free e-book on credit managementbasiccollegeaccounting.com/wp-content/uploads/2008/09/... · 2012....

Free E-Book On Credit Management

____________________________________________________________________________

http://www.fmaccounting.com/ ()

Author of http://www.fmaccounting.com/

CONTENT GENERAL An overview of Its Importance And Characteristic Of A Well Run Credit Management Department. Costs In Extending Credit /Return on Investment on Account Receivables. ACCOUNTING/DOCUMENTATION

Accounting Treatment & Workflow on Write Off Bad Debts and Provision for Doubtful Debts.

Sample of Documents or Agreements Used in Credit Management Process.

The Importance of Proper Documentation. Salient features of a good credit policy and procedural manual. CREDIT VETTING PROCESS: Credit Evaluation Criteria Used In Credit Management/Control Non financial qualitative factors in credit decision making. Granting Credit facility To Your Customer Who Belongs To A Group Of Companies

Simple Credit Evaluation Form

Reservation of Title Clause.

COLLECTIONS Collections vide Telephone Collection Approaches ,Types of Defaulters, Delaying Tactics & Signals of Potential Defaulters. Time -The Critical Factor In Credit Management LITIGATION: A brief description of Litigation process workflow SETTING TARGETS KPA And KPI Of A Credit Manager Setting A DSO Target Measurements:-KPA/KPI Used in Credit Management

MORE DETAILED ACCOUNTING ON BAD DEBTS AND PROVISION Different methods of creating provision for doubtful debts Accounting treatment for the increase or decrease of provision for doubtful debts Difference between bad debts written off and provision for doubtful debts


____________________________________________________________________________


IMPORTANCE OF CREDIT MANAGEMENT AND THE CHARACTERISTICS OF A WELL RUN CREDIT MANAGEMENT DEPARTMENT

Effective credit management and decisions are important elements in managing a successful business as it helps to:

1. reduce credit risk exposure, 2. improve cash management through timely collection, 3. balance and avoid possible losses on potential sales versus achieving sales objectives. 4. In time of recession, survival vide good credit management or for short term purposes, to tide

over cash crunches where the company is in an “overtrading” situation (share capital injected is very low compared to its sales)

Sad to say, top management may profess to be well aware of problems resulting from the existence of trade credit but frequently they underestimate the task of safeguarding against the inherent risk. Therefore, it is not unusual for a company to have some 25% of all assets and 40% of current assets in trade debtors.

Frequently, the questions asked is what constituted a company with a well run credit management department? Some good characteristics are:

1. The company should have a clear cut credit policy and procedures fully endorsed by its top management and clearly make known to all sales staff and credit management personnel,

2. Top management in its operating profit performance’s review must clearly support and review and reinforce consistently all key performance indicators like % of ageing, targeted days sales outstanding, return on invested capital that affects the capital investment in the trade debtors,

3. Top management imposes key performance indicators on their credit management personnel so that they will appreciate and understand what role they are supposed to play. In turn the key performance indicator of the credit management department are cascaded upwards to the company’s goals,

4. Daily,weekly,monthly or periodic reporting showing actual collections versus target and in these reports, we can see deviation against budgeted figures, includes specific and aggressive ongoing action plans pertaining to overdues like litigation progress report and others,


____________________________________________________________________________


5. Specific defined weekly meeting is conducted. This should be in the presence of the head of the business unit and his/her salesperson team, credit controller/manager and general manager. In these meeting. Like all serious and effective meeting, every one must come punctual, well prepared and minor disturbances like mobile phone should be on silent/vibration mode.

6. Recruitment of credit department personnel with good skill sets and attributes,

7. Mindset of Operating managers towards impact of good credit management in the company. All the operating managers understand the serious implication of losses due to bad debt.. Say, the company presently has a 5% net profit on sales, a loss of $5,000 in debt debt will nullifies the net profit on $100,000 sales,

8. Good credit management must balance with the Order to Cash process in the Company. The Order to Cash process is scrutinised, properly planned, simplify and automated wherever possible, consistently and systematically executed in the daily operation of the company,

9. The company should have an overall incentive sales system basing on cash collection from the sales rather than sales alone. In the incentive system, there should be established clawback procedure of salespersons commissions if cash has not been timely collected within certain time frame. With this been embedded in the system, this will definitely send the correct message to all salesperson to “respect” credit management.

10. Another hard to find feature is the readiness to put up the necessary action or litigation process once certain breach have been made by the customers. For CFO who are in a marketing driven organisation where sales is paramount, it’s extremely difficult to talk about putting up certain hard stances when clear signs/indicators are shown on customers in the verge of defaulting. Normally, we see Sales or the Marketing head will say things like “ ok we will see first or we don’t understand our customers and many other reasons to support the customers”. All these, make the Credit department the bad guy, people who don’t understand sales or customer satisfaction until things become too late to remedy.


____________________________________________________________________________


COSTS IN EXTENDING CREDIT

Do you know what are the costs involved in the extension of credit term? Well, let’s hope that your answers include the following:

• Cost of capital tied up in debtors, • Cash discounts, • Staffing costs of sales, ledger administration, • Expenses on printing, stationery, postage, space, equipment, etc. • Debt recovery costs, e.g. legal, credit insurance and debt collection agencies, • Bad debts.

The cost of capital tied up could be the additional overdraft, factoring, bills acceptance facility and other borrowings tied up. In most cases, the company will be using collaterals to obtain these facilities. Here, the cost of capital is essentially the interest payments from these borrowings, which can reduce the profit or income of the company.

Also, if we are able to get the debtors to pay earlier, then besides seeing the incomes/returns increased by lessening the interest costs of borrowing to finance debtors, we will also see a better RETURN ON INVESTMENT (ROI) in our Receivables/Assets.

