Receivables Management

1. RECEIVABLES
MANAGEMENT
CMA Dr. Kinnarry Thakkar
Ph. D., ACMA, C.S., M.B.A.(Finance), M. Com.
Associate Professor,
Department of Commerce,
University of Mumbai

2. MANAGEMENT OF RECEIVABLES
Receivable is defined as “debt owed to the firm
by customers arising from sale of goods or
services in the ordinary course of business”.
A firm requires to allow credit to its customers
for expansion of sales.
Receivables contribute a significant portion of
current assets.

3. Objectives of Accounts Receivables
Initiate collection
procedure on
Overdue accounts
Optimum investment
in Debtors
Doubtful debts reduces
profit. Receivables policy
ensures timely and hassle
free settlement of bills
1.Reduction of costs by
optimum investment
in receivables.
2. Balance between liberal
credit sales and investment
in receivables
Maximizing value
of the firm
1. By achieving trade off
between risk and return
2. Retaining old customers
& attracting new customers

4. According to Bolton S the objective of
receivable 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”
OBJECTIVES

5. Costs associated with receivables management
COSTS
Collection costOpportunity Cost
Delinquency cost Default cost

6. Costs of Receivables Management
1. Opportunity costs: it is the cost for arranging
additional funds to support credit sales which
could be profitably employed elsewhere.
2. Collection costs: these are cost incurred in
collecting the debts from the customers to
whom the credit sales is made. These costs
include stationery, administration expenses,
expenses incurred for collecting information
about the credit standing of the prospective
customer.

7. Costs of Receivables Management
3.Delinquency cost: It arises if customers fail to
meet their obligations on due dates. It
involves blocking up of funds for an extended
period
4. Default cost: it is the cost incurred when the
customer is not able to honor the dues of the
firm. However these can be reduced if the
firm properly evaluates the customer before
granting credit.

8. Benefits of Accounts Receivables
Management
Benefits
Increase in
Market share
Increased Sales
Increase in profits Ideal credit
policy

9. Liberal
Goods are sold to
customers whose
creditworthiness is
not up to standard
Stringent
Goods are sold on credit
on a highly selective
basis, i.e only to the
customers who are
financially sound
Credit Policy

10. Liberal credit policy
Advantages
Increase in Sales
Higher Profits
Disadvantages
Bad Debt Loss
Liquidity Problem

11. Stringent credit policy
Advantages
Less Bad Debt Loss
Sound Liquidity
Position
Disadvantages
Less Sales
Less Profits

12. OPTIMUM LEVEL OF INVESTMENT IN TRADE RECEIVABLES
Profitability
Costs &
Profitability Optimum Level
Liquidity
Stringent Liberal

13. Credit Policy Variables
• Minimum criteria for the extension of credit to the
customer
• Credit rating, credit references, average payment
period & financial ratios provide a quantitative basis
for establishing and enforcing credit standards
Credit
Standards
• It means stipulations under which goods and
services are sold
• It includes three components: Credit period,
Cash discount & Cash discount period
Credit
Terms
• It is the procedures passed to collect
amount receivables, when they become due
• It is required because all customers do not
pay on the due date
Collection
Policy

14. Collection Policy
Technique Description
Letters Initially a polite letter of overdue account is sent. Later a more
demanding letter is sent to remind the customer about payment.
Telephone
calls
If the response from the letter is not positive a telephonic conversation
requesting the payment is done. If the customer is able to give
reasonable reasons the credit period can be extended.
Personal
visits
If telephonic calls could not serve the purpose a collection person is
send requesting on the spot payment.
Collection
agencies
A firm can appoint collection agencies to collect the amount overdue.
The collection agencies can exercise all the rights necessary for
collection of amount from defaulting customers.
Legal action This is the last resort available to the firm for collection of overdue.
Legal action has different consequences, like the debtor might be
declared bankrupt and there will be remote chances of recovering the
money.

15. Steps in Credit Evaluation
1. Obtaining credit Information
2. Analyzing the information
3. Making the credit decision

16. Steps in Credit Evaluation
OBTAINING CREDIT INFORMATION:
The firm should ensure that the individual has the
capability to make payment on time. This requires
evaluation of accounts, which can be done from
(a) Internal sources & (b) External sources.
Internal source is available only for existing
customers. If an existing customer asks for
extension of credit the firm may grant credit on
the basis of the past records.

