MEANING OF RECEIVABLES Receivables arise when goods or services of a firm are sold on credit basis According to Hampton “Receivables are asset accounts representing amount owed to the firm as the resu[.]
CHAPTER- RECEIVABLES MANAGEMENT MEANING OF RECEIVABLES Receivables arise when goods or services of a firm are sold on credit basis According to hampton “receivables are asset accounts representing amount owed to the firm as the result of the sale of goods or services in the ordinary course of business.” Van horne “account receivables represent the extension of open account credit by one firm to another firm and to individuals.” As proceeds of credit sales are collected, receivables are reduced RECEIVABLE MANAGEMENT Receivable management involves decisions concerning the extension of credit to customers, protection of the investment in receivables, achievement of timely collections and maintenance of appropriate records These tasks are accomplished through the establishment of sound credit policies Credit policies involve the duties and responsibilities of the credit manager, general guidelines as to the credit terms, collections and write-off procedures, etc… The policies are usually specified in writing as part of the firm’s internal control procedures IMPORTANCE OF RECEIVABLES Sales growth: - Credit sales are a powerful stimulant for increasing sales Especially during the period of inflation accompanied by recession and stagnation in the industry In such situation many customers may not have sufficient cash for cash purchases If a firm doesn’t sale on credit it will have fewer customers and decline in sales Hence, receivable help growth of sales Increase in profit: - Increase in profitability by striking a balance between the cost of extending credit and the gains from sales expansion Capability to face competition: - If competitors sale on credit, the firm will be able to face the competition only by selling on credit The firm should adopt similar credit policies with its competitors to retain customers Protection of Company’s Liquidity: - Slow collection procedures and efforts lead to rapid deterioration in the company’s cash position FACTORS INFLUENCING THE SIZE OF RECEIVABLES The amount and the level of receivables is affected by Influence of economic condition and Credit policy of the firm The common influences of economic condition are cyclical and seasonal variances Credit policies include credit standards, credit terms, default risk (risk of bad debt), collection policies and procedures of collection of the receivables Symbolically R = f (Cs, Ct, CR, CPP , SC) R – Level of receivables Cs – Amount and size of credit Ct – Credit term (discount period, & credit period) Cr – Credit risk (credit standing of individual customers who purchase on credit) Cpp - Collection policies and procedures Sc – Seasonal fluctuation in business FACTORS INFLUENCING THE SIZE OF RECEIVABLES Besides sales, a number of other factors also influence the size of receivables The following factors directly and indirectly affect the size of receivables Size of Credit Credit Policies Terms of Trade Expansion Plans Relation with Profits Credit Collection Efforts: Habits of Customers DIMENSIONS OF RECEIVABLES MANAGEMENT Receivables management involves the careful consideration of the following aspects: A Forming of credit policy B Executing the credit policy C Formulating and executing collection policy 1 FORMING OF CREDIT POLICYFor efficient management of receivables, a concern must adopt a credit policy A credit policy is related to decisions such as credit standards, length of credit period, cash discount and discount period, etc (a) Quality of Trade Accounts of Credit Standards: The volume of sales will be influenced by the credit policy of a concern By liberalizing credit policy the volume of sales can be increased resulting into increased profits The increased volume of sales is associated with certain risks too It will result in enhanced costs and risks of bad debts and delayed receipts (b) Length of Credit Period: Credit terms or length of credit period means the period allowed to the customers for making the payment The customers paying well in time may also be allowed certain cash discount (c) Cash Discount (d) Discount Period EXECUTING CREDIT POLICY After formulating the credit policy, its proper execution is very important The evaluation of credit applications and finding out the credit worthiness of customers should be undertaken (a) Collecting Credit information: The first step in implementing credit policy will be to gather credit information about the customers (b) Credit Analysis: After gathering the required information, the finance manager should analyse it to find out the credit worthiness of potential customers and also to see whether they satisfy the standards of the concern or not (c) Credit Decision: After analysing the credit worthiness of the customer, the finance manager has to take a decision whether the credit is to be extended and if yes then upto what level FORMULATING AND EXECUTING COLLECTION POLICY The collection of amounts due to the customers is very important The collection policy the termed as strict and lenient A strict policy of collection will involve more efforts on collection Such a policy has both positive and negative effects This policy will enable early collection of dues and will reduce bad debt losses On the other hand a rigorous collection policy will involve increased collection costs It may also reduce the volume of sales A lenient policy may increase the debt collection period and more bad debt losses STEPS TO COLLECT RECEIVABLES The objective is to collect the dues and not to annoy the customer The steps should be like (i) sending a reminder for payments (ii) Personal request through telephone etc (iii) Personal visits to the customers (iv) Taking help of collecting agencies and lastly (v) Taking legal action The last step should be taken only after exhausting all other means because it will have a bad impact on relations with customers ILLUSTRATION 1: ABC & Company is making sales of Br.1, 600,000 and it extends a credit of 90 days to its customers However, in order to overcome the financial difficulties, it is considering to change the credit policy The proposed terms of credit and expected sales are given hereunder: Policy Terms Sales I 75 days Br.1,500,000 II 60 days Br 1,450,000 III 45 days Br 1,425,000 IV 30 days Br 1,350,000 V 15 days Br.1,300,000 The firm has variable cost of 80% and fixed cost of Br.100,000 The cost of capital is 15% Evaluate different policies and which policy should be adopted ILLUSTRATION-2: Traders whose current sales are Br.1,500,000 per annum and average collection period is 30 days wants to pursue a more liberal credit policy to improve sales A study made by consultant firm reveals the following information Credit Policy A B increase in collection period 15 days 30 days Increase in sales Br.60,000 90,000 C 45 days 150,000 D 60 days 180,000 E 90 days 200,000 The selling price per unit is Br.5 Average Cost per unit is Br.4 and variable cost per unit is Br.2.75 per unit The required rate of return on additional investments is 20 percent Assume 360 days a year and also assume that there are no bad debts Which of the above policies would you recommend for adoption? ...MEANING OF RECEIVABLES Receivables arise when goods or services of a firm are sold on credit basis According to hampton ? ?receivables are asset accounts representing... INFLUENCING THE SIZE OF RECEIVABLES Besides sales, a number of other factors also influence the size of receivables The following factors directly and indirectly affect the size of receivables Size... deterioration in the company’s cash position FACTORS INFLUENCING THE SIZE OF RECEIVABLES The amount and the level of receivables is affected by Influence of economic condition and Credit policy