Simple Illustration: Return on Investment (ROI) In RECEIVABLES

Year 2004 Year 2005 Sales $2m $5m Profits say 5% (a) $100k $250k Assets Employed $1m $1.8m Return on Assets 10% 13.9% Receivables (b) $600k $650k DSO 110 days 47 days If DSO=110 days (original) (d) $1,507,000 Reduction in Receivables because DSO now is 47days (d-b) $ 857,000 Say overdraft interest @12% savings from reduction of receivables (DSO from 110 to 47 days)

12%x(d-b) $ 102,700

Profit is now increased to (c) $352,700 ROI in RECEIVABLES (a/b) 16.7% ROI in RECEIVABLES (c/b) 54.3%

If you look at the table, with the concerted effort from management to reduce receivables from a DSO of 110 days to 47 days, big savings from interests from borrowing is derived, which gives the Company a better return/income and leading to better ROI in Receivables. (in ROA, besides receivables there is also inventory and other assets), Here we are only demonstrating that receivables are improving, but others assets might be deteriorating, etc.


____________________________________________________________________________


ACCOUNTING TREATMENT & WORKFLOW ON WRITE OFF BAD DEBTS AND PROVISION FOR DOUBTFUL DEBTS.

The discussion is confined to amount owing by Trade Receivables and excludes any amount owing by Inter-company and Associate Debtors.

There are two (2) ways of handling loss in Trade Receivables, namely:

1. write off 2. provision made in the event of non-recoverability

For Write off of bad debts:

Here, we need to consider the time or period that the company have being owed for the debt. For example, say we have been owed by a trade debtor for more than 450 days hence we contemplate writing off this debt.

Next we should seek the necessary approval to write off these debts. The suggested method is to have a Approval for Write Off Form signed off by the necessary signatory preferably the head of business unit manager, CFO and Managing Director. This write off form and legal letters from solicitors and other supports need to be filed for future tax deductibility purposes.

The trade debtor should be written off and recorded as Write Off of Bad Debts, with a corresponding credit to knock-off the trade receivable (balance sheet ) listed in the below accounting entry.

Debit : Loss on Trade Receivables (Profit & Loss Account) Credit : Trade Receivables (Balance Sheet)

It’s important for visibility purposes to maintain on a MEMO basis any material write-off of any trade receivables. Such receivables should be reviewed, the information updated monthly, and collection efforts continued until deemed uncollectible. The receivables maintained on a memo basis should be removed from all records when one of the following occurs:

1. Monies are collected, 2. A collection agency or appointed company solicitors declares the debt as uncollectible, 3. Legal action against the customer has been pursued and completed, 4. The equipment has been repossessed and collection activities has stopped,

Approvals are required from the respective Business Unit Manager, Financial Controller and Managing Director in order to remove the above receivable from the memo files.


____________________________________________________________________________


Loss on Bad Debts on Trade Debtor:

Can be either general or specific provisions and in exceptional cases where in situations the debts are recovered even though it had been written off, this will be classified as bad debt recovery and, if the debt recovered is less than full amount, the trade receivable account should not be re-instated for the remaining uncollected balance.

1. A provision for Doubtful Accounts is effected by charging into the following entry:

• Debit - Provision for Doubt ful/Bad debts ( Profit and Loss a/c) Credit - Provision for Doubtful/Bad debts ( Balance Sheet item)

In order to maintain realistic company profits, there is the need to consistently update the provisions for AR which are deemed uncollectible.

To match profits relating to the sales, there should a provision for doubtful debt policy, for example like the following:

• 1% of trade receivable outstanding less than 180 days, • 50% of trade receivable outstanding more than 180 days, • 100% of trade receivable outstanding more than 360 days.

Suggestion:

It is interesting to note that most companies would place the loss in bad debts whether it is a write off or provision into the Marketing category. Hence, at times of low collections, the marketing expenses category will show very high figures deflating the profit or income of the company. Vice versa, it has the opposite effect, when recoverability or high collections will increase the income of the company.

But in reality, should we do that?

Why don’t we think that this is part of asset management. The suggested way perhaps is to have a separate line altogether from marketing, operation, etc, and coined it as Asset Management Utilisation. (Incidentally, matters relating to inventories should also be included into this line)

By doing so, two objectives can be attained:

• making sure Senior Management and the business unit manager understand the implication of too high of assets allocated into their individual profit and loss account,

• will not cause distortion into other lines ( when we have too high or low collections)


____________________________________________________________________________


SAMPLE OF DOCUMENTS OR AGREEMENTS USED IN CREDIT MANAGEMENT PROCESS.

Appended below are some sample agreements and/or documents for those who might need them:

1. Business Trade Reference, 2. Bank Guarantee,

Sample of a BUSINESS TRADE REFERENCE

To : Name & Address of the Company who are asking for reference on Customer A

From : Business Referee (Name & Address)

Dear Sir(s)

Reference : Customer A

1. The abovenamed customer

� has maintained an account with us since ____________

� account has been closed on ______________________

� has no business relationship with us

2. Terms of Payment

ÿ Cash

ÿ Secured Basis

ÿ Credit of _______days

ÿ To be stipulated from time to time

3. Current Credit Limit Granted : $_________________________

� Initial Credit Limit given was $____________________

� Subsequent Credit Limit given was $_______________

4. Average Credit Period to date


____________________________________________________________________________


ÿ 30 days

ÿ 60 days

ÿ 90 days

ÿ 120 days

ÿ 150 days

ÿ 180 days and above

5. Average monthly sales to the abovenamed Customer $________

6. Financial Status: ÿ Large ÿ Medium ÿ Small

7. Market Reputation:

ÿ Good

ÿ Average

ÿ Bad

ÿ Newly established

(Please note that the above information is given in strictest confidence and without liability.)

Yours truly,

………………………………………..

Authorised Signatory/Company Stamp


____________________________________________________________________________


SAMPLE OF A BANK GUARANTEE

(UNDER THE BANK LETTERHEAD)

Date

Name & Address of the Company giving credit (say ABC Company)

Dear Sir, BANK GUARANTEE NO

In consideration of you, ABC Company ( Name & Address) at our request agreed to supply computers and related accessories (hereinafter referred to as “the said supply”) to

………………………………………………………………………………………………..

(hereinafter referred to as “the customer”), we hereby agree with you as follows:-

We, ( Bank name & Address)

hereby guarantee to pay to you within fourteen (14) days of written demand and on the pre-condition that the proof of indebtedness is made available to us by way of delivery orders and invoices, all sum of the money which now or shall at any time by owing to you by the customer arising from or in connection with the said supply PROVIDED ALWAYS that the total liability ultimately enforceable against us under this Guarantee shall not exceed in aggregate that the sum of $…………………………………..

