ACCOUNTS RECEIVABLE

MANAGEMENT

FINMAN230LENDING COMPANY

August 18, 2014

“Any fool can lend money, but it takes a lot of skill to get it

back.”

INTRODUCTIONWhat are receivables?

Why do we need receivables?

Understanding Receivable?• Reach sales potential• Competition

• Receivables are sales made on credit basis.

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

GRANTING CREDITBasic decisionsTo give credit or not Selecting the right policy

OBJECTIVES AND FACTORS IN DETERMINING A/R POLICY

• Creating, presenting and collecting accounting receivables• Establish and communicate the credit policies• Evaluation of customers and setting credit limits• Ensure prompt and accurate billing• Maintaining up-to-date records• Initiate collection procedures on overdue accounts

Credit PoliciesA set of rules that includes the firm’s credit period, discounts, credit standards, and collection procedures offered.

Credit Policies(1) Average Collection period(2) Bad-debtLosses

Quality ofTrade

Account

Length ofCredit Period

FirmCollectionProgram

Possible Cash

Discount

Credit PoliciesCredit period is the length of time buyers are given to pay for their purchases.

Collection policy refers to the procedures used to collect past due accounts, including the toughness or laxity used in the process.

Credit standards refer to the required financial strength of acceptable credit customers. With regard to credit standards, factors considered for business customers include ratios such as the customer’s debt and interest coverage ratios, the customer’s credit history (has the customer paid on time in the past or tended to be delinquent),

Discounts are price reductions given for early payment. The discount specifies what the percentage reduction is and how rapidly payment must be made to be eligible for the discount.

Setting and Implementing the Credit PolicyCredit policy is important for three main reasons: 1. It has a major effect on sales2. It influences the amount of funds tied up in receivables,3. It affects bad debt losses.

COSTS ASSOCIATED WITH ACCOUNTS RECEIVABLES• COLLECTION COST: Administrative costs incurred in collecting the accounts receivable.• CAPITAL COST:Cost incurred for arranging additional funds to support credit sales.• DELINQUENCY COST: Cost which arises if customers fail to meet their obligations.• DEFAULT COST: Amounts which have to written off as bad debts.

TRADE-OFFS BETWEEN THE CREDIT POLICYDeveloping a credit policy is something a business eventually has to face. One of the basic decisions you have to make when starting a business is whether or not you are going to extend credit to other businesses and consumers. This is a decision to be taken very seriously as it will impact your cash flow and even your profit.

TRADE-OFFS BETWEEN THE CREDIT POLICYHere are some factors that you should consider when developing a credit policy and that should influence your decision whether or not to extend credit to customers. You should grant credit only if the positives of doing so outweigh the negatives. Often, this is difficult to determine.1.The Effect on Sales Revenue2.The Effect on Cost of Goods Sold3.The Probability of Bad Debts4.Offering a Cash Discount5.Taking on Debt

TRADE-OFFS BETWEEN THE CREDIT POLICY1. The Effect on Sales Revenue

– The reason you would grant credit in the first place is so yourcustomers can delay paying you. This is convenient for your customers and will probably win customers for you, but it is not so convenient for you and your bottom line, at least on an immediate basis. Sales revenue from the sale you made to your customer will be delayed for either the discount period or the credit period, or perhaps longer if the customer is late in making the payment. The upside is that you may be able to raise your prices if you offer credit.– You have a trade-off. The possibility of more customers andhigher sales prices if you offer credit in exchange for possible delayed and late payments. Unfortunately, it's hard to quantify this.

TRADE-OFFS BETWEEN THE CREDIT POLICY2. The Effect on Cost of Goods Sold

– Whether you sell products or services you have to havethem available and, in the case of products, in stock, when a sale is made. When you extend credit, that means paying for that product or service in order to have it in stock but not getting paid for it immediately when it is purchased. Even though you will eventually get paid, your business has to have enough cash flow to compensate for the delayed payment. In addition, you lose any interest income you might have earned on that money.– Again, you have a trade-off. This time it is more customersand higher sale prices in exchange for lost interest income and temporarily lower cash flow.

TRADE-OFFS BETWEEN THE CREDIT POLICY3. The Probability of Bad Debts

– If a company makes all its sales for cash, there is nopossibility of bad debts or debts it cannot collect. If any percentage of the company's sales are on credit, there exists the possibility of bad debts or debts you, as a business owner, will never collect. When you are developing your credit policy, you should allow for some percentage of your credit accounts that will never be paid.– The trade-off here is that some percentage of your credit sales will never be paid. You have to decide if this factor is worth more customers and higher sales prices.

TRADE-OFFS BETWEEN THE CREDIT POLICY4. Offering a Cash Discount

– Particularly when you offer credit on a business-to-business (B2B) basis, most companies offer other businesses a cash discount. In other words, if the business pays the bill within the discount period, that business gets a discount. If they don't pay within the discount period, then they must pay within the credit period or the original period within which the bill is due.– Cash discounts are often stated like this example: 2/10, net 30. If those are your credit terms, it means that you offer a 2% discount if the bill is paid in 10 days. If you don't take the discount, the bill is due within the 30 day credit period.– Is getting your money in 10 days worth the 2% discount that you offer? That's the trade-off you have regarding cash discounts and whether you should offer them

TRADE-OFFS BETWEEN THE CREDIT POLICY5. Taking on Debt

– If you, as a business owner, decide to offer credit to your customers, chances are you will have to take on debt to finance your accounts receivables. As a small business, you may not be able to afford to sell your products or services without immediate payment unless you have a good working capital base. If you have to take on debt, you have to factor in the cost of short-term borrowing as part of your decision to offer credit.– Offering credit to your customers is a big decision with wide-reaching effects for your company. You have to consider the factors above and more. Will offering credit result in repeat business? Do you have the time and resources to collect late payments? Make this decision wisely.

THE 5C’s of CREDIT• Character- Reputation, Track Record• Capacity- Ability to repay ( earning capacity)• Capital- Financial Position of the company• Collateral- The type and kind of assets pledged• Conditions- Economic conditions & competitive factors that may affect the profitability of the customer

SUMMARY1. For most firms, account receivables and inventories are the most important categories of current assets. Management is concerned with reaching optimal levels where the marginal benefits of added investment just equal incremental costs.2. Returns from investments in accounts receivable are realized through increased profitable sales. Costs include the expenses of financing and losses from bad debts.

SUMMARY3. Credit information on individual accounts is available from credit rating agencies, banks, other suppliers, and from customers themselves.4. The cost of short-term bank borrowing is usually the cost of financing receivables. The most difficult aspect of credit analysis is the assessment of the effects of altered credit policies on sales and the estimation of bad debts.

“Today, there are three kinds of people:  the have’s, the have-not’s, and the have-not-paid-for-what-they-have’s.”-Earl Wilson