RECEIVABLES MANAGEMENT

3RD MODULE

Meaning, Objectives, Management of Receivables

Accounts Receivables: Management making decisions relating to the
investment in receivables with objectives of maximisating returns on receivables

Objectives:
Maximise value of the firm Optimum investment in debtors Control and managing cost of trade credit

Costs and Benefits of Receivables Management

Costs: Capital cost Bad debt cost/default cost Collection cost Delinquency cost Benefits: Increased sales Market share increases Increased profits

Factors Influencing Receivables Investments

Volume of credit sales Credit policy of firm Seasonality of business Trade terms Collection policy Bill discounting

Credit Policy
Lenient/liberal Credit Policy: Positive: Sales increases and increased profits Negative: Bad debt loss, less liquidity Stringent Credit Policy: Positive: Less bad debt losses; and sound liquidity Negative: Less sales and less profits

Credit Policy Variables

Credit standards Credit Terms Collection policy and procedures

Credit Standards
Credit Standards: Minimum criteria for extension of credit to a customer
Format for Calculation of Incremental Profit (Residual income)
Particulars
Increase in Sales Less: Variable Cost Contribution Less: Bad debt loss on new sales Earnings Before Tax (EBT) Less: Tax Earnings After Tax (EAT) Less: Opportunity cost Residual Income

Amount (Rs.)
XXXX XXX XXX XX XXX XX XXX XX XXX

Credit Period
Credit Period: The period of time allowed to a customer to economic value of purchases

Particulars Increase in Sales Less: Variable Cost Contribution Less: Bad debt loss on new sales Earnings Before Tax (EBT) Less: Tax Earnings After Tax (EAT) Less: Opportunity cost Change in Net Profit

Amount (Rs.) XXXX XXX XXX XX XXX XX XXX XX XXX

Cash Discount
Cash Discount: A per cent reduction in sales price for early payment of invoices

Particulars Increase in Sales Less: Variable Cost Contribution Less: Increase in discount cost (CDC) Earnings Before Tax (EBT) Less: Tax Earnings After Tax (EAT) Add: Savings on Investment (KI) Change in Net Profit

Amount (Rs.) XXXX XXX XXX XX XXX XX XXX XX XXX

Collection Policy
Collection Policy: The procedure followed to collect accounts receivables when they become due.
Particulars Increased Sales Less: Variable Cost Contribution Less: Increase in bad debt cost (Note 1) Earnings Before Tax (EBT) Less: Tax at 40 % Earnings After Tax (EAT) Less: Opportunity cost (Note 2) Increase in Net Profit Amount (Rs.) XXXX XXX XXX XX XXX XX XXX XX XXX

Evaluation of Individual Accounts

1. Obtain credit information

(a) Internal sources (b) External sources: Annual reports; Bank references; Trade references; Credit rating agency 2. Analyse information (a) Quantitative (b) Qualitative 3. Make credit decision

Monitoring Accounts Receivables

Receivables turnover Average collection period Days sales out standing Aging schedule Collection matrix

Monitoring Accounts Receivables

Receivables turnover- provides relationship between credit sales and debt of a firm. Average collection period- Is a time take by firm in collecting receivables cash from the customer. Days sales out standing- The ratio of receivables outstanding at the time to sales per day.

Aging schedule
A statement shows age-wise groups of debtors. It breaks down the debtors according to the length of time for which they have been outstanding. This is helpful for identifying slow paying debtors with which firm may have to encounter a stringent collection policy.

Aging schedule
Age Group(in days) Less than 30 31 - 45 46- 60 Amount outstanding 40,00,000 20,00,000 30,00,000 % of debtors to total debtors 40 20 30

Above 60
Total

10,00,000
1,00,00,000

10
100

Collection Matrix
Collection matrix is a methods of showing percentage of receivables collected during the month of sales and subsequent months. It helps in studying the efficiency of collections whether they are improving or deteriorating.

