payment pattern: The normal timing within which a firm’s

customers pay their accounts

• Percentage of monthly sales collected the following

month
• Should be constant over time; if payment pattern
changes, the firm should review its credit policies.

33
• A companion ratio is the Average Collection Period:
 Credit Monitoring:
Aging of Accounts Receivable

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 Account Receivable Monitoring
and Control
• Monitoring and control is the responsibility of the
credit manager.
• Receivables turnover
least favored technique
• Monitoring conducted on individual accounts through
aging schedules.
• Monitoring conducted at the aggregate level using
days’ sales outstanding (DSO).
 the principles of granting credit include
analysis of 5 Character of Credit,7 P
• Capacity
-Measures a borrower’s ability to reply a
loan by comparing income against
recurring debts
- Can the borrower generate adequate
cash to reply the loan?
. Capital
- Refers to the net worth, or equity, of a
business
 - is the borrower adequately capitalized
within industry standards to withstand
unexpected loss
. Conditions
- The economic, industry, and market
environment can and will change: the state
of the borrower or the state of the
economy
. Collateral
- Helps secure the debt
- Is there an alternative source of
repayment in case the primary source
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• Character
- Personal integrity of business owners and
officers
-Is management willing to repay the loan
and will it attempt to do so under adverse
conditions?

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 7 Principles of Credit
• Principle of productive purpose
• Principle of Personality,
• Principle of Productivity,
• Principle of Phased disbursement,
• Principle of Proper utilization,
• Principle of repayment, and
• Principle of protection

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 Accounts Receivable Management:
Credit Scoring
• Credit scoring is a procedure resulting in a score that
measures an applicant’s overall credit strength,
derived as a weighted-average of scores of various
credit characteristics.
• The procedure results in a score that measures the
applicant’s overall credit strength, and the score is
used to make the accept/reject decision for granting
the applicant credit.

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 Credit Scoring

Uses statistically-derived weights for key credit

characteristics to predict whether a credit applicant will pay
the requested credit in a timely fashion.

– Used with high volume/small dollar credit requests

– Most commonly used by large credit card operations, such as banks, oil
companies, and department stores

42
 Accounts Receivable Management:
Credit Scoring (cont.)
• The purpose of credit scoring is to make a
relatively informed credit decision quickly and
inexpensively.
• For a demonstration of credit scoring,
including the use of a spreadsheet for that
purpose, see the book’s Web site at
www.aw.com/gitman.

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 FACTORING & RECEIVABLES
MANAGEMENT
• For the investment in receivables, a firm has to
incur certain costs such as cost of financing, cost
of collection, cost of bad debts etc.,
• To save these costs specifically large concerns
hires the factor services.
• A factor is a financial institution which offers
services relating to management & financing of
debts arising out of credit sales. In this factor
purchases receivables from the firm, control &
administers the receivables on the behalf of the
firm.
 MECHANISM OF FACTORING
 An agreement is entered in to between the
selling firm & the factor firm
The sales documents should contain the
instructions to make payments directly to
factor.
When the payments received by the factors,
the account of the selling firm is credited by
the factor after deducting their fees &
expenses.

Functions of a factor
 Bill discounting facility
 Administration of credit sales
 Maintance of sales ledger
 Collections of account
receivables
 Credit control
 Protection from bad debts
 Provision of finance
 Rendering advisory services
Benefits of a factor
• Definite pattern of cash inflow
• Source of short term finance
• Better management of
receivables
• Transfer of non payments risk
• Selling firm can concentrate on
other matters
• Saves the basics costs related
to collection
• Benefited by advisory services
given by factor
 Example

Keterangan 2007 2008

Net Credit Sales 200.000.000 300.000.000
Reciavable :
Awal tahun 35.000.000 50.000.000
Akhir tahun 45.000.000 50.000.000
Average Reciavables 40.000.000 50.000.000

Reciavables Turnover ? ?
Average Collection Period ? ?
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