RECEIVABLES

MANAGEMENT

“Any fool can lend money, but

it takes a lot of skill to get it
back”

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Group Members Roll No

Tushar Bhirade 8

Rohan Cambell 11

James Fernandes 20

Chanky Jain 33

Ajinkya Lavate 49

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RECEIVABLES MANAGEMENT INTRODUCTION

 What are receivables?

•Receivables are sales made on credit basis.

Why do we need receivables? Cash Receivables

•To increase total sales
•To increase profits Operating
Cycle
•To meet increasing Competition

Understanding Receivables
•As a part of the operating cycle Inventory
•Time lag between sales and receivables creates
need for working capital
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RECEIVABLES MANAGEMENT DIFFERENT TYPES OF COSTS ASSOCIATED

 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.

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RECEIVABLES MANAGEMENT OBJECTIVES

• 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

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 STEPS IN CREDIT ANALYSIS
RECEIVABLES MANAGEMENT

“Investigating the customer”

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

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 CREDIT POLICY
CREDIT POLICY
RECEIVABLES MANAGEMENT

-Whether and how much credit to be extend

Determination of (1)Credit Standard
(2) credit analysis
Important aspect of Credit Policy
a. Credit Standard
b. Credit Period
c. Cash Discount
 1.CREDIT STANDARD
RECEIVABLES MANAGEMENT

Basic 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

 2.CREDIT PERIOD
RECEIVABLES MANAGEMENT

• 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 Decreases investment in a/c

receivable receivable

Higher incidence of bad debt Less incidence of bad debt

 3.CASH DISCOUNT
RECEIVABLES MANAGEMENT

• 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
 Collection Efforts
RECEIVABLES MANAGEMENT

Monitoring Receivable
↓
Sending Letters
↓
Telegraphic Advice
↓
Threat of Legal action (overdue)
↓
Legal Action
 STEPS IN CREDIT ANALYSIS
RECEIVABLES MANAGEMENT

“Investigating the customer by Ratio Analysis”

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 Assets
a) Current ratio = ----------------------
Current Liabilities

Current Assets - Inventory

b) 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.
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 STEPS IN CREDIT ANALYSIS
RECEIVABLES MANAGEMENT

“Investigating the customer by Ratio Analysis”

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

Debt
e) Capital Structure ratio = ------------
Equity

Net profit after tax and preference share

dividend
f) Return On Equity = -----------------------------------------------------------------
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Owner Equity
 STEPS IN CREDIT ANALYSIS
RECEIVABLES MANAGEMENT

“Investigating the customer”

 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.

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RECEIVABLES MANAGEMENT STEPS IN CREDIT ANALYSIS

• 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

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 STEPS IN CREDIT ANALYSIS
RECEIVABLES MANAGEMENT

“Credit Evaluation Report on X co. Ltd”

Item Head For X co. Standard Remark

Ltd

Current Ratio 1.70 1.75

Liquidity position is
Quick Ratio 1.15 1.00 good

Average Payment Period 45 Days 40 Days Can be persuaded to

pay within 40 days.
Average Collection 40 Days 30 Days This may have caused
Period delay in payments.
Lower because of
Debt - Equity Ratio 1.5 : 1 2:1 capital structure.

Return On Equity 15 % 18 %

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 STEPS IN CREDIT ANALYSIS
RECEIVABLES MANAGEMENT

“Risk Classification Scheme”

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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RECEIVABLES MANAGEMENT BENEFITS

• 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 18

 CREDIT GRANTING DECISION
RECEIVABLES MANAGEMENT

“DECISION- TREE APPROACH”

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.

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 CREDIT GRANTING DECISION
“DECISION- TREE APPROACH”
RECEIVABLES MANAGEMENT

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.

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 CREDIT GRANTING DECISION
RECEIVABLES MANAGEMENT

“DECISION- TREE APPROACH”

• 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.

