Receivables Management

1. Introduction
Management of receivables refers to planning and controlling of 'debt' owed to the firm
from customer on account of credit sales. It is also known as trade credit management. The
basic objective of management of receivables (debtors) is to optimize the return on
investment on these assets.

When large amounts are tied up in receivables, there are chances of bad debts and there will be
cost of collection of debts. On the contrary, if the investment in receivables is low, the sales may
be restricted, since the competitors may offer more liberal terms. Therefore, management of
receivables is an important issue and requires proper policies and their implementation.

2. Importance of Receivables Management

Key Importance of Receivables Management:

 Ensures Smooth Cash Flow: Converts sales on credit into cash quickly, providing funds for
payroll, inventory, and expenses.

 Reduces Bad Debt & Risk: Proactive credit checks and monitoring minimize losses from
customers who can't or won't pay.

 Supports Business Growth: Available cash allows for reinvestment, hiring, and expansion
without relying solely on external financing.

 Maintains Healthy Customer Relations: Clear policies, timely invoices, and responsive
service build trust and loyalty, encouraging repeat business.

 Improves Financial Health: Provides data for key metrics (like Days Sales Outstanding) that
reveal operational efficiency and financial stability.

 Optimizes Sales: Allows businesses to offer competitive credit terms that attract more
customers while managing risk.

3. Cost of Maintaining Receivables

Cost of maintaining receivables is:

1. Cost of Capital/Financing: Funds tied in receivables (credit sales) can't be invested

elsewhere, so this is the lost opportunity, often calculated as (Average AR Balance × Cost of
Capital/Required Rate of Return).

2. Administrative Costs: Expenses for the credit department, like salaries, stationery, and
managing accounts.

3. Collection Costs: Expenses for chasing late payments (salaries, communication, collection
agencies).
4. Bad Debt/Default Costs: The actual loss when customers simply don't pay, a significant risk
with credit sales.

5. Cash Discount Costs: Cost of offering discounts (e.g., 2/10 net 30) to encourage early
payment, which reduces the average collection period and capital tied up.

4. Impact of Credit Policy (Credit Standard, Credit Period, Cash Discount, Collection
Program)
A credit policy significantly impacts a company's cash flow, profitability, and growth by
setting rules for extending credit, balancing sales opportunities with financial risk, and
managing collections, affecting liquidity, customer loyalty, and overall financial stability for
both businesses and the broader economy.

1. Credit Standards (Who gets credit?)

Stricter standards reduce sales but lower bad debts, costs, and investment in receivables;
liberal standards boost sales/market share but increase risks (losses, admin, capital tied up).

2. Credit Period (How long to pay?)

Longer periods attract more sales (competitive edge) but delay cash, increasing working
capital needs and risk; shorter periods improve cash flow but might deter buyers.

3. Cash Discount (Incentive to pay early?)

Offers like "3/10, net 60" encourages early payment, improving cash flow and reducing
average collection days, but add cost (the discount itself).

4. Collection Program (How to chase late payments?)

Aggressive collection reduces bad debts and speeds up payments but can damage customer
relations and sales; lax collections risk higher losses and slow cash.

5. Credit Evaluation and Monitoring Receivables

5.1 Credit Evaluation

Credit evaluation is the process lenders use to assess a borrower's creditworthiness and
ability to repay a loan by analysing their financial history, income, debts, and credit score,
using tools like the "5 Cs of Credit" (Character, Capacity, Capital, Collateral, Conditions) to
gauge risk and determine loan terms, aiming to minimize default risk and ensure financial
health

5.1.1 Key Components of Credit Evaluation:

 Credit History/Score: Past repayment behaviour, length of credit history, types of credit
used.

 Income & Capacity: Ability to generate income (salary, investments) and manage current
debts (Debt-to-Income ratio)
 Assets & Capital: What the borrower owns (savings, property) that could be used as security
or to repay debt.

 Collateral: Assets pledged as security for the loan.

 Character: The borrower's reputation and willingness to repay.

 Conditions: The purpose of the loan, economic conditions, and loan terms.

