Introduction The term Receivables is defined as debt owned to the firm by customers arising from sale of goods or services

in the ordinary course of businesses. When a firm makes an ordinary sale of goods or services and does not receive payment, the firm grants trade credit and creates accounts receivable which could be collected in the future. Receivables management is also called trade credit management. Thus, accounts receivable represent an extension of credit to customers, allowing them a reasonable period of time in which to pay for the goods received. In other words, A Receivable is the money owed to a company by a consumer for products and services purchased on credit. This is usually treated as a current asset of accounts receivable after the customer is sent an invoice. Accounts receivable are known by various names, such as accounts receivable aging, days receivable, accounts receivable turnover and invoice factoring. Accounts receivable are reported on the balance sheet of the seller at net realizable value, which is the net amount the seller expects to collect. According to the experts, receivable or invoice factoring is one of a series of accounting transactions. These accounting transactions deal with the billing of customers who owe money to a person, company or organization for goods and services purchased. With businesses looking for improved bottom line performance, better receivables management, collections is a key focus area along with timely and accurate billing for organizations across industries. The sale of goods on credit is an essential part of the modern competitive economic systems. In fact, credit sales and, therefore, receivables are treated as a marketing tool to aid the sale of goods. The credit sales are generally made on open account in the sense that there are no formal acknowledgements of debt obligations through a financial instrument. As a marketing tool, they are intended to promote sales and thereby profits. However, extension of credit involves risk and cost. Management should weigh the benefits as well as cost to determine the goal 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 capital). It can be argued that revenue generation is the most critical function of a company. Every company expends substantial resources to generate increasing levels of revenue. However the revenue must be converted into cash. Cash is the lifeblood of any company. Every rupee of a companys revenue becomes a receivable that must be managed and collected in time. Therefore the staff and processes that manage your receivables are asset to a company.

Why do we need receivables? To increase total sales. To increase profits. To meet increasing Competition.

Operating cycle

Understanding Receivables As a part of the operating cycle. Time lag between sales and receivables creates need for working capital.

COSTS ASSOCIATED WITH ACCOUNTS RECEIVABLES MANAGEMENT

The major categories of costs associated with the extension of credit and accounts receivable are: Collection Cost Collection costs are administrative costs incurred in collecting the receivables from the customers to whom credit sales have been made. Included in this category of costs are: Additional expenses on the creation and maintenance of a credit department with staff. Accounting records. Stationery. postage and Other related items; expenses involved in acquiring credit information either through outside specialist agencies or by the staff of the firm itself. These expenses would not be incurred if the firm does not sell on credit.

Capital Cost The increased level of accounts receivable is an investment in assets. They have to be financed thereby involving a cost. There is a time-lag between the sale of goods to, and payment by, the customers. Meanwhile, the firm has to pay employees and suppliers of raw materials, thereby implying that the firm should arrange for additional funds to meet its own obligations while waiting for payment from its customers. The cost o the use of additional capital to support credit sales, which alternatively could be profitably employed elsewhere, is, therefore, a part of the cost of extending credit or receivables. Delinquency Cost This cost arises out of the failure of the customers to meet their obligations when payment on credit sales becomes due after the expiry of the credit period. Such costs are called delinquency costs. The important components of this cost are: (a) blocking-up of funds for an extended period, cost associated with steps that have to be initiated to collect the overdues, such as, reminders and other collection efforts, legal charges, where necessary, and so on.

Default Cost Finally, the firm may not be able to recover the overdues because of the inability of the customers. Such debts are treated as bad debts and have to be written off as they cannot be realised. Such costs are known as default costs associated with credit sales and accounts receivable.

Administrative Cost The costs relating to the administration of receivables is as follows: Screening the potential customers for granting credit. Accounting, recording and processing costs of debtors balances.

Expenditure incurred for credit control checks. Cost incurred for sending invoices and statements of accounts to individual customers. Chasing up slow paying debtors. Cost incurred for classification of queries. Recording receipt of cash and processing on individual customer records. Use of office space, processing equipment and remuneration of sales force involved in debtors collection etc. BENEFITS OF ACCOUNTS RECEIVABLES MANAGEMENT

Apart from the costs, 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. When firms extend trade credit, that is, invest in receivables, they intend to increase the sales. The impact of a liberal trade credit policy is likely to take two forms. First, it is oriented to sales expansion. In other words, a firm may grant trade credit either to increase sales to existing customers or attract new customers. This motive for investment in receivables is growth-oriented. Secondly, the firm may extend credit to protect its current sales against emerging competition. Here, the motive is sales-retention. As a result of increased sales, the profits of the firm will increase and other benefits of effectively managing the receivables are like Increased Cash Flow, Reduced Bad debt loss, Lower Administrative cost in the entire revenue cycle, Decreased deduction and concession losses, Reduced Interest loss.