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RECEIVABLES MANAGEMENT COLLECTION METHODS

• 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 22
RECEIVABLES MANAGEMENT COLLECTION METHODS
• Centralised / Decentralised collection system

• Post – dated cheques Under a lock box system, customers are

advised to mail their payments to special
• Pay Orders / Bank drafts post office boxes called lockboxes,
which are attended to by local collection
• Bills of Exchange banks, instead of sending them to
corporate headquarters.
• Lock – box System
Thus the lock box system:
• Drop – box System (i) cuts down the mailing time, because
Cheque are received at a nearby post
• Collection staff/ agents office instead of at corporate
headquarters,
• Debt collector (ii) reduces the processing time because
the company does not have to open the
• Del Credere agent envelopes and deposit the Cheque for
collection, and
• Concentration banking (iii) shortens the availability delay
because the Cheque are typically drawn
on local banks
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Thank You
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RECEIVABLES MANAGEMENT COLLECTION METHODS
• Centralised / Decentralised collection system

• Post – dated cheques

• Pay Orders / Bank drafts

• Bills of Exchange

• Lock – box System

• Drop – box System

• Collection staff/ agents

an agency, factor, or broker acting
• Debt collector
as an intermediary between sellers
• Del Credere agent and buyers and guaranteeing
payment
• Concentration banking

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RECEIVABLES MANAGEMENT COLLECTION METHODS
• Centralised / Decentralised collection system
A firm may open collection centres
• Post – dated cheques (banks) in different parts of the
country to save the postal delays.
• Pay Orders / Bank drafts This is known as concentration
banking.
• Bills of Exchange
The firm may instruct the customers
• Lock – box System
to mail their payments to a regional
• Drop – box System
collection centre / bank rather than
to the Central Office
• Collection staff/ agents
The Cheque received by the regional
• Debt collector collection centre are deposited for
collection into a local bank account
• Del Credere agent
The concentration banking results in
• Concentration banking saving of time of collection

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 MONITORING RECEIVABLES
(Measures for Monitoring Receivables)
RECEIVABLES MANAGEMENT

1) Day Sales Outstanding

2) Ageing Schedule

3) Collection Matrix

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 CONTROL OF RECEIVABLES MANAGEMENT
(Day Sales Outstanding)
RECEIVABLES MANAGEMENT

• 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

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RECEIVABLES MANAGEMENT SALES AND RECEIVABLES DATA

Month Sales Receivables Month Sales Receivables

January 200 460 July 200 340

February 225 360 August 200 360

March 230 315 September 220 360

April 150 310 October 230 390

May 150 300 November 245 500

June 180 320 December 250 520

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RECEIVABLES MANAGEMENT AVERAGE COLLECTION PERIOD
Quarter Average Collection Period

315
First ----------------------------------------------------------------------------- = 43 days
( 200 + 225 + 230 ) / 90 days

320
Second ------------------------------------------------------------------------------ = 61 days
(150 + 150 + 180) / 91 days

360
Third ------------------------------------------------------------------------------ = 53 days
(200 + 200 + 220) / 92 days

520
Fourth ------------------------------------------------------------------------------ = 66 days
(230 + 245 + 250) / 92 days

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RECEIVABLES MANAGEMENT AGEING SCHEDULE

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

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RECEIVABLES MANAGEMENT COLLECTION MATRIX

• 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.

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RECEIVABLES MANAGEMENT COLLECTION MATRIX

% of January February March April sales May sales June

receivables sales sales sales sales
collected during
the month

Month of sales 10 14 15 12 9 13

First following 42 35 40 38 35 31
Month

Second following 36 40 21 26 26 26
month

Third following 12 11 24 19 25 25
month

Fourth following 5 5 5
month

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RECEIVABLES MANAGEMENT CONTROL OF RECEIVABLES MANAGEMENT

• 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

Category % of accounts to Total % of Balance

Accounts Outstanding to Total
Debtors’ Balance
A 15 75
B 35 20
C 50 5
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RECEIVABLES MANAGEMENT PROFORMA
Type A- If Fixed Costs is given
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 xxx xxx xxx xxx
Average Investment in Receivables
(Based on Total Costs)
Costs of Extending Credit:
1) ____ % Opportunity Cost of Capital xx xx xx xx
(Calculated on Avg. Invst. in Receivables)
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 35
Incremental Net Benefits --- xx xx xx
RECEIVABLES MANAGEMENT PROFORMA

Type B: If Fixed costs is NOT given.

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 xxx xxx xxx xxx
(Based on Sales)
Costs of Extending Credit:
1) ____ % Opportunity Cost of Capital xx xx xx xx
(Calculated on Avg. Invst. in Receivables)
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

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RECEIVABLES MANAGEMENT

• 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 .
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