5.2 Monitoring Receivables

Constant monitoring of the current status of receivables is very essential for any
organization to make sure that its receivables management is as effective as it should
be. Various steps that constitute constant monitoring are:
(i) Computation of average age of receivables: It involves computation of average
collection period.

(ii) Ageing Schedule: When receivables are analysed according to their age, the process is
known as preparing the ageing schedules of receivables. The computation of average
age of receivables is a quick and effective method of comparing the liquidity of
receivables with the liquidity of receivables in the past and also comparing liquidity of
one firm with the liquidity of the other competitive firm. It also helps the firm to
predict collection pattern of receivables in future. This comparison can be made
periodically.
The purpose of classifying receivables by age groups is to have a closer control over
the quality of individual accounts. The following is an illustration of the ageing
schedule of receivables: -
Ageing Schedule

Age Classes As on 30th June, 2025 As on 30th September, 2025

(Days) Month Balance of Percentage Month of Balance of Percentage
of Sale Receivables to total Sale Receivables to total
(INR) (INR)
1-30 June 41,500 11.9 September 1,00,000 22.7
31-60 May 74,200 21.4 August 2,50,000 56.8
61-90 April 1,85,600 53.4 July 48,000 10.9
91-120 March 35,300 10.2 June 40,000 9.1
121 and more Earlier 10,800 3.1 Earlier 2,000 0.5
3,47,400 100 4,40,000 100

The above ageing schedule shows a substantial improvement in the liquidity of

receivables for the quarter ending September, 2025 as compared with the liquidity of
receivables for the quarter ending June, 2025. It could be possible due to greater
collection efforts of the firm.
(iii) Debt Collection Programme:

(a) Monitoring the state of receivables.

(b) Intimation to customers when due date approaches.
(c) E-mail and telephonic advice to customers on the due date.
(d) Reminding the legal recourse on overdue A/cs and follow escalation matrix if
available.
(e) Legal action on overdue A/cs.
The following diagram shows the relationship between collection expenses and bad
debt losses which have to be established as initial increase in collection expenses may
have only a small impact on bad debt losses.

6. Innovations in Receivable Management

During the recent years, a number of tools, techniques, practices and measures have
been invented to increase effectiveness in accounts receivable management.
Following are the major determinants for significant innovations in accounts receivable
management and process efficiency.
1. Re-engineering Receivable Process: In some of the organizations real cost reductions
and performance improvements have been achieved by re- engineering in accounts
receivable process. Re-engineering is a fundamental re-think and re-design of business
processes by incorporating modern business approaches. The nature of accounts
receivables is such that decisions made elsewhere in the organization are likely to
affect the level of resources that are expended on the management of accounts
receivables.
The following aspects provide an opportunity to improve the management of
accounts receivables:
(a) Centralisation: Centralisation of high nature transactions of accounts
receivables and payable is one of the practices for better efficiency. This
focuses attention on specialized groups for speedy recovery.
(b) Alternative Payment Strategies: Alternative payment strategies in addition to
 traditional practices result into efficiencies in the management of accounts
receivables. It is observed that payment of accounts outstanding is likely to be
quicker where a number of payment alternatives are made available to
customers. Besides, this convenient payment method is a marketing tool that is
of benefit in attracting and retaining customers. The following alternative
modes of payment may also be used along with traditional methods like
Cheque Book etc., for making timely payment, added customer service,
reducing remittance processing costs and improved cash flows and better
debtor turnover.
(i) Direct debit: I.e., authorization for the transfer of funds from the
purchaser’s bank account.