17. External sources of information
1. Financial statement
2. Bank references
3. Trade references
4. Credit rating agencies
5. Field visit

18. Analysis of Information
The general aspects of analysis include
QUANTITATIVE & QUALITATIVE analysis.
Quantitative analysis is done on the basis of
financial statements and firms past records.
Various ratios like liquidity ratio, profitability
ratio can be used. A comparison of firm’s ratios
with the standard / industry ratio helps in
identifying the credit standing of the customer.

19. Six C’s of credit
Character:
It is moral integrity &
willingness to make
payment
Capacity:
It is the ability of the
prospective customers to
pay (Cash Flow)
Capital:
It is the financial position
of the company with
special reference to net
worth and profitability
Case history:
In case of existing
customers past record
can be used
Collateral:
The type of assets the
potential customer
pledges against the credit
Conditions:
The general position of
the business, economic
conditions & competitive
factors.

20. Making credit Decision
Actual creditworthiness is compared with
standards, if actual creditworthiness is
above the standards, credit is granted.

21. Techniques of Monitoring
Accounts Receivables
1. Receivables turnover: It provides the
relationship between credit sales and debtors. It
indicates how quickly the receivables are
converted into cash.
Debtors Turnover rate = Credit sales
Average net Debtors

22. Techniques of Monitoring
Accounts Receivables
2. Average Collection period: It indicates the
time period of taken by the firm to convert sales
made into cash.
Average Collection period =
Number of days in year
Debtors turnover ratio

23. Techniques of Monitoring
Accounts Receivables
3. Aging Schedule:
The average collection period measures quality of
receivables in an aggregate manner. However aging
schedule is a statement that shows age wise grouping
of debtors. It helps in identifying slow pay debtors. It
breaks down debtors according to the length of time
for which they have been outstanding.

24. Hypothetical Aging schedule
Age Group (in
days)
Amount
Outstanding
Percentage of
Debtors to total
debtors
Less than 30 40,00,000 40
31 – 45 20,00,000 20
46 – 60 30,00,000 30
Above 60 10,00,000 10
Total 1,00,00,000 100

25. Techniques of Monitoring
Accounts Receivables
4. Collection Matrix:
It is a statement showing percentage of
receivables collected during the month of sales
and subsequent months. It helps in studying the
efficiency of collections whether they are
improving or deteriorating.

26. Hypothetical Collection Matrix
Percentage of
receivables collected
during the
April May June July August
Sales ( in lakhs) 350 340 320 300 250
Month of sales 10 12 14 11 08
First month following 30 38 40 30 34
Second month following 25 24 22 20 21
Third month following 20 26 22 19 18
Fourth month following 15 10 02 15 20
Fifth month following - - - 05 09

27. Changing Credit Standards
The firm may sometimes contemplate changing its credit policy to improve
its returns. The figure shows the effects on profit due to change in policy
Sales
Investment in
receivables
Bad debts
Increase
Increase
Increase Negative
Negative
Positive
Variable Direction of Change Effects on profits

28. FORMAT- Evaluation of Credit Policies
Present Policy Option 1 Option 2
Sales
Less : Variable Cost
Contribution
Less : Fixed Costs
Profits/ Benefits (A)
Total Costs = Variable Cost + Fixed Cost
Average Investments in Receivables
Costs of Extending Credit
1. Opportunity cost (% of Average
Investment
2. Bad debts
3. Administration costs
TOTAL COSTS (B)
Net Benefits (A –B)

29. Illustration 1
In order to increase sales from the normal level of 2,40,000 p.a., the
marketing manager submits a proposal for liberalizing credit policy as
under: The credit period allowed presently is 30 days.
The P/V ratio of the company is 33.33%. The company expects a return
on investment of 20%. Evaluate the above alternatives and advice.
Assume 360 days in a year.
Proposed increase in credit
period beyond normal 30 days
Relevant increase over
normal sales
15 days 12,000
30 days 18,000
45 days 21,000