This Guarantee shall be a continuing Guarantee to you (within the limits aforesaid) for the whole amount which shall be due and owing to you by the customer which may have arisen from …………………(both dates inclusive) (hereinafter referred to as “the guarantee period”).

You may at any time, at your absolute discretion and without giving any notice whatsoever to us, refuse any of the said supply or any credit facilities to the customer and grant to him any time or other indulgence and compound with him without discharging or impairing our liability under this Guarantee.

Notwithstanding any other provisions herein before contained, if on the expiry of ninety(90) days after the date of expiry of this Guarantee or any subsequent renewed guarantee given by us, we have not received any demand from you, this Guarantee or any subsequent renewed guarantee as the case may shall be lapse and cease to have any effect whatsoever and we shall be deemed to be discharged and released from all and any liability under this Guarantee without prejudice however to any claim which you may make prior to the expiration of the said ninety day period.

Yours faithfully,


____________________________________________________________________________


(Signed by Bank)

THE IMPORTANCE OF PROPER DOCUMENTATION.

In credit management, never underestimate the need for proper documentation. This is especially so when we are thinking of suing delinquent debtors. Without proper documentation, all is practically lost.

It’s important to bear in mind the following points:

1. the name of the customer on the invoice or delivery order must be exactly the same as in the approved Application of New Accounts,

2. the receipt or acknowledgement of goods must be provided by the party invoiced unless authorised otherwise by the party invoiced. It is crucial that we get written confirmation or authorisation for delivery to the third party, or it could end up very messy to prove,

3. the acknowledgement must also bear the rubber stamp of the company, 4. a copy of all invoices and delivery orders with acknowledgement by the customer must be filed

systematically in the office for verification. In practical situations, the transporter of the company usually collects the acknowledgement from the customer. It’s therefore important to ensure this is filed,

5. always remember that the chop “overdue interest at XX% payable…” should be chopped on the delivery order as the proper “claim for damage” is when we forsake our goods for future payment.

A good Credit Policy and Procedures Manual should contain the following:

1. A clear statement of credit policy, 2. Credit terms, 3. Conditions of sale, 4. Cash discounts, 5. Methods of payment for various types of account, 6. Procedures for

o opening of accounts, o account collection, o credit sanctioning, o legal action, o disputes, o bad debts, o stopping the supply of goods to a customer, o credit limits (including extension of new credit limits whether higher or lower amount), o export collection, o credit insurance, o specimens of management information forms and reports and the timeline, o standard letters.


____________________________________________________________________________


Explanatory notes to the above:

1. A statement of Credit policy This is the most important as Top management must set the policy. It is logical as this will quells any future disputes between marketing and credit management departments. Sales will therefore not being overreach at the expense of higher credit risk.Therefore, this policy statement shall depend on many factors like cash needs, sales volume, market conditions, type of business and others. By having a proper policy, credit personnel will be able to do an efficient job by avoiding unreasonable and unnecessary risk, constant look out of receivables, prompt collection efforts and alertness to danger signals indicating an account in trouble.The credit policy will be reviewed periodically by top management to ensure that the company’s goals remain unchanged.

2. Credit Terms The Company’s credit term must be clearly defined. For example, “strictly with 30 days ” from the date of invoices.Otherwise, certain interest charges will be imposed. No customers like to charge interest hence the important of dictating this clause and making sure customers are aware of it. Typical example like “ interest charges of 1.5% per month calculated on a Daily basis, will be levied on all amount that exceeds 45 days from the date of the Invoices/Debit Note”. This should be imprinted or chop onto our Delivery Order and Sales Invoice.Interest charges levied on overdue account will have to be settled promptly and there will be no waiving of the interest charged unless approved by the Managing Director.

3. Conditions of Sales It is important that the customer clearly understands the company’s terms and condition of sale and their contractual obligations upon signing the purchase agreement with the company.

4. Cash Discounts Cash discounts assist the cash flow of the company when the customers would like to take pay earlier before the expiry of their credit terms. Therefore, it is important that the exact criteria to achieve these cash discount should be clearly stated to avoid possible disputes with the customers.

5. Methods of payment for various type of accounts Where the company has conducted several type of business like project basis, sale of goods or sales of services, it needs to state the method of payment otherwise this will hinder the future


____________________________________________________________________________


cash collection from the customers who will say that they are not aware of it as it was not correctly spelled upfront.

CREDIT EVALUATION CRITERIA USED IN CREDIT MANAGEMENT/CONTROL

In the Credit Evaluation, the 5 Cs that should be considered are:

1. Capital: Ability to pay 2. Character: Willingness to pay 3. Capacity: Ability to turn business into profit 4. Condition: Business and trading environment 5. Collateral: Guarantee available

Evaluation Criteria Measurement Capital • Cash availability

• Quick Asset ratio • Average debtors day • Credit facilities

Character • Average creditors day • Directors of the company

Capacity • Net profit before tax ratio • No of years trading

Condition • Nature of business activities

Collateral • Legal constitution • Guarantee


____________________________________________________________________________


NON FINANCIAL QUALITATIVE FACTORS IN CREDIT DECISION MAKING.

Financial ratios have always been used to evaluate the credit worthiness of a new customer.

But, how about non-financial and qualitative factors that you as a Credit Manager might want to look for?

This should at least include the following:

1. Payment History (rating: mostly prompt, prompt-slow and mostly slow),

2. Need of Customer’s business(rating: great, average and small),

3. Character of Management (rating: above average, average and below average),

4. Years in Business: (rating: more than 5 years, 1-5 years and less than 1 year),

5. Bank Borrowing (rating: unsecured, none, unknown, secured by fixed assets, secured by current assets),

6. Competition (rating: heavy, average and below average),

7. Product Profitability (rating: high, average and low),

8. Credit’s manager assessment: (rating: comfortable, uncomfortable, very uncomfortable)


____________________________________________________________________________


GRANTING CREDIT FACILITY TO YOUR CUSTOMER WHO BELONGS TO A GROUP OF COMPANIES

During the credit vetting process of granting a new credit facility or additional credit amount to the customer, you might notice from the Application Form that a particular customer belongs to a group of companies. You might find that the credit standing based on all your financial and non-financial ratios on this stand-alone company might not qualify it for new or additional credit facility from your company.

