Receivable Management

Receivable Management
 Meaning:-
 Receivables represent amounts owed to the firm as a result of sale of goods or services
in the ordinary course of business. These are claims of the firm against its customers and
form part of its current assets. Receivables are also known as account receivables, trade
receivables, or book debts. The receivables are carried for the customers. The period for
credit and extent of receivables depends upon the credit policy followed by the firm. The
purpose of maintaining or investing in receivables is to meet competition, and to increase
the sales and profits.
 “Receivables management is the process of making decisions relating to an investment
in trade debtors. If you want to increase sales turnover and profits of the firm, you have to
sale goods on credit basis, which includes the risk of bad debts. The objective of receivables
management is “to promote sales and profits until that point is reached where the return
on investment in funding of receivables is less than the cost of funds raised to finance that
additional credit”
 Objectives of Receivable Management
 Monitor and Improve Cash Flow: Receivable management monitors and control all cash
movements of organizations. It maintains a systematic record of all sales transactions.
Receivable management helps business in deciding appropriate investment in trade debtors. It
aims that a sufficient amount of cash needed for day-to-day activities is maintained at business.
Credit facilities are extended by doing proper analysis and planning to ensure optimum cash
flow in a business organization.
 Minimizes bad debt losses: Bad debts are harmful to organizations and may lead to heavy
losses. Receivable management takes all necessary steps to avoid bad debts in business
transactions. It designs and implement schedules for collection of outstanding amount timely
and informs the collection department on due dates. Customers are notified for amount
standing against them and charges interest on delay in payments.
 Avoids invoice disputes: Receivable management has an efficient role in avoiding
any disputes arising in business. Disputes adversely affect the relationship between
customers and business organizations. Complete and fair record of all transactions with
customers are maintained on a daily basis. There is no chance of confusion and dispute
arising as all sales transactions are accurately maintained.
 Boost up sales volume: Receivable management increase the sales and the
profitability of the organization. By extending the credit facilities to their customers
business are able to boost up their sales volume. More and more customers are able to
do transactions with the business by purchasing products on a credit basis. Receivable
management helps business in managing and deciding their investment in credit sales.
This leads to increase in the number of sales and profit level.
 Improve customer satisfaction: Customer satisfaction and retention are key goals
of every business. By lending credit, it supports financially weaken customers who can’t
purchase business products fully on a cash basis. This strengthens the relationship
between customer and organization. Customers are happy with the services of their
business partners. Receivable management help in organizing better credit facilities for
their customers.
 Helps in facing competition: Receivable management helps in facing stiff
competition in the market. Several competitors existing in market offers different
credit options to attract more and more customers. Receivable management process
analysis all information about market and helps the business in farming its credit lending
policies. Customers are provided better services by extending credit at convenient
rates. Appropriate amount and rates of credit transactions can be easily decided through
receivable management process. All credit and payment terms are decided for every
customer as per their needs.
 Cost of Maintaining Receivables.
 The allowing of credit to customers means giving of funds for the customer’s use. The concern incurs
the following costs on maintaining receivables:-
 COST OF FINANCING: The credit sales delay the time of sales realization & therefore the time gap
between incurring the cost & the sales realization is extended. This results in the blocking of funds for
a longer period. The firm, on the other hand, has to arrange funds to meet its own obligations towards
payment to the supplier, employees etc., and these funds are to be procured at some explicit or
implicit cost. This is known as the cost of financing the receivables.
 ADMINISTRATIVE COST: A firm will also be required to incur various costs in order to maintain
the record of credit customers after the credit sales
 DELINQUENCY COST: The firm has to incur additional costs known as delinquency costs if there
is a delay in the payment by a customer. The firm may have to incur costs on reminders, phone calls,
postages, legal notices etc. There is always an opportunity cost of the funds tied up in the receivables
due to delays in payment.
 COST OF DEFAULT BY THE CUSTOMER: If there is a default by the customer & the receivables
become partly or wholly, unrealizable, then this amount is known as bad debt, also becomes a cost to
the firm. This cost does not appear in the case of sales.
 BENEFITS OF RECEIVABLES
 INCREASE IN SALES: Most of the firms sell goods on credit, either because of trade
customs or other conditions. The sales can be further increased by liberalizing the credit
terms. This will attract more customers to the firm resulting in higher sales & growth of the
firm.
 INCREASE IN PROFITS: Increase in sales help the firm to easily increase the operating
profit of the firm.
 EXTRA PROFIT: Sometimes, the firm makes the credit sales higher than the usual cash
selling price. This brings an opportunity to the firm to make extra profit over & above the
normal profit.
 Factors influencing the size of Receivables.
 Size of credit sales.
 Credit policies.
 Terms of trade.
 Expansion plans.
 Relation with profits.
 Credit collection efforts.
 Habits of customers.
 Issues of Receivable Management:
 The management of receivables is a very critical area in the total working capital
management as it can be very costly and time-consuming activity. The efficient receivables
management results ample opportunities for a firm to achieve advantages through
improvements in customer service, cash management and reductions in costs. The
management of receivables can be divided into:
 (i) Credit Policy
 (ii) Credit Analysis
 (iii) Collection Policy
 Credit policy
 Credit policy: It covers the questions concerning terms of credit, credit limits, discounts,
etc. A business firm is not required to accept the credit policies employed by its competitors,
but the optimal credit policy cannot be determined without considering competitors’ credit
policies. A firm’s credit policy has an important influence on its volume of sales, and thus on
its profitability. Therefore, a firm should have a well expressed and written credit policy for
the purpose of attaining the efficiency in cash flow, clarity of objectives, good customers’
relations, etc.