Collection matrix
% of receivables collected during the year April May June July August

Sales Month of sales 1st month of sales 2nd month of sales 3rd month of sales

350 10 30 25 20

340 12 38 24 26

320 14 40 22 22

300 11 30 20 19

250 08 34 21 18

4th month of sales

15

10

02

15

20

PROBLEM 1 (CASH DISCOUNT AND CREDIT PERIOD A firm is currently selling a product at Rs. 10 per unit. The most recent annual sales (cr,) were 30,000 units. The variable cost per unit is Rs. 6 and average cost per unit, given a sales Volume of 30,000 units, is Rs. 8. the total fixed cost is Rs. 60,000. the Average collection Period may be assumed to be 30 days.
The firm is contemplating a relaxation of credit standards that is expected to result in a 15% Increase in units sales. The average collection period would increase to 45 days with no Change in bad debt expenses. It is also expected that increased sales will result in additional Net working capital to the extent of Rs. 10,000. the increase in collection expenses may Be assumed to be negligible. The required return on investment is 15%. Should the firm relax the credit standard?

LONG METHOD:
PROPOSED PLAN SALES (34,500 X 10) LESS: VARIABLE COST (34,500 X 6) LESS: FIXED COST PROFIT FROM SALES CURRENT PLAN SALES (30,000 X 10) LESS: VARIABLE COST (30,000 X 6) LESS: FIXED COST PROFIT FROM SALES

3,45,000 2,07,000 60,000 78,000

3,00,000 1,80,000 60,000 60,000

PROFIT FROM INCREMENTAL SALES (78,000-60,000) RS. 18,000

SHORT CUT METHOD INCREASE IN SALES X CONTRIBUTION MARGIN PU (4,500 X 4) is Rs. 18,000

SAVINGS IN AVG COLLECTION PERIOD: AVG. INVESTMENT IN A/R= PRESENT PLAN = COST OF SALES/RECEIVABLE TURNOVER

30,000 X 8 360/30 Rs. 20,000 PROPOSED PLAN = (30,000 X 8 ) + ( 4,500 X 6) 360/15 Rs. 11,125 If cash discount is allowed, the avg investments in receivables will decline by Rs. 8,875 (20,000 11,125). Given a 15% ROR, a firm count earn Rs. 1,331.25 On Rs. 8,875. therefore, the savings from decrease in avg collection period is Rs. 1,331.25 TOTAL BENEFITS PROFIT ON ADDITIONAL SALES 18,000 SAVINGS IN COST 1,331.25 TOTAL 19,331.25 CASH DISCOUNT: 60% OF TOTAL SALES AT 2% CASH DISCOUNT (60% X 3,45,000) 2,07,000 X 0.02 = 4,140 NET GAIN = 19,331.25 4,140 = 15,191.25 The firm should implement the proposal to allow 2% cash discount and reduce collection period to 15 days.

Problem 2 CREDIT PERIOD Suppose a firm is contemplating an increase in the credit period from 30 to 60 days. The Average collection period which is at present 45 days is expected to increase to 75 days. It is also likely that the bad debt expenses will increase from the current level of 1% To 3% of sales. Total credit sales are expected to increase from the level of 30,000 units To 34,500 units. The present average cost per unit is Rs. 8. the variable cost and sales Per unit is Rs. 6 and Rs. 10 respectively. Assume the firm expects a rate of return of 15%. Should the firm extend the credit period?

1. Profit on additional sales = 4 x 4,500 Rs. 18,000 2. Cost of additional investment in receivables = cost of sales/ receivable turnover
proposed plan = 30,000 x 8 + 4,500 x 6 360/75 Rs. 55,625 present plan = 30,000 x 8 360/45 Rs. 30,000 Additional investment in accounts receivable = 55,625 30,000 = 25,625 Cost of additional investment = 0.15 x 25,625 = Rs. 3,843.75 3. Additional bad debt expenses = Proposed plan = 0.03 x 3,45,000 = 10,250 current plan = 0.01 x 3,00,000 = 3,000 Additional bad debt expense = Rs. 7,350 Thus the incremental cost associated with the extension of credit period is 11,193.75 (3,843.75 +7,350). The incremental profit is Rs. 18,000 NET GAIN is Rs. 6,806.25.(18,000 11,193.75) The firm should implement the plan of extending the credit period from 30 to 60 days.