So what should you do as a Credit Manager?

Attached below is a sample of a Corporate Guarantee that you might be able to use to persuade the customer to bring forth to its holding company to guarantee the amount of credit given by your company.

This Corporate Guarantee acts as a sort of “collateral”.

When the subsidiary company whom you have granted the credit facility fails in its obligations to pay, your company can then have the recourse to seek payment from the customer’s holding company which has a higher or better credit standing.

More often, nowadays, a holding company normally uses its management company or a special vehicle company (for example, a realty company for a special project) to obtain credit facilities from its suppliers.

Once this Corporate Guarantee has been signed and a Board Resolution raised, this might hopefully make them aware that your company is a bit “more special/preferential” than its other unsecured creditors.

Sample of a CORPORATE GUARANTEE

(UNDER THE LETTERHEAD OF THE CORPORATE GUARANTOR SAY XYZ GROUP)

Date

To : Name & Address of the Company giving the credit period (ABC Company)

Dear Sir,

In consideration of the extension of credit by ABC Company (hereinafter referred to “ABC”) to XYZTY ( hereinafter called the “Customer”), which extension of credit is at the request of the Guarantor, the


____________________________________________________________________________


undersigned Guarantor hereby unconditionally guarantees the payment when due of all amounts owing by Customer to ABC, to a total amount of $150,000.00, whether such amounts now be owing or may be owing in the future.

Guarantor consents to any renewal, extension, postponement, or other indulgence granted to Customer, any modification, supplement, or alteration to Customer indebtness; any substitution, release or exchange of collateral; and any release of other obligors or guarantors. Guarantor waives notice of acceptance, notice of goods sold to Customer, and any notice of default by Customer.

The total amount payable by the Guarantor hereunder shall not exceed $150,000.00; provided however, that this shall be a continuing guarantee for said $150,000.00 regardless of amounts paid by Customer, and that ABC may extend credit to Customer for amounts in excess of $150,000.00 without affecting the obligations of the Guarantor hereunder.

This guarantee is to be valid and binding on us and is a continuing security. Notwithstanding the revocation of this Guarantee, if any, we will pay the guaranteed sum antecedent to the revocation of this Guarantee.

Yours faithfully,

XYZ GROUP

……………… Director.


____________________________________________________________________________


SIMPLE CREDIT EVALUATION FORM

Append below a simple credit evaluation checklist:

What Do We Evaluate What Do We Look For Sources of Information

Who are the directors Director(s) name & Identification or Passport Form 49 (Malaysia) - filing in Registrar of Companies

Majority shareholders Is this a subsidiary of a more reputable company? (Can we also get a Corporate guarantee?)Is it linked to holding or associated companies that have very bad credit status in the market?

Form 24 (Malaysia) - filing in Registrar of Companies

Size of company Total number of employees Annual Turnover

Credit Application Form

Type of company (a)Legal Constitution: Sole proprietorship, partnership, private or public listed status, (b)Holding company/Associated/Subsidiary


Trade Reference Fellow companies that we know that we can called to ask, Any names of reputable suppliers that are presently giving credit to the applicant,

Business Trade Reference, Association of Credit Bureau.

Credit Rating/Monitoring Agency

Bankruptcy Winding Up Petition

Registrar of Companies

Capital Authorised Paid-up Too “little” capital re: overtrading (against its sales)

Audited Financial Statements and Annual Returns

Ability to pay Net Tangible Assets Quick Asset Ratio Current Asset Ratio

Audited Financial Statements

Viability of Company PBT Audited Financial Statements

Collection Period Average Debtors day Audited Financial Statements

Payment Period Average Creditors day Audited Financial Statements

Guarantee Available Corporate guarantee Personal guarantee Joint & severally Bank guarantee

Credit Application Form showing type and shareholding status


____________________________________________________________________________


No. of years trading Date of Incorporation Date of Commencement of business


RESERVATION OF TITLE CLAUSE.

Understanding the infamous “Romalpa case” will further assist us to tighten our terms and conditions.

If we recalled, the Romalpa case relates to the reservation of title clause.

It either states: Clause 1: Ownership to the goods does not pass until the goods are paid for, or

Clause 2: Ownership to the goods does not pass until all monies due to the supplier have been paid.

For Clause 1, it is essential that the goods supplied can be separately identified. Hence, it will be necessary specifically to identify goods with unpaid invoices. This usually means some form of batch or serial number on the goods which matches with the same number on the invoice.

If Clause 2 above is used, any identifiable goods may be reclaimable.

Always consult your solicitor on the suitability of using this Romalpa case in relation to the nature of your company business.


____________________________________________________________________________


COLLECTIONS VIDE TELEPHONE

The telephone is basically an immediate and flexible method of “two-way” communication which is both time saving and flexible. Do not belittle collection by telephone as it is a very important task for a credit personnel as it demands a combination of credit knowledge, communication skills and understanding of people.

Cash collection using telephone is not a one-time process. We occasionally need to call more than once. At times, even if we have closed the deal by having certain committed payment plan, we still need to call the same customer to remind him of his commitments.

There are certain cardinal rules which we should follow during a telephone collection:

• Be positive instead of taking a negative or a critical approach; • We should give the customer the benefit of the doubt. Hence let the customer “ save face”

whenever possible • Our opening statement must get the customer’s full attention and should not be over critical or

sarcastic • We should admit any of our mistakes frankly at the outset if we or our company are, or have

been, in the wrong.

It is essential that the collector should follow the basic etiquette of speaking clearly, control the volume, using the right tone and controlling the rate of the speech. Putting the mouthpiece too close and not control the volume and our tone will sound like we are shouting or intimidating the customers.

Like any follow up on credit collection, there are also three (3) stages in collection vide telephone:

1. First, we need to plan ahead of the call, 2. Secondly, we must know what we want to say during the call to make it very effective, 3. Subsequently, we still need to follow-up again.

