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MANAGEMENT OF

RECEIVABLES

Dr. Neeraj Chitkara

Assistant Professor

Samalkha Group of Institutions

Email- neer.chitkara@gmail.com

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INTRODUCTION

The term receivables refers to debt owned to the firm by the customers resulting from the sale of goods or services in the ordinary course of business. There are the funds blocked due to credit sales.

Receivables management refers to the decision a business makes regarding to the overall credit, collection policies and the evaluation of individual credit applicants.

Receivables Management is also called trade credit management.

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OBJECTIVES OF RECEIVABLES MANAGEMENT

The objective of Receivables Management is to promote sales and profits until that point is reached where the return on investment in further funding receivables is less than the cost of funds raised to finance that additional credit i.e. cost of capita.

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TRADE CREDIT VS. CONSUMER CREDIT

Trade CreditIt occurs when one business sells

goods to another business.

Consumer CreditIt occurs when a business sells goods

to an individual.Trade credit terms are more liberal

than consumer credit terms. A company may offer credit on open account or trade bill as documentation of the debt.

Forms of Bank CreditCash credits/overdrafts, loans, Purchase/discount bills,

letter credit, working capital term loans.

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DIFFERENCE BETWEEN TRADE CREDIT & BANK CREDIT

Sr. No.

Attribute Trade Credit Bank Credit

1Length of Terms

Relatively short usually 30,60 or 90 days

Ignore

2Security Usually Unsecured Higher standards for

unsecured loans , otherwise secured.

3Amount Involved

Smaller larger

4Resource transferred

Goods or Services Money

5Extent of analysis

Extensive, when size of transaction is large

In-depth analysis regarding safety and collectability

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MOTIVES FOR EXTENSION OF TRADE CREDITS

Financial MotiveSeller charge a higher price when selling on

credit. Operating Motive

Here suppliers respond to variable demand by the way in which they extend trade credit instead of using more costly response such as installing extra capacity building or depleting inventories of forcing customers to wait in line.

Contracting Cost MotiveBuyers can inspect the quantity as well as

quality prior to payment. Pricing Motive

If change in selling price is not possible due to oligopoly or govt. norms then by extending credit seller can charge varying amounts to their customers.

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COST & BENEFITS OF MAINTAINING RECEIVABLES

Cost of Receivables

Collection Costs : i.e. for maintenance of credit &

collection department, expenses incurred for obtaining information about credit-worthiness of potential customers.

Capital Cost/ Cost of Financing Delinquency Costs:

i.e. cost of financing for an extended period, cost of extra steps to be taken to collect overdue e.g. reminders, legal charges etc.

Default Costs E.g. Bad debts etc.

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BENEFITS OF RECEIVABLES

Increased Sales Anticipated Profits

A liberal policy can take two forms:

Sales Extension Sales Retention

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DETERMINATION THE APPROPRIATE RECEIVABLES POLICY

Our aim is to derive a techniques which the company can apply in order to determine an optimum credit policy. We can gain a greater appreciation for the credit granting process if we know the sequence of events initiated when a business makes a credit sales.

While determining the credit policy the firm has to decide the following two things:

Whether or not to extend credit to a customer.

How much credit to extend.

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The following steps must be taken in determining the appropriate receivables policy:

Credit Standards:The term credit

standards represent the basic criteria for the extension of credit to customers. The quantitative basis of establishing credit standards are:

Credit Ratings Credit References Average Payment Periods Financial Ratios

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CONT…..

Here we have to find the trade-off between benefit and cost to the firm as a whole, so we have divided the overall standards into two parts i.e.

Tight or restrictive Liberal or non-restrictive

We have to check what happens to the trade-off between cost and benefit if these standards are relaxed or tightened.

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The following factors are considered while deciding the credit standards:

Collection Costs Investment in receivables or average

collection period Bad debts expenses Sales Volume The effects of relaxed or tightened credit

standards can be proved with an example in two manners.

Long-Term approach Short-Term/ Marginal Approach

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CREDIT ANALYSIS & DECISION

The second aspect of the receivables policy is credit analysis and investigation. Two basic steps are involved in the credit investigation process i.e.

Obtaining credit information Analysis of credit information

Obtaining credit informationInternal Sources

Filling up of various formsTrade referencesInternal records

External SourcesFinancial StatementsBank referencesTrade referencesCredit Bureau reports

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ANALYSIS OF CREDIT INFORMATION

Quantitative i.e. ratio analysis of liquidity,

profitability & debts capacity, Trend analysis of over a period of time to reveal the financial strength.

Qualitative i.e. references from other suppliers,

bank references and special bureau reports.

It must be clear that the main purpose of credit analysis is to assess the credit worthiness of the customers.

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THE 5 C’S OF CREDIT ANALYSIS

1. Capital Aggregate Liquidity position Total Dept position

2. Character Willingness to pay the debts

3. Collateral4. Capacity

Management capacity to run the business Physical Capacity

5. Condition Economic condition of applicant Industry condition in general

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CREDIT TERMS

The terms under which goods are sold on credit are referred as credit terms. These relate to the payment of the amount under the credit sales. Thus, credit terms specify the repayment terms of receivables.

Components of Credit Terms Credit Period Cash Discount

Cash Discount PeriodThese components are usually written in

abbreviations such as 2/10 net 30.The effect of these components on the receivables

management can be proved with the help of an example.

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COLLECTION POLICIES

The next step involved in the receivables management is collection policies. They refer to the procedures followed to collect accounts receivables after the expiry of the credit period.

Components of Collection Policies Degree of collection efforts

i.e. strict, lenientThe effect on receivables management of the

above degrees with example. Type of collection efforts

Letters Telephone Calls Help of collection agencies Legal action

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MARGINAL ANALYSIS

It involves a systematic comparison between the marginal returns and the marginal cost from a change in the discount period or the collection process. The change should be accepted if the marginal return from a proposed change in the management of accounts receivables is greater than the marginal cost on additional investments in the receivables.

Process of Marginal Analysis Determine the marginal benefit Determine required rate of return on marginal

investment Compare marginal benefit with required return

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CONT…

The logic behind this approach of credit policy is to examine the incremental or marginal benefit and cost or required rate associated with any change in credit policy. If the change promises more profit than costs the change should be made or vice-versa.

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HEURISTIC APPROACH

This approach is based on a manufacturing company’s actual experience. To establish a credit limit and grant credit the following factors need to be considered. The formula or procedure described here has the weight of managerial experience and infusion behind it and therefore is heuristic in nature.

The factors which should be considered are as follows

Credit requirementsDegree of dependence Discount <25% 0%

25-50% 5%.50% 10%

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Paying Habits Payment during discount period 10% Payment during credit period 5%Late Payment (-)5%

Duration of the Business Less than 3 years 0%3-10 years 5%More than 10 years 10%

Profit MarginIf margin is less than 5% 0%

Current Ratio Total debt to asset ratio Inventory turnover Ratio Qualitative Factor

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DISCRIMINANT ANALYSIS

Discriminant Analysis is a computer based technique for predicting whether a new credit applicant will prove to be good or bad credit risk.

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SEQUENTIAL DECISION ANALYSIS