(ii) Integrated Voice Response (IVR): This system uses human operators and
a computer-based system to allow customers to make payment over
phone. This system has proved to be beneficial in the organizations
processing a large number of payments regularly.
(iii) Collection by a third party: The payment can be collected by an
authorized external firm. The payments can be made by cash, cheque,
credit card or electronic fund transfer. Banks may also be acting as
collecting agents of their customers and directly depositing the
collections in customers’ bank accounts.
(iv) Lock Box Processing: Under this system an outsourced partner captures
cheques and invoice data and transmits the file to the client firm for
processing in that firm’s systems.
(v) Payments via Internet using fund transfer methods like RTGS, NEFT, IMPS
UPIs, App based payment like Paytm, Phone Pay, etc.
(c) Customer Orientation: Where individual customers or a group of customers
have some strategic importance to the firm a case study approach may be
followed to develop good customer relations. A critical study of this group may
lead to formation of a strategy for prompt settlement of debt.
2. Evaluation of Risk: Risk evaluation is a major component in the establishment of an
effective control mechanism. Once risks have been properly assessed controls can be
introduced to either contain the risk to an acceptable level or to eliminate them
entirely. This also provides an opportunity for removing inefficient practices. This
involves a re-think of processes and questioning the way that tasks are performed.
This also opens the way for efficiency and effectiveness benefits in the management
of accounts receivables.
3. Use of Latest Technology: Technological developments now-a-days provides an
opportunity for improvement in accounts receivables process. The major innovations
available are the integration of systems used in the management of accounts
receivables, the automation and the use of e- commerce.

(a) E-commerce refers to the use of computer and electronic telecommunication

technologies, particularly on an inter- organisational level, to support trading in
goods and services. It uses technologies such as Electronic Data Inter-change
 (EDI), Electronic Mail, Electronic Funds Transfer (EFT) and Electronic Catalogue
Systems to allow the buyer and seller to transact business by exchange of
information between computer application systems such as Amazon, Flipkart
etc.
(b) Automated Accounts Receivable Management Systems: Now-a- days all the
big companies develop and maintain automated receivable management
systems. Manual systems of recording the transactions and managing
receivables are not only cumbersome but ultimately costly also. These
integrated systems automatically update all the accounting records affected by
a transaction. For example, if a transaction of credit sale is to be recorded, the
system increases the amount the customer owes to the firm, reduces the
inventory for the item purchased, and records the sale. This system of a
company allows the application and tracking of receivables and collections,
using the automated receivables system allows the company to store important
information for an unlimited number of customers and transactions, and
accommodate efficient processing of customer payments and adjustments.
4. Receivable Collection Practices: The aim of debtors’ collection should be to reduce,
monitor and control the accounts receivable at the same time maintain customer
goodwill. The fundamental rule of sound receivable management should be to reduce
the time lag between the sale and collection. Any delays that lengthen this span
causes receivables to unnecessary build up and increase the risk of bad debts. This is
equally true for the delays caused by billing and collection procedures as it is for
delays caused by the customer.
The following are major receivable collection procedures and practices:

(i) Issue of Invoice credit terms or time limits.

(ii) Periodic statements and follow ups.
(iii) Use of payment incentives and penalties.
(iv) Record keeping and Continuous Audit.
(v) Export Factoring: Factors provide comprehensive credit management, loss
protection collection services and provision of working capital to the firms
exporting internationally.
(vi) Business Process Outsourcing: This refers to a strategic business tool whereby
an outside agency takes over the entire responsibility for managing a business
process like collections in this case.
5. Use of Financial tools/techniques: The finance manager while managing accounts
receivables uses a number of financial tools and techniques. Some of them have been
described hereby as follows:
(i) Credit analysis: While determining the credit terms, the firm has to evaluate
individual customers in respect of their credit worthiness and the possibility of
bad debts. For this purpose, the firm has to ascertain credit rating of
prospective customers.
Credit rating: An important task for the finance manager is to rate the various
 debtors who seek credit facility. This involves decisions regarding individual
parties so as to ascertain how much credit can be extended and for how long. In
foreign countries specialized agencies are engaged in the task of providing
rating information regarding individual parties.
The finance manager has to look into the credit-worthiness of a party and
sanction credit limit only after he is convinced that the party is sound. This
would involve an analysis of the financial status of the party, its reputation and
previous record of meeting commitments.
The credit manager here has to employ a number of sources to obtain credit
information. The following are the important sources:

