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UNIT-5 RECEIVABLES MANAGEMENT

 LEARNING OBJECTIVES
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 Emphasize the need and goals of establishing a sound

credit policy
 Show how an optimum credit policy can be established
 Explain the credit policy variables
 Indicate the credit procedure for and control of individual
accounts
 Suggest methods of monitoring receivables
 Discuss the nature and costs and benefits of factoring
 INTRODUCTION
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 Trade credit happens when a firm sells its products or

services on credit and does not receive cash
immediately.

 A credit sale has three characteristics:

 First, it involves an element of risk that should be carefully
analyzed.
 Second, it is based on economic value.
 Third, it implies futurity.
 Nature of Credit Policy
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 Investment in receivable
 volume of credit sales
 collection period
 Credit policy
 credit standards
 credit terms
 collection efforts
 Goals of Credit Policy
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 Marketing tool
 Maximisation of
sales Vs. incremental
profit
 production and selling
costs
 administration costs

 bad-debt losses
 Optimum Credit Policy
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 Estimation of incremental
profit
 Estimation of incremental
investment in receivable
 Estimation of incremental
rate of return (IRR)
 Comparison of incre-mental
rate of return with required
rate of return (RRR)
 Optimum credit policy: IRR
= RRR
Costs of Credit Policy
 Basic Strategies
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 Prompt Invoicing
 Accurate Invoicing
 Avoiding Quality Disputes
 Printing an Invoice with Tear-off
Acknowledgement Slip
 Proper Accounting and Customer Classification
 ABC Classification based on risk
 Credit Policy Variables
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Credit standards and analysis

Credit terms
Collection policy and procedures
 Credit Standards
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 Credit standards are the criteria which a firm

follows in selecting customers for the purpose of
credit extension.
 The firm may have
 Liberal Credit Standards
 Stringent Credit Standards
 Moderate Credit Standards
 Credit Standards
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 Credit analysis
 Average collection period (ACP)
 Default rate

 Trade Enquiry

 Bank Enquiry

 Credit Rating Agencies

 3 Cs

 Customer categories
• good accounts
• bad accounts
• marginal accounts
 Credit Standards
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 Numerical credit scoring

• ad hoc approach
• simple discriminant approach
• multiple discriminant approach
 Credit terms
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 Creditperiod
 Cash discount
 Collection policy and procedures
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 regularity of collections
 clarity of collection procedures
 responsibility for collection and follow-up
 case-by-case approach
 cash discount for prompt payment
 MONITORING RECEIVABLES
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 Average Collection Period

 Aging Schedule
 Line of Credit
 Collection Experience Matrix
 Ageing Schedule
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Age (days) Percentage of total receivables

00 – 30 55
31 – 45 15
46 – 60 12
61 – 75 10
76 and above 8
 Collection Experience Matrix
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Month of Sales April May June July

Month of collection

April 25

May 28 30

June 41 18 40

July 8 40 36 5

Aug - 12 20 18

Sep - - 22
 Credit Policy Decisions-Examples
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 Super Sports Co., dealing in sports goods, have an annual sale
of Rs 50,00,000 and are currently extending 30 days’ credit to
the dealers. Current Level of Bad Debts is 1%. It is felt that
sales can pick up considerably if the dealers are willing to
carry increased stock, but the dealers have difficulty in
financing their inventory. Super Sports Co., is therefore
considering shift in credit policy. The following information is
available:
 The Average Collection Period is 30 days. Variable cost 80%
of sales and Fixed Cost 6 Lakhs per annum. Required Pre-tax
return on investment is 20%. The proposed credit policies are
as follows:
Credit Policy ACP (Days) Annual Sales (in Lakhs) Expected Level of Bad Debts
A 45 56 2%
B 60 60 3%
C 75 62 4%
D 90 63 5%
 Credit Policy Decision-Example
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 High Vision Limited has current sales of Rs.

2000000. The company is planning to introduce a
cash discount policy of 2/10 Net 30. As a result the
company expects the average collection period to
go down by 10 days and 80% of the sales opt for
cash discount facility. If the company’s required
return on investment in receivables is 20%, should
it introduce the new discount policy?
 Factoring-Example
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A company is considering using a factor, the following
information is relevant.
1) The current average collection period for the company’s debts
is 80 days and 0.5% debtors default. The factor has agreed to pay
over money due, after 60 days, and it will suffer the loss of any
bad debts.
2) The annual charge for the factoring is 2% of turnover payable
annually in arrears. Administration cost saving will total Rs
100000 per annum.
3) Annual sales, all on credit are Rs 10000000. Variable costs
total 80% of sales and there are no fixed costs. The company’s
cost of borrowing is 15% per annum. Should the company enter
into a factoring arrangement?
 FACTORING
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 Factoring may be defined as ‘a contract between the

suppliers of goods/services and the factor under which
 Factoring Services
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 Credit administration
 Credit collection and protection
 Financial assistance
 Other services
 Factoring and Short-term Financing
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 Factoring involves ‘sale’ of book debts.

 Factoring provides flexibility as regards credit
facility to the client.
 Factoring is a unique mechanism which not only
provides credit to the client but also undertakes the
total management of client’s book debts.
 Factoring and Bills Discounting
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1. Bills discounting is a sort of borrowing while factoring is the

efficient and specialized management of book debts along with
enhancement of the client’s liquidity.

2. The client has to undertake the collection of book debt. Bill

discounting is always ‘with recourse’, and as such, the client is not
protected from bad-debts.

3. Bills discounting is not a convenient method for companies having

large number of buyers with small amounts since it is quite
inconvenient to draw a large number of bills.
 Types of Factoring
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 Full service non-recourse Advance factoring

Maturity factoring
 Full service recourse factoring
 Bulk/agency factoring
 Non-notification factoring
 Costs of Factoring
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 the factoring commission or service fee

 the interest on advance granted by the factor to the
firm.
 Benefits of Factoring
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 Factoring provides specialized service in credit

management, and thus, helps the firm’s management
to concentrate on manufacturing and marketing.

 Factoring helps the firm to save cost of credit

administration due to the scale of economics and
specialization.