Stage 1: Planning the call

Before the call, we must plan ahead to understand the following:

• Is our company at fault? • Have there been any previous collection “steps”? • What is the past payment trend? • Who is the right person to talk to? • In the event of partial settlement, what sort of payment plan could we agree to? • We need to do our homework to search for fact-finding questions so as to be able to retain the

initiative and keep control of the conversation, • We need to prepare an opening statement for example like identify ourself and our company,

give reason for call & others


____________________________________________________________________________


Stage 2: Making the Call

• When making the call, we must identify the person to whom we are speaking to, introduce ourselves and our company whom we are working for,

• We also need to give a reason for the call, • We should always leave “Strategic Pauses” to allow and elicit a response, • We should listen to response and other information offered and make notes, • Start asking “fact-finding” questions structured to determine the real reason for non-payment, • At an appropriate time, try to “ bridge” to a payment plan, • Introduce the payment plan, • Overcome any objections, • Obtain the agreement and commitment, • Close the call by summarizing the agreed payment plan and thank the customer.

Stage 3: Follow Up

• By recording the notes, • Update our records, • Take the relevant action.

In Stage 3, we need to record our progress of the collections with the customers. At times, customers might even deny certain statements said and agreed during the previous telephone conversation. Therefore, it is essential that we should keep an infallible record of what have transpired.

A typical example of a Telephone Cash Collection Follow Up Sheet to record the progress of the collections vide telephone.

Sample Telephone Cash Collection Follow Up Sheet

Date & Time of Calls

Title/Name of decision maker

Spoken to Date & value of last payment

Outstanding balance

Payment received

Promised date

Notes or Other Comments


____________________________________________________________________________


COLLECTION APPROACHES ,TYPES OF DEFAULTERS, DELAYING TACTICS & SIGNALS OF POTENTIAL DEFAULTERS.

Basic Collection Approaches: There are many ways to try to collect. Do you know them? Collection approaches can be broadly classified into:

• Persuasion, e.g. “Pay now because it’s better for you…” • Coercion, e.g. “We’ll have to take other forms of action……….” • Education, e.g. “Your payment isn’t here. It is important to pay because….” • Problem solving / Emphatic, e.g. “How can we help?”

Can you identify the types of Non-Paying Borrowers? We can classify them as :

• The chronic forgetter, i.e. always forgets to pay; always needs to be reminded • The accidental forgetter • Changed situation, i.e. excuses • The deliberate delayer

Next, what are their Delaying Tactics in Payments?

• Cheques submitted are short of one other signature • Claims that equipment is not working as specified • Claims that their copy of invoices have not been received • Amount in figures and words on cheques differ • Signatory is overseas or outstation • Cheques not received by main contractor, hence, they as a sub-contractor have yet to receive it

Do you know what are the Signals Alerting that Debts Might Turn Bad? Some of the danger signals include:

• A customer who cannot be contacted for quite some time, • A change in customer habits, especially gambling, • Market rumors and information which give negative reports about the customers, • A customer who has been paying regularly is now having cashflow problems, • A sudden large order. Prior to this, the customer trend of payment is very prompt and his credit

line could be small, • Heard rumors or news that the customer is required to charge his assets or asked to charge

additional assets to the bank.


____________________________________________________________________________


TIME -THE CRITICAL FACTOR IN CREDIT MANAGEMENT

Needless to say that when debtors are not paying us on time, we need to raise our alertness level as this can ultimately lead to a future bad debt.

So what might be some of the warning signs of a future bad debt?

Some examples are as follows:

• longer credit terms taken with approval, particularly for smaller orders • use of post-dated checks by debtors who normally settle within agreed terms • evidence of customers switching to additional suppliers for the same goods • new customers who are reluctant to give credit references • receiving part payments from debtors.

A BRIEF DESCRIPTION OF LITIGATION PROCESS WORKFLOW

Below demonstrates the various stages of the litigation process that the Credit Manager or Controller will usually have to go through:

1. Letter of Demand

On the instructions of the Company, the lawyer writes a Letter of Demand (LOD) to the debtor. The letter informs the debtor that they should settle the debt within a stipulated time (usually 7 days) failing which legal action will be instituted against them. (The lawyer can be an in-house lawyer)

2. Filing of Writs or Summons

If the debtor does not comply with the Letter of Demand, the Company will instruct the lawyer to prepare a summons and a statement of claims for filing with the Court Registry. The ‘sealed’ summons would be extracted from the Court within three (3) weeks from the date of filing. Thereafter this sealed copy of the summons is served on the debtor.

3. Service of Summons

1. The sealed summons is served on the debtor not less than 14 days before the day fixed for the return or Mentioned Date of the case. This date is fixed by the Court and it is written on the summons.


____________________________________________________________________________


2. In the event that the debtor avoids acceptance of the summons, it is possible to apply to the Court for substituted service. Before this application to be made, it has to prove that 3 attempts must be made to serve on the debtor.

3. When the application is approved by the Court, steps taken to notify the debtor can be through publication of the summons in the local newspaper.

4. Judgement

1. If the debtor does not appear in Court on the date fixed by the Court, judgement in default of appearance shall be entered against them. However, if they appear in Court and disputes the claims, the Court may order them to file and serve a defence (usually 2 weeks). The Court then fixes a day for hearing where the Court will make its judgement concurrently. However, if debtor defence is weak or raises no disputes application for Summary Judgement (Order 014/026A) can be obtained.

2. After the judgement is made and drawn up it will be served on the debtor where the sum awarded has to be paid within 14 days.

5. Execution Proceedings

In the event that the debtor does not adheres to the summons to pay the sum awarded, execution proceedings commences. There are various modes of execution processes in which payment for the sum awarded can be obtained, namely:

(a) Writ of Seizure and Sale

(i) Application is made to the Court for such a writ and when issued, the Court Bailiff has the authority to take into possession of goods of the debtor and conduct a sale by public auction to to realise the sum awarded to the judgement creditor.

(b) Garnishee Proceedings

(i) This proceedings is only appropriate if the judgement creditor knows of any debt or money due and payable to the debtor by a third party. This third party is called ‘garnishee’ and any remittance of such money shall be paid to the judgement creditor to offset the sum awarded by the Court.

(c) Judgement Debtor Summons (J.DS)

(i) This proceedings is only appropriate if the judgement creditor has little knowledge of the assets or financial position of the judgement debtor so as to decide on the appropriate form of execution to satisfy the judgement debt, the judgement debtor will be cross-examined by the judgement creditor’s solicitors to his assets or funds and his means of satisfying the judgement debt.


