Receivable Management

1. “Any fool can lend money,
but it takes lot of skills to get it back”
Compiled By – CA Sapna Bhupendra Jain

2. Receivables ( Sundry Debtors ) result
from CREDIT SALES.
A concern is required to allow credit in order to
expand its sales volume.

3. A firm makes significant investment by extending
credit to its customers and thus requires a suitable
and effective credit policy to control the level of
total investment in the receivables. The basic
decision to be made regarding receivable is to
decide how much credit be extended to a customer
and on what terms. This is what is known as the
credit policy. The credit policy may be defined as
the set of parameters and principles that govern
the extension of credit to the customers.
This requires the determination of-
(i) The credit standard i.e. the conditions that the
customer must meet before being granted credit,
and
(ii) The credit terms i.e. the terms and conditions on
which the credit is extended to the customers.
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4. MEANING
Receivables is defined as the debt owed to the firm by customers arising from
Sales of goods and services in the ordinary course of business. When a firm
makes an ordinary sale of goods or services and does not receive payment
,the firm grants trade credits and creates accounts receivable which could
be collected in future. Receivables Management is also called Trade Credit
Management.
 NEED
 Reach Sales potential
 Compete with Competitors
 Optimize the return on investments on the assets
UNDERSTANDING RECEIVABLES
 As a part of Operating Cycle
 A time lag between sales and receivables creates need for Working Capital
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5. Receivables
Inventory
Cash
Operating
Cycle
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6. OBJECTIVES
The objective of Receivables Management is to take
sound decision as regards to investment in Debtors.
In the words of BOLTON S E., the objective of
receivables management is
“ to promote sales and profits until that point is
reached where the return on investment in further
funding of receivables is less than the cost of funds
raised to finance that additional credit”
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7. OTHER OBJECTIVES
Achieving growth in sales and profit.
Meeting Competition.
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.
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8. COSTS OF MAINTAINING DEBTORS
CAPITAL COST: It is the cost on the use of additional capital
to support credit sales which alternatively could have been
employed elsewhere.
COLLECTION COSTS: Administrative costs incurred in
collecting the accounts receivable. Costs of additional steps to
increase the chances for eventful payment.
DELINQUENCY COSTS: Cost of financing the debtors for
extended period, and cost of additional steps to collect over-due
debtors.
DEFAULT COSTS: Amounts which are to be written off as
Bad-debts, which cannot be collected in spite of serious efforts.
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9. CREDIT POLICIES
It is the determination of credit standard and
credit analysis. The credit policy of a firm
provides the framework to determine whether
or not to extend credit to a customer and how
much credit to extend. The credit policy decision
of a firm has two dimensions.
A)CREDIT STANDARD-It is the minimum
requirement for extending credit to a customer.
B)CREDIT ANALYSIS-This involves obtaining credit
information and evolution of credit applicant.
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10. CREDIT STANDARDS
Following factors should be considered while deciding whether to relax credit
credit standards or not.
COLLECTION COST-The implications of relaxed credit standards
are more credit,a large credit departments to service accounts receivable and
increase in collection cost while opposite in case of strict credit standards.
AVERAGE COLLECTION PERIOD-The extension of trade
credit to slow paying customers would results in a higher level of accounts
receivable and vice versa.
BAD DEBT EXPENSES-Bad debt can be expected to increase with
relaxation in credit standards and vice versa.
SALES VOLUME-Sales volume is expected to increase as standards are
relaxed,conversely tightening decreases sales.
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11. CREDIT ANALYSIS
Two basic steps are involved in the credit investigation Process.
A)OBTAINING CREDIT INFORMATION-The first step in credit
analysis is obtaining the information which form the basis for the evaluation of
customers.The sources of information may be internal such as the historical
payment pattern of a customers,or may be external such as :
I)FINANCIAL STATEMENTS-The published financial statements such as
balance sheet and profit and loss account.
II)BANK REFERENCES-The firm’s banker collects the necessary information
from the applicant’s Bank.
III)TRADE REFERENCES-Reputed Credit organization are approached about
the credit worthiness of proposed customers.
IV)CREDIT BUREAU REPORTS-Credit Bureau reports from organization
which specializes in supplying credit information can also be utilized.11/3/2019 CA Sapna Bhupendra Jain 11