30. Solution 1 ( )
Present Policy
30 days
Option 1
45 days
Option 2
60 days
Option 3
75 days
Sales 2,40,000 2,52,000 2,58,000 2,61,000
Less : Variable Cost 1,60,000 1,68,000 1,72,000 1,74,000
Contribution 80,000 84,000 86,000 87,000
Less : Fixed Costs Not Available N.A N.A N.A
Profits/ Benefits (A) 80,000 84,000 86,000 87,000
Total Costs = Variable + Fixed Cost
Average Investments in Debtors (As
F.C is not given, Investments=Sales
2,40,000 X
30/360 =
20,000
2,52,000
X 45/360
= 31,500
2,58,000
X 60/360
= 43,000
2,61,000
X 75/360
= 54,375
Costs of Extending Credit
1. Opportunity cost 20% of 4,000 6,300 8,600 10,875
2. Bad debts Nil Nil Nil Nil
3. Administration costs Nil Nil Nil Nil
TOTAL COSTS (B) 4,000 6,300 8,600 10,875
Net Benefits (A –B) 76,000 77,700 77,400 76,125

31. Practice Problem
Tanay Ltd gives the following information.
The variable cost is 70% of sales. The company expects a
return on investment of 25%. Evaluate the above alternatives
and advice.
Present policy
3 months
Plan I
4 months
Plan II
5 months
Sales 50,00,000 60,00,000 67,50,000
Fixed Cost 3,00,000 3,00,000 3,75,000
Bad Debts 1,50,000 3,00,000 4,50,000

32. Solution 2 ( )
Present policy
3 months
Plan I
4 months
Plan II
5 months
Sales 50,00,000 60,00,000 67,50,000
Less : Variable Cost 35,00,000 42,00,000 47,25,000
Contribution 15,00,000 18,00,000 20,25,000
Less : Fixed Costs 3,00,000 3,00,000 3,75,000
Profits/ Benefits (A) 12,00,000 15,00,000 16,50,000
Total Costs = Variable + Fixed Cost
Average Investments in Debtors (As
F.C is not given, Investments=Sales
38,00,000 X
3/12 =
9,50,000
45,00,000 X
4/12 =
15,00,000
51,00,000 X
5/12 =
21,25,000
Costs of Extending Credit
1. Opportunity cost 25% of 2,37,500 3,75,000 5,31,250
2. Bad debts 1,50,000 3,00,000 4,50,000
TOTAL COSTS (B) 3,87,500 6,75,000 9,81,250
Net Benefits (A –B) 8,12,500 8,25,000 6,68,750

33. Practice Problem
Tanay Ltd gives the following information.
The P/V ratio of the company is 30%. The company expects a
return on investment of 20%. Evaluate the above alternatives
and advice.
Present policy
20 days
Plan I
40 days
Plan II
70 days
Plan III
100 days
Sales 15,00,000 16,00,000 18,00,000 21,00,000
Fixed Cost 3,00,000 3,00,000 4,00,000 4,00,000
Bad Debts (%) 0.25 0.5 1 2.5

34. Solution ( )
Presently
20 days
Option 1
40 days
Option 2
70 days
Option 3
100 days
Sales 15,00,000 16,00,000 18,00,000 21,00,000
Less : Variable Cost 10,50,000 11,20,000 12,60,000 14,70,000
Contribution ( 30% of sales) 4,50,000 4,80,000 5,40,000 6,30,000
Less : Fixed Costs 3,00,000 3,00,000 4,00,000 4,00,000
Profits/ Benefits (A) 1,50,000 1,80,000 1,40,000 2,30,000
Total Costs = Variable + Fixed Cost
Average Investments in Debtors (As
F.C is not given, Investments=Sales
13,50,000 X
20/365 =
73972
14,20,000
X 40/365
= 155616
16,60,000
X 70/365
= 318356
18,70,000
X 100/365
= 512328
Costs of Extending Credit
1. Opportunity cost 20% of 14795 31123 63671 102466
2. Bad debts 3,750 8,000 18,000 52,500
TOTAL COSTS (B) 18,545 39,123 81,671 1,54,966
Net Benefits (A –B) 1,31,455 1,40,877 58,329 75,034