____________________________________________________________________________


(d) Bankruptcy/Winding-up Proceedings

(i) This action entails the application to the Court to appoint an officer called the Official Assignee (O.A.) to manage the overall debtor’s business and supervise the distribution of assets among the Creditors. The O.A. will then make its recommendation based on whatever is available from the debtor and distribute it fairly without preference (parri passu) to the unsecured creditor.

Workflow:

During the progress of the litigation process, the Credit Manager will need to update senior management of the progress. A sample of the litigation progress report is attached below.

With this litigation progress report, management may able to measure the performance of their solicitors and the speed the case is heading.

Progress Status Report:

Progress in Legal

Proceeding (A)

Notice of

Demand Sent (B)

Writ or Summons

Filed ©

Application of

Substitue Service

(D)

Summon Served

(E)

Defence Filed (F)

Application for Order

14 (G)

Hearing of

Order 14 (H)

Full Hearing Fixed

(I)

Judgement Extracted

(J)

Name of Deliquent Debtors

Continued after column Judgment Extracted: (due to insufficient space)

Writ of Seizure or Sale

(K)

Date of Execution

(L)

Bankruptcy notice filed

(M) Name of Deliquent Debtors

(Order 14 is a process for the solicitor to obtain a summary judgement against the debtor by justifying that the debtor is having a “sham” defence. This normally involves affidavits and supports like delivery orders of our goods or services , purchase orders from debtors, contracts or agreements signed )


____________________________________________________________________________


KPA AND KPI OF A CREDIT MANAGER

By setting targets to the credit personnel employee, this will directly enable the objectives of the company to be achieved. The employee himself/herself will have a better focus and knows exactly what Managements wants from him/her and others.

The below suggest at least those KPA and KPI which you should put up in the TPM Worksheet of the Credit manager:

KPA KPI Comments 1 Accounts

Receivable Management

Ageing % · To reduce the debts ageing % > 120-day from the current of 25% to 5% by the end of Qtr 4 ‘2006.DSO

·To achieve a DSO of 90-day as at the end of Qtr 4’2006

Aged analysis of Overdues:

• To reduce from the current 30% to 10% by Qtr 3’2006

Overdues as a % of Total debtors,

• To reduce from from the current 20% to 5% overdues as a % of total debtors

Disputed Debts (including Debit notes ) as a % of Total debtors

• To reduce from from the current 20% to 5% disputed debts as a % of total debtors

Out Performance- < 3% of total amount Exceeded Expectation– 3% - 5% of total amount Met Expectation– 5% of total amount Below Expectation– 5.01% - 20% of total amount Inadequate Performance- > 20% of total amount Out Performance - < 75 days Exceeded Expectation – 75 days to 89.99 days Met Expectation - 95 days Below Expectation – 95.1 days to 115 days Inadequate Performance - > 115 days

[PS: You can also include some of the KPA/KPI of the Order-To-Cash Cycle into the above table. ]


____________________________________________________________________________


SETTING DSO TARGET FOR CASH COLLECTION

What if your boss said to you, “I want you to achieve only 70 Days Sales Outstanding for this coming month September 2005.” How then do I calculate the cash required to achieve 70 Days DSO?

Illustration:

Assuming that for August 2005’s DSO is 75 days and the scenario is as below:

August’05 31 days Sales value $1,500,000

July’05 31 days Sales value $1,000,000

June’05 13 days Sales value $ 650,000 (out of total sales of $1,500,000 x 13/30 )

Total 75 days $3,150,000 Receivables

To achieve a target of DSO for 70days for September 2005, you need to:

(a) take September 05 sales as intact 30 DSO plus

(b) whole month of August 2005 sales alone 31 DSO and leave

(c) another 9 days sales in July 2005. 9 DSO ———– 70 DSO ++++++

So, your collections should be:

• to collect all outstanding receivables remaining in June’2005 (13 DSO) $650,000 • to collect 22 days of receivables of July’2005 (22/31*1,000,000) $677,420 • Grand Total Collection to achieve above-said 70 DSO $1,327,420

Well what if you cannot make it?

You would then need to be more aggressive in the collections for the old debts or from litigation cases. This should help you to achieve the desired DSO


____________________________________________________________________________


MEASUREMENTS:-KPA/KPI USED IN CREDIT MANAGEMENT As mentioned in my earlier articles, Top management must review and reinforce the importance of certain measurements used in Credit management.. What are they? Measurements in Credit Management includes the following :

1. Days Sales Outstanding (DSO) 2. Aged analysis of Overdues, 3. Overdues as a % of Total debtors, 4. Disputed Debts (including Debit notes ) as a % .

For the methodology and computation of DSO, please refer to my article on Cash Conversion Cycle, We shall now discuss the following usefulness of using DSO as the measurement in Credit Management. 1. Days Sales Outstanding: We must not narrow ourselves by thinking that DSO can only be apply to a company. The following illustrations show otherwise. In fact, we can create a “football league” table using DSO which will assist us to narrow down to the model champion or the culprits. DSO: By Company or By Total Group Company A Company B Company C Total Group Actual 80 90 100 95 Budget 60 75 80 75 DSO: By Department or By Overall Company Department A Department B Department C Overall

Company Actual 80 90 100 95 Budget 60 75 80 75 DSO: By Salesperson or By Salesperson Group Salesperson A Salesperson B Salesperson C Salesperson Group Actual 80 90 100 95 Budget 60 75 80 75 DSO: By Projects Project A Project B Project C Overall


____________________________________________________________________________


Project Actual 80 90 100 95 Budget 60 75 80 75 2. Aged Analysis of Overdues: Use to calculates the quality of overdues. Ideally, overdues should only be restricted to 1-30 days. However, this is really not possible, hence we need to understand whether the overdues are improving or deteriorating by reviewing the overdue ageing analysis schedule: Assuming total debtors totaled $3,000,000 of which $1,000,000 is current (1-30days). The remainder of $2,000,000 is overdue. Therefore, we need to analyse the $2,000,000 into further ageing bucket like for the following example:

Total overdue 1-30days 31-60days 61-90days 91-120days 121+days $3,000,000 $1,000,000 $500,000 $300,000 $200,000 $1,000,000