12. CREDIT ANALYSIS(CONTD)
B)ANALYSIS OF CREDIT INFORMATION-The
information collected from different sources are analyzed to determine
the credit worthiness of the applicant.The analysis should cover two
aspects:
I)QUANTITATIVE-The quantitative aspects is based on the
factual information available from the financial statements,the past
records of the firm’s and so on.
II)QUALITATIVE-The qualitative judgement would cover
aspects relating to the quality of management.
.
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13. STEPS IN CREDIT ANALYSIS
“Investing The Customers”
Customers Evaluation-The 5 C’s-
 CHARACTER- Reputation, Track Record
 CAPACITY- Ability to repay( earning capacity)
 CAPITAL- Financial Position of the co.
 COLLATERAL- The type and kind of assets pledged
 CONDITIONS- Economic conditions & competitive factors
that may affect the profitability of the customers11/3/2019 CA Sapna Bhupendra Jain 13

14. FACTORS AFFECTING SIZE OF
DEBTORS
LEVEL OF SALES: The most important factors in determining the
volume of Debtors is the level of credit sales. Others being constant ,more
credit sales mean more Debtors and vice versa.
 CREDIT TERMS: A change in credit terms will have a direct effects
on Debtors.When credit terms are relaxed in leads to a n increase in
Debtors balance and vice versa.
COLLECTION POLICY:Collection policy of a firm also has some
influences on the actual Debtors balance.Due to a relatively lax collection
policy,customers do not meet their commitments on time.
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15. CREDIT TERMS
Credit terms specify the repayments terms required of credit
customers. It has three components:
CREDIT PERIODS-It is the time for which trade credit is
extended to customers in the case of credit sales.
CASH DISCOUNTS-It is the incentive to customers to make
early payments of sum due.
CASH DISCOUNTS PERIOD-The duration of the period
during which discount can be availed off.
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16. BENEFITS
 INCREASED SALES-The impact of liberal trade policy result
in increased in sales volume.
 STREAMLINE REVENUE ALLOCATION-To fit
business needs calculations are managed.
 ENHANCE PRODUCTIVITY-The decrease in administrative
cost enhances productivity.
 HELPS IMPROVE CUSTOMER SATISFACTION-Enhances
service level and increase retention with customized information.
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17. Q.1- A Co. currently has an annual turnover of Rs. 10,00,000 and an
average collection period of 45 days. The co. wants to experiment
with a more liberal credit policy on the ground that increase in
collection will generate additional sales. Form the following
information, kindly indicate which of the policies you would like the
company to adopt :
Credit policy increase in credit period increase in sales % of
default
I 15 days Rs. 50,000 2%
II 30 days Rs. 80,000 3%
III 40 days Rs. 1,00,000 4%
IV 60 days Rs. 1,25,000 6%
The selling price of the product is Rs. 5, average cost per unit at
current level is Rs. 4 and the variable cost per unit is Rs. 3. The
current bad debts loss is 1% and the required rate of return on
investment is 20%. A year can be taken to comprise of 360 days.
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18. Q.2- Primer steel limited has a present annual sales turnover of Rs.
40,00,000. The unit sale price is Rs. 20. The variable cost are
Rs.15 per unit and fixed costs amount to Rs. 5,00,000 per
annum. The present credit period of one month is proposed to
be extended to either 2 or 3 months whichever will be more
profitable. The following additional information is available.
On the basis of credit period of
1 month 2 month 3 month
Increase in sales by - 10% 30%
% of bad debts to sales 1 2 3
Fixed costs will increase by Rs. 75,000 when sales will increase by
30%. The company requires a pretax return on investment at
20%. Evaluate the profitability of the proposals and recommend
best credit period for the co.
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19. Q.3 A ltd. are considering the liberation of existing
credit terms to three large customers. Relevant data:
