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WHAT IS RECEIVABLES?
Receivables is defined as the debt owed to the firm by customers arising from
Sales of goods and services in the ordinary course of business. When a firm makes an ordinary sale of goods or services and does not receive payment ,the firm grants trade credits and creates accounts receivable which could be collected in future. Receivables Management is also called Trade Credit Management.
WHY DO WE NEED RECEIVABLES?
Reach Sales potential Compete with Competitors
Optimize the return on investments on the assets
As a part of Operating Cycle
A time lag between sales and receivables creates need for Working Capital
Cash Receivables Operating Cycle Inventory .
Maintaining up-to-date records. . Evaluation of customers and setting credit limits. Initiate collection procedures on overdue accounts. Meeting Competition. Establish and communicate the credit policies. Ensure prompt and accurate billing.OBJECTIVES Achieving growth in sales and profit.
COLLECTION COSTS: Administrative costs incurred in collecting the accounts receivable. Costs of additional steps to increase the chances for eventful payment. and cost of additional steps to collect over-due debtors. .COSTS OF MAINTAINING DEBTORS CAPITAL COST: It is the cost on the use of additional capital to support credit sales which alternatively could have been employed elsewhere. DEFAULT COSTS: Amounts which are to be written off as Baddebts. which cannot be collected in spite of serious efforts. DELINQUENCY COSTS: Cost of financing the debtors for extended period.
CREDIT POLICIES It is the determination of credit statandard and credit analysis.The credit policy of a firm provides the framework to determine whether or not to extend credit to a customer and how much credit to extend. A)CREDIT STANDARD-It is the minimum requirement for extending credit to a customer.The credit policy decision of a firm has two dimensions. information . B)CREDIT ANALYSIS-This involves obtaining credit and evolution of credit applicant.
SALES VOLUME-Sales volume is expected to increase as standards are relaxed. AVERAGE COLLECTION PERIOD-The extension of trade credit to slow paying customers would results in a higher level of accounts receivable and vice versa.conversely tightening decreases sales. .a large credit departments to service accounts receivable and increase in collection cost while opposite in case of strict credit standards.CREDIT STANDARDS Following factors should be considered while deciding whether to relax credit credit standards or not. BAD DEBT EXPENSES-Bad debt can be expected to increase with relaxation in credit standards and vice versa. COLLECTION COST-The implications of relaxed credit standards are more credit.
EFFECT OF RELAXATION OF STANDARDS ITEM DIRECTION OF CHANGE(Increase=1 Decrease =D) Sales Volume EFFECT ON PROFITS (Positive+ Negative -) 1(D) 1(D) +(-) Average Collection period -(+) Bad Debts 1(D) -(+) .
or may be external such as : I)FINANCIAL STATEMENTS-The published financial statements such as balance sheet and profit and loss account. . A)OBTAINING CREDIT INFORMATION-The first step in credit analysis is obtaining the information which form the basis for the evaluation of customers. IV)CREDIT BUREAU REPORTS-Credit Bureau reports from organization which specializes in supplying credit information can also be utilized. II)BANK REFERENCES-The firm’s banker collects the necessary information from the applicant’s Bank.CREDIT ANALYSIS Two basic steps are involved in the credit investigation Process. III)TRADE REFERENCES-Reputed Credit organization are approached about the credit worthiness of proposed customers.The sources of information may be internal such as the historical payment pattern of a customers.
II)QUALITATIVE-The qualitative judgement would cover aspects relating to the quality of management. .the past records of the firm’s and so on.CREDIT ANALYSIS(CONTD) B)ANALYSIS OF CREDIT INFORMATION-The information collected from different sources are analyzed to determine the credit worthiness of the applicant. .The analysis should cover two aspects: I)QUANTITATIVE-The quantitative aspects is based on the factual information available from the financial statements.
STEPS IN CREDIT ANALYSIS “Investing The Customers” Customers Evaluation-The 5 C’s- CHARACTER. Track Record CAPACITY.Economic conditions & competitive factors that may affect the profitability of the customers .Financial Position of the co. COLLATERAL.Reputation.The type and kind of assets pledged CONDITIONS.Ability to repay( earning capacity) CAPITAL.