3. Overdues as % of total debtors: Just a calculation of the value of Overdues as a% of total debtors at a certain cut off say month end. It is important to combine this overdues as % of total debtors and further break down into an Aged analysis of overdue schedule in order to make these two ratios more meaningful. 4.Disputed Debts

We must not underestimated disputed debts in credit management. Usually, these disputed debts will clogged up the cash in flows of the company. Always split up the total debtors by taking this disputed debts and then re-analyse the disputed debts as a % of total debtors and also as a number of days sales unpaid. Normally, these disputed debts are in the form of debit notes claim. Ultimately, once resolved, might be credited/deduced eventually from the amount owing by the debtors. Other reports which assists in measurement of the progress of cash collections from trade debtors are as follows:

• Daily cash collection report: actual versus target, • Summary of trade debtors by Department manager and by salesperson • Summary of trade debtors by salesperson only


____________________________________________________________________________


A Sample of Daily Collection Report to monitor cash collections for Companies with Branches:

CASH COLLECTION : ACTUAL VERSUS TARGET

Department Head Office Branch A Branch B Week 1 Week 2 Week 3 Week 4 Total Dept A: Actual Target Collections Dept B: Actual Target Collections Grand Total: Actual Total Target Collections Variance Post-Dated Cheques Week

1 Week 2 Week 3 Week 4 Total

Head Office Branch A Branch B Total We can actually summarized a trade debtors report to be presented to Top management which is as follows: SAMPLE OF A MONTHLY DEBTOR REPORT AS AT 31 st October 2005

Budget This Month Last

Month Previous Year

1 Days Sales Outstanding (DSO) 69 67 65 77

2 Overdues % 10% 9% 9% 10%

3 Aged Analysis of Overdues (%) Rm % Rm % Rm % Rm %

31-60 100 4% 100 4% 100 4% 100 4% 61-90 200 9% 200 9% 200 9% 200 9% 91-120 300 13% 300 13% 300 13% 300 13% 121-150 400 17% 400 17% 400 17% 400 17% 151-180 500 21% 500 21% 500 21% 500 21% 181-360 600 26% 600 26% 600 26% 600 26% 360-450 150 6% 150 6% 150 6% 150 6% 361-450 100 4% 100 4% 100 4% 100 4% >451 - 0% - 0% - 0% - 0%


____________________________________________________________________________


Total Overdue >31 days onwards 2,350 100% 2,350 100% 2,350 100% 2,350 100%

> 90 days - $ / % 2,050 87% 2,050 87% 2,050 87% 2,050 87% 4 Disputed Debts $ 48 91 102 123 % of total debtors 2% 4% 4% 6% DSO 1.5 2.8 2.7 4.6 Data Total Debtors 2,250 2,450 2,570 1,970 Overdue Debtors 221 220 235 200 Sales 1,100 1,320 930 870 Cash Collected 1,000 1,200 1,100 900

It is crucial that Senior management should consistently and constantly review the progress of credit management vide the aforesaid measurement or key performance indicators as this will inevitably affects the company’s Return on Investment Ratio ( ROI). By getting the debtors to pay earlier will enhance ROI as:

• The investment in trade debtors is reduced, • The returns or income is increased by lessening the interest cost of borrowing to finance

debtors

Any provision or write off of bad debts will reduce the net income of the company.


____________________________________________________________________________


DIFFERENT METHODS OF CREATING PROVISION FOR DOUBTFUL DEBTS

METHOD 1: GENERAL PROVISION BASED ON AS % OF CLOSING TRADE DEBTORS BALANCE

This methodology is normally called general provision for doubtful debts

The term general is because there is NO SPECIFIC identification of the trade debtors who has really turn back.

This estimate is based on past trend or management in-depth understanding of the industry

Illustration:

Say, at Year End Trade Debtors BalanceÂ is $5,000,000

Based on experience, Management decided to create a provision of 1% on the year end trade debtor balance::

1% x $5,000,000=$50,000 by:

Debit: Provision for Doubtful Debt ( Income Statement) $50,000

Credit: Provision for Doubtful Debt ( Balance Sheet) $50,000

Being 1% general provision created based on year end trade debtor balance

METHOD 2: GENERAL PROVISION BASED ON AS A PERCENTAGE OF WHOLE YEAR BILLINGS

Similar explanation as above.

The difference is that we are only taking an estimate based on the whole year billing. This estimate is based on past trend or management in-depth understanding of the industry

Illustration:

Say, whole year revenue is $10,000,000

Based on experience, we create a provision of 0.5% of the whole year revenue :

0.5% x $10,000,000=$50,000 by:


____________________________________________________________________________


Debit: Provision for Doubtful Debt ( Income Statement) $50,000

Credit: Provision for Doubtful Debt ( Balance Sheet) $50,000

Being 0.5% general provision created based on whole year’s revenue

METHOD 3: AS SPECIFIC PROVISION BY IDENTIFY SPECIFIC CUSTOMERS WHO TURNS BAD

The word SPECIFIC means that this provision is created based on reviewing the INDIVIDUAL trade debtor who are owing to the company.Say there is 100 trade debtors owing, management at certain interval will review individually the trade debtor account and believe that only 10 accounts needs to be selected for doubtful debt.

Unlike the aforesaid general provision, these specific provisions might be based on documentary evidence like litigation and other investigations that prove that the debtors might turn bad hence the need to create the specific provision

As for as the accounting treatment is concerned, it is the same as the general provision. ( see illustrations above)

METHOD 4: BASED ON DETAILED AGEING SCHEDULE

In this case, this provision for doubtful debt is creating from the AGEING Trade Debtors Schedule. Every month, management are presented with such AGEING schedule which reflects the AGE of these trade debtors. Based on company’s internal policy /procedures, the provision for doubtful debt is created.

Illustration:

Assuming that Company A has the following accounting policy & procedure for provision for doubtful debt:-

Trade Debtors >120 days - 10%of trade debtors amount

Trade Debtors >180 days old 50% of trade debtors amount

Trade Debtors >365 days - 100 % of trade debtors amount

Instead of looking at the AGEING schedule,

: provision for doubtful debts can also be created based on a review of the OVERDUES BALANCES


____________________________________________________________________________


ACCOUNTING TREATMENT FOR THE INCREASE OR DECREASE OF PROVISION FOR DOUBTFUL DEBTS

INCREASE IN PROVISION FOR DOUBTFUL DEBTS:

Assuming earlier in Quarter 1, we have created a provision for doubtful debts of $100,000. Say,at end of Quarter 2, we have reviewed our trade debtors and wanting to increase the provision by an additional amount $50,000.