Credit period (days) Quantity of sales
A B C
0 1,000 1,000 ---
30 1,000 1,500 ---
60 1,000 2,000 1,000
90 1,000 2,500 1,500
Selling price Rs. 9000/- per unit. Variable cost is 80%
of selling price. Cost of carrying debtors is 20% p.a.
Determine the credit period allowed to each
customer. Assume 360 days in a year.
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20. Q. 4 E ltd. is a company having an annual credit sales of Rs. 30 lakhs. It deals in only
one product. Currently it has an average collection period of 30 days. It is
anticipated that liberalisation of credit terms can lead to increased sales as
indicated below: -
Increase in collection period (days) Increase in sales (Rs. 000)
15 200
30 300
45 350
60 375
The unit selling price for the product is Rs. 50 and its unit variable cost is Rs. 30.
At current volume it has an unit total cost of RS. 35. It also noted that the
liberalisation of credit will lead to the following incidence of bad debts losses.
Policy Increased in collection period (days) Bad debts %
on sales
A 15 0.5
B 30 1.0
C 45 1.5
D 60 2.0
• Currently the company in free from bad debts losses. What will be the most
rewarding credit policy under these circumstances? The company expects a
return of 18% on investment. Tabulate your presentation. [Ans. 60 Days]
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21. Q. 5- A group of new customers with 10% risk of
non-payments desires to establish business
connection with you. This group would desire
one and a half months credit and is likely to
increase your sales by Rs.60,000 p.a. Cost of
sales would be 80% of sales. Tax rate 50%,
required rate of return is 40% (after tax), should
the new business connection be established?
Also state the degree of risk of non-payment
that you would be willing to assume if required
rate of return after tax were 30%.
[Ans. Accepted, Risk – 14%]
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22. Q. 6- A firm sells 40,000 units of its products per
annum at the rate of Rs.35 per unit. Variable
cost Rs.28. Average cost Rs.31. Credit period 60
days, Bad debts 3% of sales. Collection charges
Rs.15,000. The firm intends to reduce the credit
period to 45 days, it would reduce bad debts
equal to 1% of sales. Sales would be reduced by
1000 units and collection charges will increase
by Rs.10,000. Required rate of return 20%.
Assume 360 days a year. Advice.
[Ans. Accepted]
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23. Q. 7- A group of customers want to enter into a
contract with you to buy goods worth Rs. 20
lakh during 2019, deliveries to be made in four
equal installments quarterly. Sales price Rs. 20,
variable cost Rs. 10. Additional expenditure Rs.
10,000 p.a. 15% of amount of bills would be
received after 30 days, 25% after 60 days, 40%
after 90 days and 20% after 100 days. Assuming
an opportunity cost of 20% of funds locked up in
account receivables, will it be desirable to
accept the new proposals?
[Ans. Accepted]
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24. Q. 8- Slow payers a group of customers wants to purchase
goods of Rs.15 lakhs from your company. Deliveries have
to be made in equal quantities on the first day of each
quarter. Sale price Rs.150, Profit per unit Rs.5. Extra
expenditure Rs.5000 p.a. On an analysis pattern of
payment schedule emerges:
Schedule Pattern
• At the end of 30 days 15% of the bill
• At the end of 60 days 34% of the bill
• At the end of 90 days 30% of the bill
• At the end of 100 days 20% of the bill
• Non recovery 1% of the bill
If the opportunity cost of funds in the hands of your
company is 24% p.a., would you recommend dealing with
slow payers.
[Ans. Rejected]
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25. CONCLUSION
The framework of analysis of all decisions area in
receivables management is to secure a trade-off
between the costs and benefits off the
measurable effects on the sales volume, capital
costs due to change in investment in debtors
,collection costs, bad debts and so on. The firm
should select the alternative which has
potentials of more benefits than the costs.
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