COLLECTION POLICY:Collection policy of a firm also has some influences on the actual Debtors balance.FACTORS AFFECTING SIZE OF DEBTORS LEVEL OF SALES: The most important factors in determining the volume of Debtors is the level of credit sales. CREDIT TERMS: A change in credit terms will have a direct effects on Debtors.more credit sales mean more Debtors and vice versa.Due to a relatively lax collection policy.When credit terms are relaxed in leads to a n increase in Debtors balance and vice versa. Others being constant . .customers do not meet their commitments on time.
It has three components: CREDIT PERIODS-It is the time for which trade credit is extended to customers in the case of credit sales. CASH DISCOUNTS PERIOD-The duration of the period during which discount can be availed off. .CREDIT TERMS Credit terms specify the repayments terms required of credit customers. CASH DISCOUNTS-It is the incentive to customers to make early payments of sum due.
EFFECT OF INCREASE IN CASH DISCOUNT ITEM DIRECTION OF CHANGE(I=Increase D= Decrease) EFFECT ON PROFITS (Positive +or Negative-) Sales volume Average collection period I D + + Bad debt expenses Profit per unit D D + - .
TYPE OF COLLECTION EFFORTS Steps usually taken are Letters. including reminders Telephone call for personal contact Personal visit Help of collection agencies Legal action .
BENEFITS INCREASED SALES-The impact of liberal trade policy result in increased in sales volume. . ENHANCE PRODUCTIVITY-The decrease in administrative cost enhances productivity. HELPS IMPROVE CUSTOMER SATISFACTIONEnhances service level and increase retention with customized information. STREAMLINE REVENUE ALLOCATION-To fit business needs calculations are managed.
Option 2 xx Rs. Sales Less: Variable Cost Contribution Less: Fixed Cost Profit [Benefits (A)] Total Cost= Variable Cost +Fixed Cost Average Investment in Receivables (Based on Total Costs) Costs of Extending Credit: 1) ____ % Opportunity Cost of Capital (Calculated on Avg. Option 1 xx Rs. Invst. in Receivables) 2) Bad debts as % of Sales 3) Credit Collection and Admin costs Total Costs [B] Net Benefits [A-B] xxxx xx xxx xx xxx xxx xxxx xx xxx xx xxx xxx xxxx xx xxx xx xxx xxx xxxx xx xxx xx xxx xxx xx xx xx xxxx xxx xx xx xx xxxx xxx xx xx xx xxxx xxx xx xx xx xxxx xxx Incremental Net Benefits --- xx xx xx . Option 3 xx Rs.PROFORMA Type A-if fixed Cost Is Given Credit Policy Credit Period (days/ weeks/months) Particulars Present Policy xx Rs.
xxxx xx xxx xxx Option 2 xx Rs. xxxx xx xxx xxx Net Benefits [A-B] Incremental Net Benefits xxx --- xxx xx xxx xx xxx xx .PROFORMA Type B. xxxx xx xxx xxx Option 3 xx Rs. in Receivables) 2) Bad debts as % of Sales 3) Credit Collection and Admin costs Total Costs [B] xx xx xx xxxx xx xx xx xxxx xx xx xx xxxx xx xx xx xxxx Present Policy xx Rs.fixed cost is not given Credit Policy Credit Period (days/ weeks/months) Particulars Sales Less: Variable Cost Contribution [Benefits (A)] Average Investment in Receivables (Based on Sales) Costs of Extending Credit: 1) ____ % Opportunity Cost of Capital (Calculated on Avg. Invst. xxxx xx xxx xxx Option 1 xx Rs.
CONCLUSION The framework of analysis of all decisions area in receivables management is to secure a trade-off between the costs and benefits off the measurable effects on the sales volume.collection costs. . capital costs due to change in investment in debtors . The firm should select the alternative which has potentials of more benefits than the costs. bad debts and so on.
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