 Types of Credit Policies:
 The credit policy will never be balanced unless managed with all precautions. A rider on horse
if not careful will get slipped. Similarly, if the credit policy is not carefully designed, it will
end- up in losses. The credit policies are different types.
 a) Liberal credit policy: Under this policy, the firm is ready to sell more on credit so as to
maximize the sales. Profits will increase in liberal credit policy as a result of increased sales.
More sales by way of liberal credit policy would also give rise to bad debts and losses there
upon.
 b) Stringent credit policy: The firm is highly careful in extending credit to customers. The
financial manager through rigid standards often sacrifices profitable sales opportunities and
profits in the name of rigid and cautious credit norms. Therefore, the objective of profit
maximization is partially fulfilled.
 c) Optimum credit policy: Optimum Credit policy is one, which maximizes the firm’s
value.
 Optimum Credit Policy
 To achieve this goal the evaluation of an investment in receivables should involve the
estimation of incremental operating profit; investment in receivables; estimation of the rate of
return of investment; comparison of the rate of return with the required rate of return Sales
increase by credit extension is associated with bad debt costs, because of defaulting accounts.
Though return on credit sales increases firm’s returns, simultaneously firm’s liquidity is
affected because of slow recovery of debts and at times no recovery of some of the debts .
 The analysis of the determination of optimum credit policy involves analysis of opportunity
cost of lost contribution and credit administration costs and bad debt losses.
An optimum credit policy covers the following aspects:
i) Investment in receivables: Financial manager has to offer certain sales on credit, which
means the credit sales is financed by the firm. Firms if rich in cash, credit extension is desirable.
If firms are not strong financially, finance has to be obtained from outside which means inviting
interest burden that goes to reduce profitability of the firm. So, financial manager has to reduce
the capital tied up on credit sales.
ii) Terms of credit: If credit terms are not competitive it will affect sales and consequently the
shareholders’ wealth. Here terms refers to what is the price if sold for cash, otherwise, what is
the credit period and cash discount, how much percentage for how many days are the issues. Like
wise the financial manager has to decide as and when situation arises.
 iii) Credit Standards: Credit standards have a bearing on sales of the firm. These standards
refer to minimum requirements for the evaluation of credit worthiness of a customer. The
company may be liberal or strict in defining the requirement in getting credit. The standards
imposed by the company are to assess the credit worthiness of customers. As long as company’s
profitability is higher, it can lower credit standards, which it would adversely, affect the sales.
Following are the effects of lowering the credit standards.
a) Rise in sales
b) Rise in collection period
c) Rise in accounts receivables
d) Rise in bad debts
e) Increase in servicing costs of accounts receivables
 Credit Analysis
 After establishing the credit policy, the firm should conduct the credit analysis for evaluating
the capabilities of the customers.
 The credit analysis would broadly divided into two steps, i.e.,
 obtaining credit information,
 and analysis of credit information.
 It is on the basis of credit analysis that the decision to grant credit to a customer as well as the
quantum of credit would be taken. The credit information may provide some insights about the
creditworthiness of the customer with respect to the character, capacity, capital, condition, cost and
collateral.
Besides establishing a credit policy, a firm should develop procedures for evaluating credit applicants.
The first step in the credit analysis is obtaining the credit information. The sources of information
broadly divided into internal and external. The internal source of information is derived from the
records of the firms contemplating an extension of credit. On the other hand the information available
from external sources are financial statements of the customer, bank references, trade references
credit bureau reports, etc.
 Collection Policy
 The third area involved in receivable management is collection policies. The firm should
follow a well laid down collection policy and procedure to collect dues from its customers.
The collection policies cover two aspects, i.e., the degree of effort to collect the over dues,
and the type of collection efforts. The collection policies may be classified into strict and
liberal. The effects of tightening the collection policy would be to decline in sales, debts,
collection period, interest costs and an increase in collection costs and whereas, the effects
of a lenient policy would be exactly the opposite.
 Firms should be practical in their approach to collecting credit sales through regular
correspondence, personal calls, telephone contacts, etc. The sudden reminders will not
make the collection programs effective unless they take follow-up action and maintain
personal relations. If the collection policy is not effective the company will incur large
expenses and fail to be ‘fund-rich.
 Credit control
The following actions are more helpful to bring the management of accounts receivables under control.
i) Prompt invoicing: Even after delivery, invoicing is made slowly. This will give impression to the
customers that invoice has not yet reached. After receiving the invoice, he starts calculating the
credit period from the day he has received the invoice. So to quicken the collection, the suppliers
should dispatch invoice immediately.
ii) Open item accounts: In many firms, ways of collections are very slow and many invoices are
turning to be bad debts due to lack of information such as which invoice in which stage. All the
amount of each invoice is not collected at one time. Practically amounts are made partially and the
payment is computed over a period of time. So for effective control the financial manager should
have information invoice-wise, product-wise, division-wise, etc. and all these particulars be
collected month-wise so that follow-up action can be initiated.
iii) Personal touch: A credit manager has to be in touch with the customer personally if possible.
Otherwise contact them over-phone at-least, so that the customer will be serious and clear the
pending dues. This kind of follow-up will bring the accounts receivables under control rather than
regular reminders, where the customers act mechanically.