Accounts

Receivable
Management

Forms of Credit
Commercial Credit

Consumer Credit

- an individual or a business
entity, such as a sole trader
or a partner, obtains for
business
purposes
not
connected
with
the
individual's
domestic,
household
or
family
interests.

- an individual obtains when

acting in a private capacity,
and which is to be used
primarily
for
domestic,
household
or
family
purposes.

Objectives of Accounts
Receivable Management
- Ensure that the firms investment in
accounts receivable is appropriate and
contributes to the shareholder wealth
maximization.

Credit Policy

- written guidelines that set

(1) the terms and conditions for supplying goods on
credit,
(2) customer qualification criteria,
(3) procedure for making collections, and steps to be
taken in case of customer delinquency. Also called
collection policy.

 Credit Standards
- The guidelines a company follows to determine
whether a credit applicant is creditworthy.

6Cs of Credit

CharacterCapacity
CapitalCollateral

Why lower the firms credit

standards?
The financial manager should continually lower
the firms credit standards as long as profitability
from the change exceeds the extra costs
generated by the additional receivables.
Optimal Credit Policy

- Involve extending trade credit more liberally until

the marginal profitability on additional sales
equals the required return on the additional
investment in receivables.

Relaxing Credit
Standards
Benefit

Increase in sales and total

contribution margin

Cost
Increase in average
collection period
Increase in account
receivable investment
Increase in bad debt
losses
Increase in servicing cost
of account receivable.

 Credit Terms
Credit Terms Specify the length of time over
which credit is extended to a customer and the
discount, if any, given for early payment. For
example, 2/10, net 30.
Credit Period The total length of time over
which credit is extended to a customer to pay a
bill. For example, net 30.

Lengthening of Credit
Period
Benefit
Increase in sales and total
contribution margin

Cost
Larger investment in
receivables
Higher incidence of bad
debt loss.

Granting Cash Discount

Benefit

Increase in sales and

total contribution margin
Opportunity income on
lower
investment
in
receivables

Cost
Lesser Profit

 Collection Policy and

Procedure
- Refers to the procedure the firm follows to
collect past-due accounts.
Collection Procedures

Letters
Phone calls
Personal visits
Legal action

Credit Analysis
A credit analyst is likely to utilize
information regarding:
the financial statements of the firm
(ratio analysis)
the character of v the company
the character of management
the financial strength of the firm
other individual issues specific to the
firm

Intensified Collection
Efforts
Benefit

Lower Default cost

Lower Opportunity Cost
or Capital Cost

Cost
Higher Collection
Expenses
Lower Sales

 Delinquency and
Default
- Whatever credit policies a business firm may
adopt, there will be some customers who will
delay and others who will default entirely.

Cost Associated with

Investment in Accounts
Receivable
Credit Analysis, Accounting and
Collection Cost
Capital Cost
Delinquency Cost
Default Cost(Bad Debts)

Any fool can lend

money, but it takes
a lot of skill to get it
back

Thank You