Chapter 9
Chapter 9
Chapter 9
payable management
Chapter agenda
Liquidity Vs
Profitability
Credit policy
Invoice
discounting
Factoring
Chapter 8
Liquidity Vs
Profitability
Payables
Key ratios
Foreign
receivables &
payables
Liquidity – Collecting debtor receipts fast to reduce the cost of financing debtors
These two aspects are captured in the credit policy of the organisation
A lenient policy may induce sales at a high cost (Higher discounts, extended credit period)
1. Assessing creditworthiness – The organisation must assess all its new customers and
review existing customers periodically. In assessing creditworthiness, they can refer
to bank references, company sales records, references from credit rating agencies
etc.
2. Setting credit limits – The credit limit should be adjusted by referring to the sales and
cash payment history of the customer.
3. Timely invoicing and collection of dues – The credit period starts when the customer
receives the invoice. There needs to be a mechanism to collect the dues promptly.
E.g., Sending reminders, telephone calls to customers etc.
4. Monitoring the credit system – The position of the receivables must be reviewed
through means such as ageing analysis, ratios etc.
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑑𝑎𝑦𝑠
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 = 𝑥 𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
365
Company XY has sales of $10 million for the previous year, receivables at the year-end were
$2 million, and the cost of financing receivables is covered by an overdraft at the interest
rate of 6% per year.
• But it acts as a saving to the organisation in terms of reducing the amount of money
tied up in receivables.
A company is offering a cash discount of 2.5% to receivables if they agree to pay debts
within one month. The usual credit period taken is three months. Assume the OD rate is
18%. Should the discount be offered by the company?
How ?
This is when an organisation borrows money from a specialist party at an interest rate
against a few selected debtor invoices. Thus, it is like debt factoring. However, in invoice
discounting, the organisation retains control over the sales ledger and customer dealings
stay confidential. This is a major benefit to the organisation.
Therefore, finance cost of invoice discounting is higher than that of factoring.
Administration charges for this service are around 0.5–1 % of a client’s revenue.
Factoring
This is when an organisation sells its debtor invoices to a factoring agent. The factoring
agent collects the debt for a fee. Factoring agents provide the following services. (Factoring
involves outsourcing the credit control department to specialist party)
Factoring is specifically useful for small firms, and fast-growing firms because these firms
may lack the capital to set up strong sales & credit systems and debt collection is not a
value-adding activity.
Liquidity – By delaying payments to suppliers, the liquid position of the business can be
improved.
all of which may affect the profitability position of the business in the long term.
• Working capital funding cost increases (Lower payables lead to larger working capital
requirement. As a result, OD interest charge may increase)
To determine whether paying early is beneficial, the business must calculate the annual
benefit of the discount.
2% discount for a payment within three weeks has been offered by a supplier. Alternatively,
full payment must be made within eight weeks of the invoice date. Assume the invoice
value is $100. Assume there are 50 weeks in a year. Calculate the annual cost of the
discount.
One supplier has offered a discount to Box Co of 3% on an invoice for $10,000 if payment is
made within one month. Payments are typically made in 3 months. If the company’s
overdraft rate is 10% per year, is it financially worthwhile for them to accept the discount
and pay early?
• When a business buys goods/materials from foreign suppliers, the business will need
to have foreign currency or convert local currency to foreign currency to pay the
supplier
• When a business sells goods to foreign customers, the business will need to convert
foreign currency to local currency
1. Export credit risk – This can arise due to illiquidity or insolvency of the foreign
customer, political risks of the customer’s country (war, change of political parties),
inconvertibility of the customer’s currency due to exchange controls, poor
remittance channels
2. Foreign exchange exposure risk – Due to fluctuations in the forex rates between the
date of the transaction and the date of settlement losses/gains may arise. (Discussed
in a latter chapter)
Countertrading – Goods and services are exchanged for other goods and services rather
than cash.
Export credit insurance – Risk of non-payment by a foreign debtor is covered with this
insurance.
Issue of LCs – This is one of the most widely used method of managing foreign debtors.
Steps in arranging a LC
• Buyer and seller set the terms for the sale of goods or services.
• The buyer/importer requests their bank to issue a letter of credit in favour of the
seller/exporter.
• The goods are dispatched to the customer and the shipping documentation is sent to
the purchaser’s bank guaranteeing payment to the seller once the conditions
specified in the letter have been complied with.
• Upon the receipt of LC, the seller’s bank issues a banker’s acceptance to the seller.
• The seller has the option to hold the banker’s acceptance until the payment date or
sell it on the money market at a discounted value.
Demerits of LCs