receivables management
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RECEIVABLESMANAGEMENT
“Any fool can lend money, but it takes a lot of skill to get it
back”
Group Members Roll No
Tushar Bhirade 8
Rohan Cambell 11
James Fernandes 20
Chanky Jain 33
Ajinkya Lavate 49
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What are receivables?
•Receivables are sales made on credit basis.
Why do we need receivables?
•To increase total sales
•To increase profits
•To meet increasing Competition
Understanding Receivables
•As a part of the operating cycle
•Time lag between sales and receivables creates
need for working capital
Receivables
Inventory
Cash
Operating Cycle
INTRODUCTIONR
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ADMINISTRATIVE COST: Administrative costs In form of salaries to clerks who maintain records of debtors, expenses on investigating the creditworthiness of debtors, etc.
CAPITAL COST:Cost incurred in terms of interest (if financed from outside) or opportunity cost (if internal resourses they could have been put to some other use)
COLLECTION COST Cost incurred for collection of amounts at the appropriate time from the customers.
DEFAULTING COST: Amounts which have to written off as bad debts.
DIFFERENT TYPES OF COSTS ASSOCIATEDR
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• 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
OBJECTIVESR
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Customer Evaluation- The 5 C’s
Character- Reputation, Track Record
Capacity- Ability to repay( earning capacity) (The working capital position and profitability)
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 customer
STEPS IN CREDIT ANALYSIS “Investigating the customer”
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CREDIT POLICY
- Whether and how much credit to be extend Determination of (1)Credit Standard (2) credit analysisImportant aspect of Credit Policy a. Credit Standard b. Credit Period c. Cash Discount
CREDIT POLICYR
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1.CREDIT STANDARDBasic criteria or minimum requirement for
extending credit to customer
LIBERAL CREDIT STIFF CREDIT
1. Pushes up the sales 1. Pushes down the sales
2. Higher incidence of Bad Debt 2. Less incidence of Bad Debt
3. Large investment in a/c receivable
3. Less investment in a/c receivable
4. Higher Cost Of Collection 4. Less Cost Of Collection
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2.CREDIT PERIOD
• Length of time the customer allowed to pay for their purchases
• Does not grant Credit → Zero
Longer Period of Credit Shorter Period of Credit
Increases sales Decreases sales
Increases investment in a/c receivable
Decreases investment in a/c receivable
Higher incidence of bad debt
Less incidence of bad debtRE
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3.CASH DISCOUNT
• Offer to customer in order to induce them to pay promptly.
• Percentage Discount and period are reflected in Credit terms
• Ex. 5 / 10, net 45
• Liberalized cash discount → increases sales → Reduces avg. collection period
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Collection Efforts
Monitoring Receivable↓
Sending Letters↓
Telegraphic Advice↓
Threat of Legal action (overdue)↓
Legal Action
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When the financial statements are obtained the financial strengths and weaknesses can be gauged by the application of ratio analysis. Some of the important ratios are
Current Assetsa) Current ratio = ---------------------- Current Liabilities
Current Assets - Inventoryb) Quick ratio = ----------------------------------------- Current Liabilities
The above two ratios are widely used to assess the liquidity position of a company in meeting its short-term obligations.
STEPS IN CREDIT ANALYSIS “Investigating the customer by Ratio Analysis”
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Average Balance of sundry Creditors c) Average payment period = ----------------------------------------------------- Average Daily Credit Purchases
Average Balance of sundry Debtors d) Average collection period = ----------------------------------------------------- Average Daily Credit Sales
Debte) Capital Structure ratio = ------------ Equity
Net profit after tax and preference share dividend
f) Return On Equity = ----------------------------------------------------------------- Owner Equity
STEPS IN CREDIT ANALYSIS “Investigating the customer by Ratio Analysis”
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What the Ratios indicate……..???
• Payment period
• Collection period
• Return on owners equity.
• It throws light on the financial strength of the company and whether the trend over the years is favourable or not.
STEPS IN CREDIT ANALYSIS “Investigating the customer”
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• Financial statements: long term, short term solvency etc can be judged
• Bank references: information about the customer from another bank
• Trade references: information about customer obtained from firms based on their experiences
• Credit bureaus: to check the financial viability of the business (Credit rating agencies)
• Third party guarantees
• Field visit: to get information of the existence and general condition of the customer’s business
STEPS IN CREDIT ANALYSISR
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STEPS IN CREDIT ANALYSIS “Credit Evaluation Report on X co. Ltd”
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Item Head For X co. Ltd
Standard Remark
Current Ratio
Quick Ratio
Average Payment Period
Average Collection Period
Debt - Equity Ratio
Return On Equity
1.70
1.15
45 Days
40 Days
1.5 : 1
15 %
1.75
1.00
40 Days
30 Days
2 : 1
18 %
Liquidity position is good
Can be persuaded to pay within 40 days.This may have caused delay in payments.Lower because of capital structure.
