receivables management. opportunity cost collection cost bad debts increased sales increase in...

RECEIVABLES MANAGEMENT

OPPORTUNITY COST

COLLECTION COST

BAD DEBTS INCREASED SALES

INCREASE IN MARKET SHARE

INCREASE IN PROFITS

COVERAGE

• Terms of Payment

• Credit Policy Variables

• Credit Evaluation

• Credit Granting Decision

• Control of Accounts Receivable

• Credit Management in India

TERMS OF PAYMENT

• Cash Mode

• Open Account

• Bill of Exchange

• Letter of Credit

• Consignment

CREDIT POLICY VARIABLES

The important dimensions of a firm’s credit policy are:

• Credit standards

• Credit period

• Cash discount

• Collection effort

CREDIT STANDARDS

Liberal Stiff

• Sales Higher Lower

• Bad debt loss Higher Lower

• Investment Larger Smaller in receivables

• Collection costs Higher Lower

IMPACT ON RESIDUAL INCOME OF RELAXATION

P = [S(1 – V) - Sbn] (1 – t ) – k I

where P = change in Profit

S = increase in sales

V = ratio if variable costs to sales

bn = bad debt loss ratio on new sales

t = corporate tax rate

I = increase in receivables investment

Q.PSD Ltd. is considering relaxing its credit standards.

S = Rs.15 million, bn = 0.10, V = 0.80,

ACP = 40 days, k = 0.10, t = 0.4

P = [15,000,000 (1 – 0.80) – 15,000,000 x 0.10] (1 – 0.4)

15,000,000 – 0.10 x x 40 x 0.80

360

= Rs.766,667

CREDIT PERIOD

Longer Shorter

• Sales Higher Lower

• Investment in Larger Smaller

receivables

• Bad debts Higher Lower

IMPACT ON RESIDUAL

INCOME OF LONGER CREDIT PERIOD

P = [S(1 – V) - Sbn] (1 – t ) – k I

INCREASE IN RECEIVABLES INVESTMENT

S0 SI = (ACPn – ACP0) + V (ACPn)

360 360

where: I = increase in receivables investment

ACPn = new average collection period (after lengthening the credit period)

ACP0 = old average collection period

V = ratio of variable cost to sales

S = increase in sales

Q. X Limited is considering extending its credit period from 30 to 60 days.

S = Rs.50 million, S = Rs.5 million, V = 0.85, bn = 0.08,

k = 0.10, t = 0.40

P = [5,000,000 x 0.15 – 5,000,000 x 0.08] (0.6)

– 0.10 (60 – 30) x + 0.85 x 60 x

= [750,000 – 400,000] (0.6) – 0.10 [4,166,667 + 708,333]

= – 277,500

50,000,000360

5,000,000360

LIBERALISING THE CASH DISCOUNT POLICY

P = [S(1 – V) - DIS] (1 – t ) + k I

DECREASING THE RIGOUR OF COLLECTION PROGRAMME

RI = [S(1 – V) - BD] (1 – t ) – k I

TRADITIONAL CREDIT ANALYSIS

Five Cs of Credit

Character : The willingness of the customer to honour his obligations

Capacity : The operating cash flows of the customer

Capital : The financial reserves of the customer

Collateral : The security offered by the customer

Conditions : The general economic conditions that affect the customer

Case History : Checking customers past transaction to extend credit to

the customer

:

MONITORING OF ACCOUNTS RECEIVABLES

• RECEIVABLES TURNOVER

• AVERAGE COLLECTION PERIOD (ACP)

• AGEING SCHEDULE

• COLLECTION MATRIX

How quickly RECEIVABLES are CONVERTED in to CASH

Receivables Turnover Rate= Total Net Sales

Avg. Debtors* (*including Bills Receivables)

Time (no. of Days) the Credit Sales are converted In to Cash

ACP= 365/ Receivables Turnover

Statement showing AGE WISE GROUPING OF DEBTORS

OR Breaking up of Debtors according to the LENGTH OF TIME for which they have been

OUTSTANDING

Age Group(in Days)

Amount Outstanding (Rs.)

Percentage of Debtors

to Total DebtorsLess Than

30

31-45

46-60

Above 60

40,00,000

20,00,000

30,00,000

10,00,000

40

20

30

10

Total 1,00,00,000 100

Shows the collection pattern (in months) for the CREDIT SALES made in a month

Percentage of Receivables January February March April May June Collected During the Sales Sales Sales Sales Sales Sales Month of sales 13 14 15 12 10 9 First following month 42 35 40 40 36 35 Second following month 33 40 21 24 26 26 Third following month 12 11 24 19 24 25 Fourth following month - - - 5 4 5