FINANCIAL MANGEMENT 2024

STUDY UNIT 7

Prof MJ Botha
STUDY UNIT 7 -
MANAGEMENT OF ACCOUNTS RECEIVABLE
CHAPTER 10: PAGE 223 – 248
LEARNING OUTCOMES:
• Discuss a credit policy of a business (credit selection, credit
standards, credit limits, credit terms and collection policy);
• Evaluate the influence of changes in credit terms of
profitability; and
• Monitor and follow-up accounts receivable.
 INTRODUCTION
WHAT IS ACCOUNTS RECEIVABLE?
• Or in other words…. Debtors?
• People or other business’s who buy goods/services from your
business on credit! (buy now, pay later)

MANY QUESTIONS CAN RISE FROM ACCOUNTS RECEIVABLE

• What terms, to whom, methods for collection, etc.
• A business must manage their debtors well!!
ESTABLISHING A CREDIT POLICY….
In establishing a credit policy, decisions should be made
on the following:

Credit selection (page 224)

Credit standards (page 229)
Credit limits (page 230)
Credit terms (page 231)
Collection policy (page 236)
Follow up on accounts receivable (page 238)
 CREDIT SELECTION (choice of debtors)

WHETHER A FIRM GRANTS CREDIT or REJECTS CREDIT…

THINK OF THE INFLUENCE ON A FIRM IF A DEBTOR (CUSTOMER)…

• Pays promptly?
• Delays payment? Table 10.1 (page 225)
• Never pays?
 CREDIT SELECTION (process…)
The influence of providing credit on a firm could be detrimental!!

That is why the credit selection process is so important!!

THE CREDIT SELECTION PROCESS CONSISTS OF THREE ASPECTS:

1. Application form
2. Sources of information
3. Credit analysis
 CREDIT SELECTION (process…) 1. Application form
The APPLICATION FORM is the basis of the credit CONTRACT!
• And can be completed by an INDIVIDUAL or FIRM

MINIMUM INFORMATION…?
INDIVIDUAL: FIRM:
• Full name, ID, address, tel nr. • Registered & trading name
• Marital status • Particulars of auditors
• Employer • Registration number
• Bank particulars • Registered address
• Trade and personal references • Full particulars of the owners,
directors, shareholders or
members
 CREDIT SELECTION (process…) 2. Sources of info
The information on the APPLICATION FORM should be verified!!
• THE FOLLOWING SOURCES ARE AVAILABLE:

1. Trade references
2. Bank references
3. Trade sources and competitors
4. Credit agencies
5. Credit insurance
6. In-house opinion
7. Own records
8. Civil judgements
 CREDIT SELECTION (process…) 3. Credit analysis
The final step in the selection process is THE EVALUATION OF
APPLICANTS or CREDIT ANALYSIS!! – to determine
creditworthiness

The traditional approach organizes information gathered according to

FIVE dimensions – THE SO-CALLED FIVE C’s OF CREDIT
1. Capital – fin statements analysed (liquidity ratio’s)
2. Collateral – recoveries on assets sold on liquidation
3. Character – willingness of customer to pay (payment history)
4. Capacity – ability to pay on time
5. Conditions – economic and political environment
 CREDIT SELECTION (process…) 3. Credit analysis
The traditional approach is very FLEXIBLE…
THIS COULD RESULT IN THE FOLLOWING (4) PROBLEMS:

1. Provides no analytical framework

2. Not linked to the creation of owner’s wealth
3. It may produce inconsistent results
4. It is difficult to execute
 CREDIT SELECTION (process…) 3. Credit analysis
TO OVEROME THESE PROBLEMS FIRMS HAVE DEVELOPED TWO
VERSIONS OF EVALUATING CUSTOMERS:

1. CHECKLIST – involves asking a series of questions

2. WEIGHTED SCORING SYSTEM – weight assigned to the
importance of questions to determine a score.
 CREDIT STANDARDS
THIS REFERS TO THE MINIMUM REQUIREMENTS FOR GIVING
CREDIT TO A CUSTOMER!!

NB!! – The tightening or relaxing of a firm’s CREDIT STANDARDS

will have a DIRECT effect on:
1. Sales volume
2. Investment in accounts receivable
3. Bad debts costs

- Look at tables 10.4 and 10.5 (page 230)

 CREDIT LIMITS
THIS REFERS TO THE CREDIT LIMIT THAT IS PUT ON AN
CUSTOMERS ACCCOUNT – in order to LIMIT the RISK!

Two reasons for CREDIT LIMITS: (R5 000 vs R20 000)

1. Limited credit checks in proportion to the amount of credit
2. Credit checks may reveal some cause for concern
 CREDIT TERMS
THIS REFERS TO THE REPAYMENT TERMS OF DEBTORS:

CREDIT TERMS cover three parameters:

1. Credit period (30 days)
2. Settlement discount (2%)
3. Settlement discount period (10 days)

- This may be indicated as follows:

- 2/10 net 30 days
 CREDIT TERMS
CALCULATION – Cost of forfeiting discount:
CD 360

1 CD N N = 30 DAYS – 10 DAYS = 20 DAYS

CREDIT TERMS cover three parameters:

1. Credit period (30 days)
2. Settlement discount (2%)
3. Settlement discount period (10 days)

- This may be indicated as follows: = [0.02 / (1 – 0.02)] x (360 / 20)

- 2/10 net 30 days = 36.73%
 CREDIT TERMS (changing credit terms)
When a firms decides to INCREASE the % of settlement discount
offered in its credit terms, it could have the following effects:

• Sales may increase

• More customers may take advantage of the discount and
settle their accounts earlier
• Bad debt expenses may decline as accounts are settled earlier
• Net earnings per unit sold can decrease
 COLLECTION POLICY
This refers to the different procedures a firm uses to COLLECT the
MONEY from DEBTORS…

- Collection stars with the timeous mailing of invoices and

statements!!!!

• INVOICES – all info must be included (bank particulars, dates,

reflect discount, description of goods, etc.)
• STATEMENTS – reconcile accounts and query.
 FOLLOWING UP ON OUTSTANDING ACCOUNTS
Prompt follow-up is necessary to PREVENT LOSSES!! – HOW??

• Telephone calls
• SMS
• Letters
• Personal visits
• Debt collection agencies
• Legal action
 MONITORING (CONTROL) ACCOUNTS RECEIVABLE

• MONITORING PAYMENT PATTERNS

• Average collection period
• Table 10.7 and 10.8

• MONITORING BAD DEBTS

• Bad debt ratio
• Page 244
Thank you