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STEPS IN CREDIT ANALYSIS “Risk Classification Scheme”
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Risk Class Description
1. Customer with no risk of default
2. Customer with negligible risk of default ( default rate less then 2 % )
3. Customer with a little risk of default ( default rate between 2 % and 5 % )
4. Customer with some risk of default ( default rate between 5 % and 10 %)
5. Customer with significant risk of default ( default rate in excess of 10 % )
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• Helps improve customer satisfaction: enhance service level and increase retention with customized information.
• Takes control of sales processes: manage your sales process more effectively by measuring trends and analyzing performance.
• Enhance your productivity: help reduce administrative costs and enhance office productivity
• Streamline revenue allocation: managed calculations to fit your business needs
• Providing access to vital information
BENEFITSR
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The probability of receiving the payment or defaulting the payment by the customer.
The Rex company is considering offering credit to customer. The probability that the customer would pay is 0.9 and the probability that the customer would default is 0.1. The revenues form the sale would be 80,000 and the cost of sale would be 60,000.
If the customer pay, the company gets a profit of Rs.20,000 while it losses Rs.60,000 if he fails to pay.
CREDIT GRANTING DECISION “DECISION- TREE APPROACH”
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Credit Granting Decision : Decision – tree Approach
The weighted net benefit is Rs.20,000 * 0.9 – Rs.60,000 * 0.1 = 12,000.Hence it is preferable to grant credit as the weighted net benefit is
positive.
CREDIT GRANTING DECISION “DECISION- TREE APPROACH”
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• Sunshine Industries is considering offering credit to a customer. The probability that the customer would pay is 0.5 % and the probability that the customer would default is 0.5 %.
• Revenue from the sale = Rs 2500• Cost of sale = Rs 1700• The expected profit from offering credit
0.5 ( 2500 – 1700 ) – 0.5 (1700) = - 500• As this is negative the company cannot offer credit.
CREDIT GRANTING DECISION “DECISION- TREE APPROACH”
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• Centralised / Decentralised collection system
• Post – dated cheques
• Pay Orders / Bank drafts
• Bills of Exchange
• Lock – box System
• Drop – box System
• Collection staff/ agents
• Debt collector
• Del Credere agent
• Concentration banking
COLLECTION METHODSR
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• Centralised / Decentralised collection system
• Post – dated cheques
• Pay Orders / Bank drafts
• Bills of Exchange
• Lock – box System
• Drop – box System
• Collection staff/ agents
• Debt collector
• Del Credere agent
• Concentration banking
COLLECTION METHODSR
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Under a lock box system, customers are advised to mail their payments to special post office boxes called lockboxes, which are attended to by local collection banks, instead of sending them to corporate headquarters.
Thus the lock box system: (i) cuts down the mailing time, because Cheque are received at a nearby post office instead of at corporate headquarters, (ii) reduces the processing time because the company does not have to open the envelopes and deposit the Cheque for collection, and (iii) shortens the availability delay because the Cheque are typically drawn on local banks
Thank You
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• Centralised / Decentralised collection system
• Post – dated cheques
• Pay Orders / Bank drafts
• Bills of Exchange
• Lock – box System
• Drop – box System
• Collection staff/ agents
• Debt collector
• Del Credere agent
• Concentration banking
COLLECTION METHODSR
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an agency, factor, or broker acting as an intermediary between sellers and buyers and guaranteeing payment
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• Centralised / Decentralised collection system
• Post – dated cheques
• Pay Orders / Bank drafts
• Bills of Exchange
• Lock – box System
• Drop – box System
• Collection staff/ agents
• Debt collector
• Del Credere agent
• Concentration banking
COLLECTION METHODSR
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A firm may open collection centres (banks) in different parts of the country to save the postal delays. This is known as concentration banking.
The firm may instruct the customers to mail their payments to a regional collection centre / bank rather than to the Central Office
The Cheque received by the regional collection centre are deposited for collection into a local bank account
The concentration banking results in saving of time of collection
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1) Day Sales Outstanding
2) Ageing Schedule
3) Collection Matrix
MONITORING RECEIVABLES(Measures for Monitoring Receivables)
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• The average number of day’s sales outstanding at any time, say end of the month or end of the quarter, is obtained by following the formula.