COST BENEFIT TRADE-OFF We all know that investments in receivables involve both benefits and costs. The extension of trade credit has a major impact on sales, costs and profitability. Other

things being equal, a relatively liberal policy and, therefore, higher investments in receivables, will produce larger sales. However, costs will be higher with liberal policies than with more stringent measures. Therefore, accounts receivable management should aim at a trade-off between profit (benefit) and risk (cost). That is to say, the decision to commit funds to receivables (or the decision to grant credit) will be based on a comparison of the benefits and costs involved, while determining the optimum level of receivables. The costs and benefits to be compared are marginal costs and benefits. The firm should only consider the incremental (additional) benefits and costs that result from a change in the receivables or trade credit policy. While it is true that general economic conditions and industry practices have a strong impact on the level of receivables, a firms investments in this type of current assets is also greatly affected by its internal policy. A firm has little or no control over environmental factors, such as economic conditions and industry practices. But it can improve its profitability through a properly conceived trade credit policy or receivables management.

Importance In marketing operations receivable management assumes paramount importance due to two reasons: a) No sale is complete until money is collected from the customer and responsibility for such collection should generally rest with concerned sales personnel. Substantial delay or even non-collection of receivables invariably results in steady erosion of profits generated through sales. b) If a large part of companys working capital gets blocked up in the receivables outstanding then it would adversely affect the marketing margin (the numerator)

because of higher interest charges and increase the level of marketing investment (the denominator), thus depressing the ROI significantly.

PROCESS OF ACCOUNTS RECEIVABLES MANAGEMENT The following process will help in efficient management of the receivables:-

Take the opinion of the sales force and internal staff.

Frame the credit terms for the customer if credit is sanctioned.

Establish the initial creditworthiness.

Check the credit before the dispatch of consignment.

Close monitoring of the credit terms and customer compliance.

Review the customer credit, if required.

Develop the reports for internal appraisal of the customer.

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. A Firms investment in accounts receivable depends on: a) The volume of credit sales b) The collection period

Firms average investment = Daily credit sales X Average collection period Credit policy is evaluated in terms of return and costs of additional sales. Credit policy refers to a) Credit standards: Criteria to decide the types of customers to whom goods could be sold on credit. Slow paying customers will increase investment in receivable and is exposed to high default risk b) Credit terms: The duration of credit and terms of payment by customers. Extended time period for making payments will increase investment in receivables. c) Collection efforts: Determine the actual collection period. The lower the collection period, the lower the investment in accounts receivables and vice versa. GOALS OF CREDIT POLICY a) A firm following a lenient credit policy will grant credit in liberal terms and standards and grant credit to longer period and also to customers whose creditworthiness is not fully known. b) A firm following a stringent credit policy sells on credit on a highly selective basis only to customers with proven creditworthiness. CREDIT POLICY AS MARKETING TOOL Firms use credit policy as a marketing tool during expansion sales. In a declining market, it is used to maintain market share.It helps to retain old customers and to create new customers. In a growing market, it is used to increase firms market share.

 Under a highly competitive situation or recessionary economic conditions, firm loosen its credit policy to maintain sales or to minimize erosion of sales. Necessity of Granting Credit Companies in India grant credit for: 1. Competition: Higher the degree of competition, the more the credit grant 2. Bargaining power: Higher bargaining power leads to less credit or no credit 3. Buyers status and requirement: Large buyers demand easy credit terms. 4. Dealer relationship 5. Marketing tool 6. Industry practice & past practice 7. Transit delays: Forced reason for granting credit. OPTIMUM CREDIT POLICY Optimum credit policy is one which maximizes the firms value. Value of firm is maximized when the incremental or marginal rate of return of an investment is equal to the incremental or marginal cost of funds used to finance the investment. MARGINAL COST- BENEFIT ANALYSIS To achieve the goal of maximization of firms value, the evaluation of investment in accounts receivable should involve: Estimation of incremental operating profit (change in contribution additional costs) Estimation of incremental investment in accounts receivable (Investment in accounts receivable = credit sales per day X Average Collection Period) Estimation of the incremental rate of return of investment (Operating profit after tax / Investment in accounts receivable) Comparison of the incremental rate of return with the required rate of return. Credit Policy Variables

In establishing an optimum credit policy, the financial manager must consider the important decision variables which influence the level of variables. The major controllable decision variables include the following: Credit standards and analysis Credit terms Collection policy and procedures. CREDIT STANDARDS The two aspects of quality of customers are Time taken by customers to repay credit obligation. The average collection period (ACP) determines the speed of payment by customers. The default rate: It can be measured in terms of bad debt losses ratio. The customers are categorized as good, bad and marginal accounts.