How should we do it ?

For Quarter 1,

The Original Entry is:

Debit : Provision for doubtful debt ( Income Statement) 100,000

Credit: Provision for doubtful debt ( Balance Sheet) 100,000

Being creation of provision for doubtful debts at Quarter 1.

In Quarter 2,

We increase the provision by an additional $50,000 namely:-

Debit: Provision for doubtful debt ( Income Statement) 50,000

Credit: Provision for doubtful debt ( Balance Sheet) 50,000

Being further increase in provision for doubtful debts at Quarter 2

Let’s look at the impact

From the Income Statement:-

For Quarter 1, Profit is lowered by $100,000

For Quarter 2, Profit is additionally lowered by $50,000


____________________________________________________________________________


For Year To Date Quarter 2 : Overall profit is lowered by $100,000+$50,000 =$150,000

From the Balance Sheet :-

At Quarter 1:

Trade Debtors $500,000 ( say)

Less:

Provision for doubtful debt (100,000)

Net Trade Debtors $400,000

At Quarter 2:


Less:

Provision for doubtful debt (150,000) ( $100,000+50,000)


Based on the dual aspect concept, the creation of the additional provision will reduce the profit and also reduce the value of the asset which is the trade debtor.

In this case, with the increase in provision for doubtful debt, it results in an additional amount of $50,000 reduction in the Income Statement with a corresponding decrease in the Trade Debtors of the Balance Sheet. ( provision for doubtful debt shown in the debit side of the Balance Sheet as a reduction of Trade debtors

(DECREASE) IN DOUBTFUL DEBTS:

Assuming that during the quarter 2, some of these doubtful customers paid $80,000 .How do we treat it?


____________________________________________________________________________


Scenario 1: If bad debts already being written off

As money is received and the bad debts have earlier been written off meaning that the trade debtors no longer exist in the books of accounts,

then we should:

Debit: Bank (money is received) $80,000

Credit: Bad Debts Written Off ( Income Statement) $80,000

Being money received from earlier bad debts written off.

Scenario 2: Assuming that previously there is a general provision for doubtful being created

then we should:

Debit : Provision for doubtful debt (Balance Sheet) 80,000

Credit: Provision for doubtful debt ( Income Statement) 80,000

Being recovery of earlier provision for doubtful debt ( receipt of cash $80,000)

Let’s look at the impact

From the Income Statement:-

Assuming that earlier in Quarter 1, provision for doubtful debts of $100,000 is created hence reducing corresponding the profit by the same amount.

For Quarter 2, due to the receipt of cash from the doubtful debts, profit is now higher by $80,000 as this effectively reduce Â the provision for doubt debts

For Year To Date Quarter 2 : the net Profit $100,000-$80,000 =$20,000

From the Balance Sheet :-


____________________________________________________________________________


At Quarter 1:


Less:

Provision for doubtful debt (100,000) (say)


At Quarter 2:


Less:

Provision for doubtful debt (20,000) ( $100,000-80,000)


To sum up, with money recovered from doubtful trade debtors, we can either:-

(1) in the case of bad debts already written off, credit this money received as a credit to the bad debts written off in the Income Statement or

(2) in the case of merely an earlier provision created without any write off, then we can credit the provision for doubtful debts in the Income Statement. Also, the money received will then be offset against the trade debtors ( not written off) and reflected in the bank account.


____________________________________________________________________________


DIFFERENCE BETWEEN BAD DEBTS WRITTEN OFF AND PROVISION FOR DOUBTFUL DEBTS

WHAT IS BAD DEBT WRITTEN OFF?

Nowadays the company needs to extend credit to its customers. If the company insists on cash term, it will drive away the customers. This might be worsened if other competitors are able to extend generous credit terms to the customers.

In the real world of doing business, there will definitely be some of these customers that cannot pay up their debts.

To ensure that this type of doing business expenses can be charged/expensed off into the Income Statement so that the profit will not be overstated, we need to create an accounting entry called bad debt written off. What’s it really mean is to write off the irrecoverable amount of the trade debtors and directly charged/expensed into the Income Statement.

Illustration:

Say the Company has an accounting period from 1 st January to 31 st December. It has billed customer A for $10,000 in mid- January’06. By September’06, customer A only paid $8,000. The customer A has become bankrupt and has absconded leaving the amount $2,000 unpaid.

(1) The original double entry when the Company billed customer A is:

Debit : Trade Debtor (Balance Sheet) $10,000

Credit: Revenue( Income Statement) $10,000

(2) Next, the Company needs to initiate the following entry to write off the bad debt of customer A:

Debit: Bad Debts Written Off (Income Statement) $2,000

Credit: Trade Debtor Accounts ( Balance Sheet ) $2,000

However, we need to understand that bad debt write off is not consistent with the Matching concept.

The billing to the customers might not really turn irrecoverable or bad during the year it has been billed. Say for the above illustration, we assume that customer A only become a real bankrupt and has absconded only in the middle of year 2007. So what should the Company do?

Hence, the need to look at another way of handling this irrecoverable debt which is called:


____________________________________________________________________________


PROVISION FOR DOUBTFUL DEBTS:

Provision For Doubtful debts takes into consideration that when a company conducts it business, there is bound to be some billings during the year whereby the customers might not be able to pay hence eventually turning bad. If this occurs during the accounting year then the company can DIRECTLY write it off in the Income Statement, otherwise a Provision needs to be created for these doubtful customers.

Illustration:

Debit: Provision for doubtful debts ( Income Statement) XX

Credit: Provision for doubtful debts ( Balance Sheet) XX

Being provision for doubtful debts

For Balance Sheet’s presentation:

Trade Debtors YYY

Less: Provision for doubtful debts (XX)

Net Trade Debtors ZZZ

[ In my earlier article on provision, this provision for doubtful debt instead being a credit amount and classify as liabilities, it is classify as an asset side SO AS TO REDUCE THE VALUE OF THE ASSET in this case, Trade Debtors Account.]