Trade references; Bank references; Credit bureau reports; Past experience;

Published financial statements; and Salesman’s interview and reports.
Once the credit-worthiness of a client is ascertained, the next question is to set
a limit of the credit. This credit limit once set can be further enhanced as the
favorable experience is gained while dealing with that client. In all such
enquiries, the credit manager must be discreet and should always have the
interest of high sales in view at the same time balancing any risk of non-
collection.
(ii) Control of receivables: Another aspect of management of debtors is the control of
receivables. Merely setting of standards and framing a credit policy

is not sufficient; it is, equally important to control receivables by constant monitoring

and follow ups.
(iii) Collection policy: Efficient and timely collection of debtors ensures that the bad debt
losses are reduced to the minimum and the average collection period is shorter. If a
firm spends more resources on collection of debts, it is likely to have smaller bad
debts. Thus, a firm must work out the optimum amount that it should spend on
collection of debtors. This involves a trade- off between the level of expenditure on
the one hand and decrease in bad debt losses and investment in debtors on the other.
The collection cell of a firm has to work in a manner that it does not create too much
resentment amongst the customers. On the other hand, it has to keep the amount of
the outstanding in check. Hence, it has to work in a very smoothen manner and
diplomatically.
It is important that clear-cut procedures regarding credit collection are set up. Such
procedures must answer questions like the following:
(a) How long should a debtor balance be allowed to exist before collection process
is started?
(b) What should be the procedure of follow up with defaulting customer? How
reminders are to be sent and how should and at what frequency, each
successive reminder be drafted?
(c) Should there be collection machinery whereby personal calls by
company’s representatives are made?
 (d) What should be the procedure for dealing with doubtful accounts? Is legal action to
be instituted or some escalation matrix to be followed? How should account be
handled?

7. Financing Receivable – By Pledging and Factoring

7.1 Pledging

Pledging of accounts receivables and Factoring have emerged as the important sources
of financing of accounts receivables now-a-days. This refers to the use of a firm’s
receivable to secure a short-term loan.
After cash, a firm’s receivables can be termed as its most liquid assets and this serve as
prime collateral for a secured loan. The lender scrutinizes the quality of the account
receivables, selects acceptable accounts, creates a lien on the collateral and fixes the
percentage of financing receivables which ranges around 50 to 90%. The major
advantage of pledging accounts receivables is the ease and flexibility it provides to the
borrower. Moreover, financing is done regularly. This, however, suffers on account of
high cost of financing. Also being a loan, it leaves an impact on the debt equity ratio as
well by increasing the amount of debt.

7.2 Factoring

Factoring is a relatively new concept in financing of accounts receivables. This refers to

outright sale of accounts receivables to a factor or a financial agency. A factor is a firm
that acquires the receivables of other firms. The factoring lays down the conditions of
the sale in a factoring agreement. The factoring agency bears the risk of collection and
services the accounts for a fee.

Factoring arrangement can be either on a recourse basis or on a non-recourse basis:

- Recourse: In case factor is unable to collect the amount from receivables then, factor
can turn back the same to the organization for resolution (which generally is by
replacing those receivables with new receivables)
- Non-Recourse: The factor bears the ultimate risk of loss in case of default and hence in
such cases they charge higher commission.
There are a number of financial institutions providing factoring services in India. Some
 commercial banks and other financial agencies provide this service. The biggest
advantages of factoring are the immediate conversion of receivables into cash and
predicted pattern of cash flows. Financing receivables with the help of factoring can help
a company having liquidity without creating a net liability on its financial condition and
hence no impact on debt equity ratio. Besides, factoring is a flexible financial tool
providing timely funds, efficient record keepings and effective management of the
collection process. This is not considered as a loan. There is no debt repayment and
hence no compromise to balance sheet, no long-term agreements or delays associated
with other methods of raising capital. Factoring allows the firm to use cash for the
growth needs of business.

8. Question on Credit Policy:

9. Question on Credit Policy:

10. Account Receivable Power BI Dashboard:

[Link]
Receivable-Dashboard/td-p/2530321