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Receivables Management for Financial Management and Policy Mcom Sem 2 Delhi University

Receivables Management for Financial Management and Policy Mcom Sem 2 Delhi University

Receivables Management for Financial Management and Policy Mcom Sem 2 Delhi University

Receivables Management for Financial Management and Policy MCOM Sem 2 Delhi University : 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 accounts receivables, trade receivables, customer receivables or book debts. The receivables are carried for the customers. The period of 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 for Financial Management and Policy Mcom Sem 2 Delhi University

Costs of Maintaining Receivables

The allowing of credit to customers means giving funds for the customer’s use. The concern incurs the following cost on maintaining receivables:

(1) Cost of Financing ReceivablesWhen goods and services are provided on credit then concern’s capital is allowed to be used by the customers. The receivables are financed from the funds supplied by shareholders for long term financing and through retained earnings. The concern incurs some cost for colleting funds which finance receivables.

            (2) Cost of Collection: A proper collection of receivables is essential for receivables management. The customers who do not pay the money during a stipulated credit period are sent reminders for early payments. Some persons may have to be sent for collection these amounts. All these costs are known as collection costs which a concern is generally required to incur.

            (3) Bad Debts : Some customers may fail to pay the amounts due towards them. The amounts which the customers fail to pay are known as bad debts. Though a concern may be able to reduced bad debts through efficient collection machinery but one cannot altogether rule out this cost.

Receivables Management for Financial Management and Policy Mcom Sem 2 Delhi University

Factors Influencing the Size of Receivables

Besides sales, a number of other factors also influence the size of receivables. The following factors directly and indirectly affect the size of receivables.

(1) Size of Credit Sales: The volume of credit sales is the first factor which increases or decreases the size of receivables. If a concern sells only on cash basis as in the case of Bata Shoe Company, then there will be no receivables. The higher the part of credit sales out of total sales, figures of receivables will also be more or vice versa.

(2) Credit Policies: A firm with conservative credit policy will have a low size of receivables while a firm with liberal credit policy will be increasing this figure. If collections are prompt then even if credit is liberally extended the size of receivables will remain under control. In case receivables remain outstanding for a longer period, there is always a possibility of bad debts.

(3) Terms of Trade: The size of receivables also depends upon the terms of trade. The period of credit allowed and rates of discount given are linked with receivables. If credit period allowed is more then receivables will also be more. Sometimes trade policies of competitors have to be followed otherwise it becomes difficult to expand the sales.

(4) Expansion Plans: When a concern wants to expand its activities, it will have to enter new markets. To attract customers, it will give incentives in the form of credit facilities. The period of credit can be reduced when the firm is able to get permanent customers. In the early stages of expansion more credit becomes essential and size of receivables will be more.

(5) Relation with Profits: The credit policy is followed with a view to increase sales. When sales increase beyond a certain level the additional costs incurred are less than the increase in revenues. It will be beneficial to increase sales beyond the point because it will bring more profits. The increase in profits will be followed by an increase in the size of receivables or vice-versa.

(6) Credit Collection Efforts: The collection of credit should be streamlined. The customers should be sent periodical reminders if they fail to pay in time. On the other hand, if adequate attention is not paid towards credit collection then the concern can land itself in a serious financial problem. An efficient credit collection machinery will reduce the size of receivables.

(7) Habits of CustomersThe paying habits of customers also have bearing on the size of receivables. The customers may be in the habit of delaying payments even though they are financially sound. The concern should remain in touch with such customers and should make them realise the urgency of their needs.

Receivables Management for Financial Management and Policy Mcom Sem 2 Delhi University

Meaning and Objectives of Receivables Management

Receivables management is the process of making decisions relating to investment in trade debtors. We have already stated that certain investment in receivables is necessary to increase the sales and the profits of a firm. But at the same time investment in this asset involves cost considerations also. Further, there is always a risk of bad debts too. Thus, the objective of receivables management is to take a sound decision as regards investment in debtors. In the words of Bolton, S.E., the objectives 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.”

Receivables Management for Financial Management and Policy Mcom Sem 2 Delhi University

Dimensions of Receivables Management

Receivables management involves the careful consideration of the following aspects:

  1. Forming of credit policy.
  2. Executing the credit policy.
  3. Formulating and executing collection policy.

1. Forming of Credit Policy

For efficient management of receivables, a concern must adopt a credit policy. A credit policy is related to decisions such as credit standards, length of credit period, cash discount and discount period, etc.

(a) Quality of Trade Accounts of Credit Standards: The volume of sales will be influenced by the credit policy of a concern. By liberalising credit policy the volume of sales can be increased resulting into increased profits. The increased volume of sales is associated with certain risks too. It will result in enhanced costs and risks of bad debts and delayed receipts. The increase in number of customers will increase the clerical wok of maintaining the additional accounts and collecting of information about the credit worthiness of customers. There may be more bad debt losses due to extension of credit to less worthy customers.

