Receivable Management

Prepared by
Priyanka Gohil
Meaning of Receivable

Amounts due from customers, when

goods are sold on credit, are called
trade debits or receivables.

When goods are sold on credit, finished

goods get converted into receivables.
PURPOSE OF RECEIVABLES

1. To increase total sales

2. To increase profits
3. To meet increasing competition
Operating cycle

ACCOUNTS
CASH
RECEIVABLES

FINISHED RAWMATERIAL
GOODS INVENTORY

WORK-IN-
PROCESS
Costs associated with maintaining receivables:

1. Capital cost
2. Administration cost
3. Delinquency cost
4. Bad- debts or default cost
Credit policy

The credit policy of a company can be regarded as a king of

trade-off between increased credit sales leading to increase in
profit and the cost of having larger amount of cash locked up
in the form of receivables and the loss due to the incidence of
bad debts.
The various variables associated with credit policy are:
1. Credit standards
2. Credit period
3. Cash discount
4. Collection program
1. Credit standards

The term credit standards refer to the criteria for

extending credit to customers. The basis for setting
credit standards are
a. Credit rating
b. References
c. Average payment period
∆P= ∆S(1-V)-K ∆I-bn ∆ S
Where,
∆P= Change in profit
∆S=Increase in sales
V=Variable costs to sales ratio
K=Cost of capital
∆ I=Increase in receivables investment
∆S * Average Collection Period (ACP)*V
360
bn = Bad debts loss ratio on new sales
I-V= Contribution to sales ratio
EX. The existing sales of Laxmi company are Rs. 2 crore. The
current customers are drawn from companies having ‘high’ or
‘good’ credit rating. With partially liberalized credit standards
the company’s sales are likely to go up by Rs. 24 lakh, the
mix of new customers being 67 percent and 33 percent from
the groups rated ‘fair’ and ‘limited’ respectively. The average
collection period is likely to be 45 days and the incidence of
bad debt losses 10 percent for the new customers. The
contribution to sales ratio for Laxmi company is 20 percent
and the cost of funds is 15 percent.
∆P= ∆S(1-V)-K ∆I-bn ∆ S
=24,00,000 * 0.2 - 0.15 * 24,00,000/360 * 45*
0.8 – 0.1* 24,00,000
= 4,80,000-36,000 -2,40,000
=2,04,000
2. Credit period

Credit period refers to the length of time

allowed to its customers by a firm to make
payment for the purchases made by customers
of the firm.
EX. Credit period of ‘net 20’.
∆P= ∆S(1-V)-K ∆I-bn ∆ S
Where,
∆I=(ACPN-ACPo)[So] + V (ACPN) ∆S
360 360
∆ I= Increase in investment
∆P= Change in profit
∆S=Increase in sales
V=Variable costs to sales ratio
I-V= Contribution to sales ratio
ACPN= New average credit period ( after increasing credit period)
ACPo= Old average credit period
EX. Radha company’s existing sales are Rs. 180 lakh. It is currently
extending a credit period of ‘net 30 days’ to its customers. The company’s
contribution to sales ratio is 20 percent and the cost of funds is 15 percent.
The company is contemplating to increase its sales by Rs.16 lakh to be
achieved by means of lengthening the existing period to ‘net 45 days’. The
bad debt losses on additional sales is expected to be 5 percent. Should the
company go in for a policy change or not?
∆P= ∆S(1-V)-K ∆I-bn ∆ S
∆I=(ACPN-ACPo)[So] + V (ACPN) ∆S
360 360

= (45-30) [180/360] + 0.8* 45* 16/360

= 7.5 +1.6
9.1 lakh
∆P= ∆S(1-V)-K ∆I-bn ∆ S
P= 16 (0.2)-0.15 * 9.1 – 0.05 * 16
=3.2 – 1.365 – 0.8
=1.035 lakh
3. Cash discount

Firms offer cash discounts to induce their customers

to make prompt payments.

EX. A cash discount of 2% if 2/10 net 20.