Accounts receivable at time chosen• Day’s sales outstanding = --------------------------------------------
Average daily sales
CONTROL OF RECEIVABLES MANAGEMENT(Day Sales Outstanding)
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SALES AND RECEIVABLES DATAR
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Month Sales Receivables Month Sales Receivables
January
February
March
April
May
June
200
225
230
150
150
180
460
360
315
310
300
320
July
August
September
October
November
December
200
200
220
230
245
250
340
360
360
390
500
520
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AVERAGE COLLECTION PERIODR
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Quarter Average Collection Period
First
Second
Third
Fourth
315 ----------------------------------------------------------------------------- = 43 days ( 200 + 225 + 230 ) / 90 days
320 ------------------------------------------------------------------------------ = 61 days (150 + 150 + 180) / 91 days 360 ------------------------------------------------------------------------------ = 53 days (200 + 200 + 220) / 92 days
520 ------------------------------------------------------------------------------ = 66 days (230 + 245 + 250) / 92 days
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Classifies the outstanding accounts receivables at a given point of time into different age brackets.
Ex.
Age Group (days) % of receivables
0-30 30
31-60 40
61-90 25
>=90 5
AGEING SCHEDULER
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• In order to study correctly the changes in the payment behavior of customers, it is helpful to look at the pattern of collection associated with credit sales. From the collection pattern one can judge whether the collection in improving, stable or deteriorating.
COLLECTION MATRIXR
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COLLECTION MATRIXR
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% of receivables collected during the month
January sales
February sales
March sales
April sales
May sales
June sales
Month of sales
First following Month
Second following month
Third following month
Fourth following month
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35
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40
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9
35
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31
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• ABC Analysis of Receivables
A – Represents a small proportion of accounts of debtors representing a large value
B – Represents moderate value
C – Represents a large number of accounts of debtors but representing a small amount
CONTROL OF RECEIVABLES MANAGEMENTR
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Category % of accounts to Total Accounts
% of Balance Outstanding to Total
Debtors’ Balance
A 15 75
B 35 20
C 50 5
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PROFORMAR
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Credit Policy Present Policy Option 1 Option 2 Option 3
Credit Period (days/ weeks/months) xx xx xx xx
Particulars Rs. Rs. Rs. Rs.
Sales xxxx xxxx xxxx xxxx
Less: Variable Cost xx xx xx xx
Contribution xxx xxx xxx xxx
Less: Fixed Cost xx xx xx xx
Profit [Benefits (A)] xxx xxx xxx xxx
Total Cost= Variable Cost +Fixed Cost
Average Investment in Receivables (Based on Total Costs)
xxx xxx xxx xxx
Costs of Extending Credit:
1) ____ % Opportunity Cost of Capital (Calculated on Avg. Invst. in Receivables)
xx xx xx xx
2) Bad debts as % of Sales xx xx xx xx
3) Credit Collection and Admin costs xx xx xx xx
Total Costs [B] xxxx xxxx xxxx xxxx
Net Benefits [A-B] xxx xxx xxx xxx
Incremental Net Benefits --- xx xx xx
Type A- If Fixed Costs is given
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Credit Policy Present Policy Option 1 Option 2 Option 3
Credit Period (days/ weeks/months) xx xx xx xx
Particulars Rs. Rs. Rs. Rs.
Sales xxxx xxxx xxxx xxxx
Less: Variable Cost xx xx xx xx
Contribution [Benefits (A)] xxx xxx xxx xxx
Average Investment in Receivables (Based on Sales)
xxx xxx xxx xxx
Costs of Extending Credit:
1) ____ % Opportunity Cost of Capital (Calculated on Avg. Invst. in Receivables)
xx xx xx xx
2) Bad debts as % of Sales xx xx xx xx
3) Credit Collection and Admin costs xx xx xx xx
Total Costs [B] xxxx xxxx xxxx xxxx
Net Benefits [A-B] xxx xxx xxx xxx
Incremental Net Benefits --- xx xx xx
Type B: If Fixed costs is NOT given.
PROFORMAR
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• Though various techniques have been discussed here for the management of accounts receivable, in practice very few Indian companies have a stated and systematic credit policy.
Companies have to :-
1.Strengthen their management of receivables.
2. State explicit and articulate credit policies.
3. An efficient collection program.
4. Better co ordination between production , sales , and finance departments .RE
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