(b) Length of Credit Period: Credit terms or length of credit period means the period allowed to the customers for making the payment. The customers paying well in time may also be allowed certain cash discount. A concern fixes its own terms of credit depending upon its customers and the volume of sales. The competitive pressure from other firms compels to follow similar credit terms, otherwise customers may feel inclined to purchase from a firm which allows more days for paying credit purchases. Sometimes more credit time is allowed to increase sales to existing customers and also to attract new customers. The length of credit period and quantum of discount allowed determine the magnitude of investment in receivables.

(c) Cash Discount: Cash discount is allowed to expedite the collection of receivables. The concern will be able to use the additional funds received from expedited collections due to cash discount. The discount allowed involves cost. The discount should be allowed only if its cost is less than the earnings from additional funds. If the funds cannot be profitably employed then discount should not be allowed.

(d) Discount Period: The collection of receivables is influenced by the period allowed for availing the discount. The additional period allowed for this facility may prompt some more customers to avail discount and make payments. This will mean additional funds released from receivables which may be alternatively used. At the same time the extending of discount period will result in late collection of funds because those who were getting discount and making payments as per earlier schedule will also delay their payments.

 2. Executing Credit Policy

After formulating the credit policy, its proper execution is very important. The evaluation of credit applications and finding out the credit worthiness of customers should be undertaken.

(a) Collecting Credit informationThe first step in implementing credit policy will be to gather credit information about the customers. This information should be adequate enough so that proper analysis about the financial position of the customers is possible. This type of investigation can be undertaken only upto a certain limit because it will involve cost.

Credit information may be available with banks too. The banks have their credit departments to analyse the financial position of a customer.

In case of old customers, business own records may help to know their credit worthiness. The frequency of payments, cash discounts availed, interest paid on over due payments etc. may help to form an opinion about the quality of credit.

(b) Credit AnalysisAfter gathering the required information, the finance manager should analyse it to find out the credit worthiness of potential customers and also to see whether they satisfy the standards of the concern or not. The credit analysis will determine the degree of risk associated with the account, the capacity of the customer borrow and his ability and willingness to pay.

(c) Credit DecisionAfter analysing the credit worthiness of the customer, the finance manager has to take a decision whether the credit is to be extended and if yes then upto what level. He will match the creditworthiness of the customer with the credit standards of the company. If customer’s creditworthiness is above the credit standards then there is no problem in taking a decision. It is only in the marginal case that such decisions are difficult to be made. In such cases the benefit of extending the credit should be compared to the likely bad debt losses and then decision should be taken. In case the customers are below the company credit standards then they should not be outrightly refused. Rather they should be offered some alternative facilities. A customer may be offered to pay on delivery of goods, invoices may be sent through bank. Such a  course help in retaining the customers at present and their dealings may help in reviewing their requests at a later date.

(d) Financing Investments in Receivables and FactoringAccounts receivables block a part of working capital. Efforts should be made that funds are not tied up in receivables for longer periods. The finance manager should make efforts to get receivables financed so that working capital needs are met in time. The quality of receivables will determine the amount of loan. The banks will accept receivable of dependable parties only. Another method of getting funds against receivables is their outright sale to the bank. The bank will credit the amount to the party after deducting discount and will collect the money from the customers later. Here too, the bank will insist on quality receivables only. Besides banks, there may be other agencies which can buy receivables and pay cash for them. This facility is known asfactoring. The factoring may be with or without recourse. It is without recourse then any bad debt loss is taken up by the factor but if it is with recourse then bad debts losses will be recovered from the seller.

Receivables Management for Financial Management and Policy Mcom Sem 2 Delhi University

Factoring is collection and finance service designed to improve he cash flow position of the sellers by converting sales invoices into ready cash. The procedure of factoring can be explained as follows:

  1. Under an agreement between the selling firm and factor firm, the latter makes an appraisal of the credit worthiness of potential customers and may also set the credit limit and term of credit for different customers.
  2. The sales documents will contain the instructions to make payment directly to factor who is responsible for collection.
  3. When the payment is received by the factor on the due date the factor shall deduct its fees, charges etc and credit the balance to the firm’s accounts.
  4. In some cases, if agreed the factor firm may also provide advance finance to selling firm for which it may charge from selling firm. In a way this tantamount to bill discounting by the factor firm. However factoring is something more than mere bill discounting, as the former includes analysis of the credit worthiness of the customer also. The factor may pay whole or a substantial portion of sales vale to the selling firm immediately on sales being effected. The balance if any, may be paid on normal due date.

Receivables Management for Financial Management and Policy Mcom Sem 2 Delhi University

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