P= ∆S(1-V)+K ∆I- ∆DIS
Where,
∆S=Increase in sales
V=Variable costs to sales ratio
K=cost of capital
∆I=Savings in receivables management
So (ACP0-ACPN) - V ∆S ACPN
360 360
∆ DIS= Increase in discount cost
=Pn (S0+ ∆S)dn-PoSodo
Where,
Pn= Proportion of discount sales
after liberalizing
So= Sales before liberalizing
∆S=Increase in sales
Dn= New discount percentage
Po=Proportion of discount sales
before liberalizing
d0 = Old discount percentage
Rama company is presently having sales of Rs. 108 lakh. Its existing credit
terms are 1/10, net 45 days and the average collection period is 30 days.
Fifty percent of customers in terms of sales revenue are utilizing the cash
discount incentive. The contribution to sales ratio of the company is 20
percent and cost of funds 15 percent. In order to hasten the collection
process further as also to increase sales, if possible, the company is
contemplating liberalization of its existing credit terms to 2/10, net 45
days. It is expected that sales are likely to increase by Rs. 3 lakh and
average collection period to decline to 20 days. Eighty percent of
customers in terms of sales revenue are expected to avail themselves of the
cash discount under the liberalization scheme. Should the company
increase cash discount?
P= ∆S(1-V)+K ∆I- ∆DIS
∆I=Savings in receivables management
So (ACP0-ACPN) - V ∆S ACPN
360 360
= 108/360 (30-20) – 0.8 * 3/360 * 20
= 2,86,667
∆ DIS= Increase in discount cost
=Pn (S0+ ∆S)dn-PoSodo
=0.8* 111* 0.02-0.5* 108*0.01
= 1,23,600
P= ∆S(1-V)+K ∆I- ∆DIS
P= 3,00,000 (0.2) + 0.15 * 2,86,667 -1,23,60
= - 20,600
4. Collection programme

The success of a collection programme depends on the collection policy

pursued by the firm.
The collection programmes consists of the following.
1. Monitoring the receivables.
2. Reminding customers about due date of payment.
3. On line interaction through electronic media to customers about the
payments due around the due date.
4. Initiating legal action to recover the amount from overdue customers as
the last resort to recover the dues from defaulted customers.
∆P= ∆S(1-V) -∆BD-K ∆ I - ∆C
Increase in bad debts cost
∆BD= bn (So+ ∆S)-boSo
Increase in investment in receivables
∆ I= So (ACPN-ACPo)+ ∆S *ACPN*V
360 360
Where,
∆P=Change in profits
∆S= Increase in sales
V= Variable cost to sales ratio
K= cost of capital
∆C= Increase in collection expense
The present sales of PK Ltd. Are Rs. 108 lakh, the average collection
period 60 days, bad debt losses 6 percent of sales and collection
expenses Rs. 1 lakh. The company’s cost of funds is 15 percent. It is
contemplating to increase the collection effort through special
programs to reduce the amount of receivables and the incidence of
bad debt losses. Two separate programs called A and B are under
consideration. Program A is likely to reduce the average collection
period to 45 days, decrease bad debt losses to 4 percent of sales and
involve collection expenses of Rs. 3 lakh. Program B is envisaged to
reduce the average collection period of 30 days, decrease bad debt
losses to 3 percenst sales and involve collection expenses of Rs. 5
lakh. On the assumption that sales are not likely to get affected,
should the company go in for any programs under consideration?
Program A

∆P= ∆S(1-V) -∆BD-K ∆ I - ∆C

∆BD= bn (So+ ∆S)-boSo
= 0.04 * 108 – 0.06 * 108
= - 2.16 lakh
Increase in investment in receivables
∆ I= So (ACPN-ACPo)+ ∆S *ACPN*V
360 360
As there is no change in sales
= 108/360 * (45-60)
= - 4.5 lakh
∆C= Increase in collection expense
=3-1
= 2 lakh
∆P= ∆S(1-V) -∆BD-K ∆ I - ∆C
=0 – (-2.16)-0.15* (-4.5) -2
= 83,500
Program B

∆P= ∆S(1-V) -∆BD-K ∆ I - ∆C

∆BD= bn (So+ ∆S)-boSo
= 0.03*108- 0.06*108
= - 3.24 lakh
Increase in investment in receivables
∆ I= So (ACPN-ACPo)+ ∆S *ACPN*V
360 360
= 108/360 * (30-60)
= - 9 lakh
∆C= Increase in collection expense
=5–1
= 4 lakh
∆P= ∆S(1-V) -∆BD-K ∆ I - ∆C
= 0 –(- 3.24) – 0.15*(-9) * -4
59,000