Receivables Management
15-1
Objectives
The term receivables is defined as ‘debt owed to the firm by customers
arising from sale of goods or services in the ordinary course of
business’.
Receivables management is also called trade credit management.
Accounts Receivable represent an extension of credit to customers,
allowing them a reasonable period of time in which to pay for the
goods received.
15-2
Costs
Collection Cost is the administrative cost incurred in collecting
receivables.
Capital Cost is the cost on the use of additional capital to support
credit sales which alternatively could have been employed elsewhere.
Delinquency Cost is cost arising out of failure of customers to pay on
due date.
Default Cost are the over dues that cannot be recovered.
Another factor that has a bearing on accounts receivable management
is the benefit emanating from credit sales.
The benefits are the increased sales and anticipated profits because of
a more liberal policy.
15-3
Credit Policies
The credit policy of a firm provides the framework to determine
1) whether or not to extend credit to a customer and
2) how much credit to extend.
The credit policy decision of a firm has two broad dimensions:
1) Credit standards
2) Credit analysis.
15-4
Credit Standards
The term ‘credit standards’ represents the basic criteria
for the extension of credit to customers. The trade-off with
reference to credit standards covers
the collection cost,
cost of investment in accounts receivable,
level of bad debt losses, and
level of sales.
These factors should be considered while deciding whether
to relax credit standards or not
15-5
Credit Analysis
The second aspect of credit policies of a firm is credit
analysis and investigation.
Two basic steps are involved in the credit investigation
(a) obtaining credit information
(b) analysis of credit information.
Obtaining Credit Information
The sources of information, broadly speaking, are
(1) internal and (2) external.
15-6
Internal Sources
Get Forms filled from Customers and ask them to give
references
Internal records
15-7
External Sources of Information
1. Financial Statements
2. Bank References
3. Trade References
4. Credit Bureau Reports
15-8
Analysis of Credit Information
(1) Quantitative
Prepare an Aging Schedule of the accounts payable of the applicant
as well as calculate the average age of the accounts payable.
Ratio analysis of the liquidity, profitability and debt capacity of the
applicant. These ratios should be compared with the industry
average.
(2) Qualitative
The quantitative assessment should be supplemented by a
qualitative/subjective interpretation of the applicant’s
creditworthiness.
Here, the references from other suppliers, bank references and
specialist bureau reports would form the basis for the conclusions to
be drawn.
15-9
Credit Terms
The stipulations under which goods are sold on credit are
referred to as credit terms.
These relate to the repayment of the amount under the
credit sale.
15-10
Credit period, in terms of the duration of time for which trade credit is
extended–during this period the overdue amount must be paid by the
customer;
Cash discount, if any, which the customer can take advantage of, that is, the
overdue amount will be reduced by this amount; and
Cash discount period, which refers to the duration during which the discount
can be availed of. These terms are usually written in abbreviations, for
instance, ‘2/10 net 30’. The three numerals are explained below:
2 signifies the rate of cash discount (2 per cent), which will be available to the
customers if they pay the overdue within the stipulated time;
10 represents the time duration (10 days) within which a customer must pay to be
entitled to the discount;
30 means the maximum period for which credit is available and the amount must be
paid in any case before the expiry of 30 days.
15-11
Collection Policies
They refer to the procedures followed to collect accounts
receivable when, after the expiry of the credit period, they become
due. These policies cover two aspects:
1) degree of effort to collect the overdue,
2) type of collection efforts.
15-12