DEFAULT RISK To estimate the probability of default the following three Cs are considered. 1. Character: It refers to the customers willingness to pay. The manager should judge whether the customers will make honest efforts to honour their credit obligations. 2. Capacity: It refers to the customers ability to pay. It is judged by assessing the customers capital and assets offered as security. This is done by analysis of ratios and trends in firms cash and working capital. 3. Condition: It refers to the prevailing economic and other conditions that affect the customers ability to pay. CREDIT ANALYSIS A firm can do credit analysis using Numerical credit scoring models: It includes 1. Adhoc approach: The attributes identified by the firm may be assigned weights depending on their importance and combined to create an overall score or index.

2. Simple discriminant analysis: A firm use more objective methods of differentiating between good and bad customers.(Eg:- ratio of EBDIT to sales). 3. Multiple discriminant analysis: It combines many factors according to the importance (weight) given to each factor and determine a score to differentiate customers as good and bad. CREDIT GRANTING DECISION

CREDIT TERMS The stipulations under which the firm sells on credit to customers are called credit terms. These include 1. Credit period: The length of time for which credit is extended to customers is called the credit period. 2. Cash discount: It is a reduction in payment offered to customers to include them to repay credit obligations within a specified period of time, which will be less than the normal credit period. It is expressed as a percentage of sales. It is a cost to the firm for faster recovery of cash.

COLLECTION POLICY 1. Collection policy is needed to accelerate collections from slow payers and reduce bad debt losses. 2. It should ensure prompt and regular collection. 3. It should lay down clear cut collection procedures. 4. The responsibility for collection and follow up should be explicitly fixed. ( Accounts or sales) 5. The firm should decide on cash discounts to be allowed for prompt payment 6. It should be flexible CREDIT EVALUATION For effective management of credit, clear cut guidelines and procedures for granting credit to individual customers and collecting individual accounts should be laid down. The credit evaluation procedure includes: 1. Credit information. 2. Credit investigation. 3. Credit limits. 4. Collection procedures. CREDIT INFORMATION

To ensure full and prompt collection of receivables, credit should be allowed only to customers who have the ability to pay in time. For this the firm should have credit information of customers. Collecting credit information involves cost. The cost should be less than the potential profitability. Depending on cost and time, the following sources can be employed to collect credit information. SOURCES OF CREDIT INFORMATION Financial statement: One of the easiest ways to obtain information on the financial condition of the customer is to scrutinise his financial statements. (Balance sheet & P&L a/c). Bank references: Bank where the customer maintains his account is another source of collecting credit information. Trade references: Contacting the persons or firms with whom the customer has current dealings is an useful source to obtain credit information at no cost. Other sources: Credit rating organisations such as CRISIL, CARE,ICRA, KPMG etc. CREDIT INVESTINGATION AND ANALYSIS The factors that affect the nature and extent of credit investigation of an individual customer are: Type of customer, whether new or existing. The customers business line, background and the related trade risks. The nature of the product- perishable or seasonal. Size of the customers order and expected further volumes of business with them. Companys credit policies and practices. Steps involved in credit analysis are:

1. Analysis of the credit file: A credit file updated regularly is maintained for each customer, who gives information on his trade experiences, performance report based on financial statements, credit amount etc. 2. Analysis of financial ratios: The evaluation of the customers financial conditions should be done very carefully. Ratios should be calculated to determine the customers liquidity position, ability to repay debts etc., 3. Analysis of business and its management: The firm should also consider the quality of management and the nature of the customers business. For this a management audit. CREDIT LIMIT A credit limit is a maximum amount of credit which the firm will extend at a point of time. It indicates the extent of risk taken by the firm by supplying goods on credit to a customer. The decision on the magnitude of credit, the time limit etc depends on the amount of sales, industry norms and customers financial strength. MONITORING RECEIVABLE For the success of collection efforts, the firm needs to monitor and control its receivables. The methods used for evaluation are: 1. Average collection period. 2. Aging schedule. 3. Collection Experience Matrix.