MB0045-Financial Management Unit-14 Receivables Management

Program Semester Subject Code Subject Name Unit number

: MBA : II : MB0045 : Financial Management : 114

Unit Title
Lecture Number Lecture Title

: Receivable Management
: 14 : Receivable Management

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MB0045-Financial Management Unit-14 Receivables Management

Financial Management

Objectives:
After studying this unit, you should be able to: Explain the meaning of receivables management Recognise the costs associated with maintaining receivable Determine the credit policy variables Define the process of evaluation of credit policy

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MB0045-Financial Management Unit-14 Receivables Management

Lecture Outline

Introduction Meaning of Receivables Management

Cost Associated with Maintaining Receivables

Credit Policy Variables Collection Programme Evaluation of Credit Policy

Summary
Check Your Learning Activity

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MB0045-Financial Management Unit-14 Receivables Management

Introduction
Receivables are assets accounts representing amount due to the firm from sale of goods/services in the ordinary course of business. Trade credit is a marketing tool that functions as a bridge for the movement of goods from the firms warehouse to its customers. When a firm sells goods on credit, receivables are created. The receivables arising out of trade credit have three features: Receivables that arise out of trade credit involve an element of risk. Therefore, before sanctioning credit, careful analysis of the risk involved needs to be done. Receivables out of trade credit are based on economic value. Buyer gets economic value in goods immediately on sale, while the seller receives an equivalent value later on. Receivables out of trade credit have an element of futurity. The buyer makes payment in future.

In this session, you will learn about the meaning of receivables management, the cost associated with maintaining receivables, the credit policy variables and the process of evaluation of credit policy.
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MB0045-Financial Management Unit-14 Receivables Management

Meaning of Receivables Management

Management of accounts receivables may, therefore, be defined as the process of making decision related to the investment of funds in receivables for maximising the overall return on the investment of the firm. The purpose of receivables can be directly related to the companys objectives of promoting credit sales. The objectives are:

To increase profits

To increase sales

To meet increasing competition

Objectives

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MB0045-Financial Management Unit-14 Receivables Management

Cost Associated with Maintaining Receivables

The four different varieties of costs associated with maintaining receivables are:

Capital cost

Bad debts or default cost

Costs associated with receivables

Administration cost

Delinquency cost

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MB0045-Financial Management Unit-14 Receivables Management

Credit Policy Variables

The credit policy of a firm can be termed as a trade-off between increased credit sales leading to increase in profit and the cost of having larger amount of cash locked up in the form of receivables along with the loss due to the incidence of bad debts. The four aspects of credit policy are:

Credit policy variables

Credit standards

Credit periods

Cash discounts

Collection programme

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MB0045-Financial Management Unit-14 Receivables Management

Collection Programme
The objective of a collection policy is to achieve a timely collection of receivables. Releasing funds locked in receivables and minimising the incidence of bad debts are the other objectives of the collection policy. The collection programmes consist of the following:
Monitoring the receivables

Reminding customers about due date of payment

Interaction on-line through electronic media with customers about the payments due, around the due date Initiating legal action to recover the amount from overdue customers Formulating collection policy such that it should not lead to bad relationship with the customers

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MB0045-Financial Management Unit-14 Receivables Management

Evaluation of Credit Policy

Credit policy of every company is largely influenced by two conflicting objectives, irrespective of the native and type of company. They are liquidity and profitability.

Liquidity position of a firm can be easily improved without affecting profitability by reducing the duration of the period for which the credit is granted and further by collecting the realised value of receivables as soon as they fail due. To improve profitability one can resort to lenient credit policy as a booster of sales, but the implications are:
Chances of extending credit to those with week credit rating

Unduly lenient credit terms

Tendency to expand credit to suit customer's needs Lack of attention to over due accounts Optimum credit policy is one which would maximise the value of the firm. Value of a firm is maximised when the incremental rate of return on an investment is equal to the incremental cost of funds used to finance the investment.
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MB0045-Financial Management Unit-14 Receivables Management

Evaluation of Credit Policy (cont.)

In order to achieve the goal of maximising the value of the firm the evaluation of investment in receivables accounts should involve the following four steps:
Estimation of incremental operating profit

Step 1

Step 2

Estimation of incremental investment in accounts receivables

Step 3

Estimation of the incremental rate of return of investment

Step 4

Comparison of incremental rate of return with the required rate of return

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MB0045-Financial Management Unit-14 Receivables Management

Summary
Receivables are assets accounts representing amount due to the firm from sale of goods/services in the ordinary course of business. Trade credit is a marketing tool that functions as a bridge for the movement of goods from the firms warehouse to its customers. Management of accounts receivables may, therefore, be defined as the process of making decision related to the investment of funds in receivables for maximising the overall return on the investment of the firm. The four different varieties of cost associated with maintaining receivables are capital cost, administration cost, delinquency cost and bad debts or default cost. The four aspects of credit policy are credit standards, credit period, cash discount and collection programme. The objective of a collection policy is to achieve a timely collection of receivables. Credit policy of every company is largely influenced by two conflicting objectives, irrespective of the native and type of company. They are liquidity and profitability.
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MB0045-Financial Management Unit-14 Receivables Management

Check Your Learning

1. Name any two varieties of cost associated with maintaining receivables. Ans: The two varieties of cost are: a. Capital cost

b. Administration cost
2. List the four aspects of credit policy Ans: The four aspects of credit policy are:

a. Credit standards
b. Credit periods c. Cash discount d. Collection programme

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MB0045-Financial Management Unit-14 Receivables Management

Activity Assume that for a firm ABC Ltd., the credit policy is influenced by two conflicting objectives - liquidity and profitability. What are the steps to be involved in the evaluation of investment in receivables account in order to achieve the goal for maximising the value of the firm?

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