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ACCOUNTS RECEIVABLE MANAGEMENT

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SectionC2d)oftheF9studyguidestatesthatstudentsshouldbeabletodiscuss,applyandevaluatethe
useofrelevanttechniquesinmanagingaccountsreceivable.Furtherdetailofwhatisrequiredisthen
giveninsixsubsections.
Whilethisarticleaimstoassiststudentsinthisarea,itdoesnotintendcoveringgroundwhichhasalready
beencoveredinpreviousarticles.Hence,forfullcoverageofthissyllabusareastudents,shouldalsoread
thefollowingF9technicalarticles:
Managementofforeignaccountsreceivable
Receivablescollection

KEY AREAS OF ACCOUNTS RECEIVABLE MANAGEMENT

Therearethreekeyareasofaccountsreceivablemanagement.
Beforeacompanygrantscredittoacustomeritshouldensure,asfaraspossible,thatthecustomerisworthyofthat
creditandthatbaddebtswillnotresult.Checksshouldcontinuetobecarriedoutonexistingcustomersasacompany
wouldliketohaveearlywarningofanyproblemswhichmaybedeveloping.Thisisespeciallytrueforkeycustomers
ofthecompany.
Oncethedecisionhasbeentakentograntcredit,thensuitablecredittermsmustbesetandthereceivablesthatarise
mustbemonitoredefficientlyifthecostsofgivingcreditaretobekeptundercontrol.
Akeyareaofthemanagementofaccountsreceivableisthefinalcollectionofcashfromcustomers.Anycompany
musthavearigoroussystemtoensurethatallcustomerspayinatimelyfashionas,withoutthis,thelevelof
receivablesandthecostoffinancingthesereceivableswillinevitablyrise,aswilltheriskandcostofbaddebts.

Thesekeyareaswillnowbeexploredinmoredetail.

ASSESSING CREDITWORTHINESS
Themethodsacompanycouldusetoassessthecreditworthinessofacustomerorapotentialcustomer
include:
abankreferencewhileabankreferencecanbefairlyeasilyobtained,itmustberememberedthattheother
companyisthebankscustomerandsoabankreferencewillsticktothefacts.Itismostunlikelytoraiseanyfearsthe
bankmayhaveaboutthecompany
atradereferencethisisobtainedfromanothercompanywhohasdealingswithyourpotentialcustomer/customer.
Duetothelitigiousnatureofsocietythesedays,itmaynotbesoeasytoobtainawrittenreference.However,youmay
beabletocallcontactsyouhaveinthetradeandobtainaninformaloralreference
creditrating/referenceagencytheseagenciesprofessionalbusinessistosellinformationaboutcompaniesand
individuals.Hence,theywillbekeentogiveyouthebestpossibleinformation,soyouaremorelikelytoreturnanduse
theirservicesagain
financialstatementsfinancialstatementsofacompanyarepubliclyavailableinformationandcanbequicklyand
easilyobtained.Whileananalysisofthefinancialstatementsmayindicatewhetherornotacompanyshouldbe
grantedcredit,itmustberememberedthatthefinancialstatementsavailablecouldbeoutofdateandmayhave
sufferedfrommanipulation.Forlargercompanies,ananalysisoftheiraccountinginformationcangenerallybefound
throughvarioussourcesontheinternet
informationfromthefinancialmediainformationinthenationalandlocalpress,andinsuitabletradejournalsandon
theinternet,maygiveanindicationofthecurrentsituationofacompany.Forexample,ifithasbeenreportedthata
largecontracthasbeenlostorthatoneormoredirectorshasleftrecently,thenthismayindicatethatthecompanyhas
problems
visitvisitingapotentialnewcustomertodiscusstheirexactneedsislikelytoimpressthecustomerwithregardto
yourdesiretoprovideagoodservice.Atthesametime,itgivesyoutheopportunitytogetafeelforwhetherornotthe
businessisonewhichyouarehappytogivecreditto.Whileitisnotaveryscientificapproach,itcanoftenworkquite
well,asanyonewhorunstheirownsuccessfulbusinessislikelytoknowwhatagoodbusinesslooks,feelsandsmells
like!

SETTING CREDIT TERMS AND MONITORING ACCOUNTS RECEIVABLE

Assoonasacustomerisgivencredit,thecredittermsofthecompanyshouldbeexplainedtothem.For
instance,thenormalcreditperiodgrantedandanydiscountforpromptpayment,orinterestchargedon
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latepayment,shouldbeexplicitlydetailedtothecustomer.Veryoften,thecredittermsacompanyadopts
arethetermsthataremostcommoninitstrade.
Tousesomethingdifferentcancauseproblemsascustomerswillbeexpecting,andarelikelytotake,
whatisnormalinthetrade.Havingsaidthat,variationswithinatradedooccurand,indeed,acompany
maywellofferdifferenttermstodifferentcustomers,dependingonthecreditratingofeachcustomerand
theirrelationshipwitheachcustomer.
Initially,asuitablecreditlimitshouldbesetforeachcustomer.Thiscreditlimitshouldonlybeallowedto
growslowlyasyourfaithinthecustomergrowsandallattemptedbreachesofthecreditlimitshouldbe
broughttotheattentionofthecreditcontrollerorotherresponsibleperson.Itshouldberememberedthat
acommontrickofanunethicalcompanyistofindanewsupplier,makeasmallorderandpayforit
promptly.Alargeorderisthenmadeand,havingtakendeliveryofthisorder,thecustomerdelays
paymentforasignificanttime.
Theaccountsreceivableshouldbecontinuouslymonitored.Inordertodothisanumberofreportsare
useful:
Accountsreceivableagedanalysisthisshowstheamountsoutstandingfromeachcustomerandforhowlongthey
havebeenoutstanding.Thiswillindicateanybreachesofthecreditterms.
Acreditutilisationreportthisshowstheproportionofeachcustomerscreditlimitthatiscurrentlybeingutilised.
Therefore,itwillindicatewherecreditlimitsmayneedtobereviewedupwardsordownwardsandwhetheranycredit
limitbreacheshaveoccurred.

Takentogether,thesereportsshowhowexposedacompanyistoitsaccountsreceivable.Inlarger
organisations,customersmaybeclassifiedbytradeandcountryasitisthenpossibletoevaluate
exposurebybothcountryandtrade.Largerbusinessesmayalsocreatetheirowninhousecreditratings
fortheircustomers.
Whetherornotthebasiccredittermsofferedbythecompanyaresuitableshouldberegularlyreviewed.
Thereisnopointofferingunnecessarilylongperiodsofcredithowever,equally,acompanymayfind
thatextendingitscredittermsleadstoanincreaseinsales.Anyalterationincredittermscouldbe
evaluatedusingthetechniquesdemonstratedintheaforementionedReceivablescollectiontechnical
article.

COLLECTING CASH
Itmayseemveryobvious,butifcashistobecollected,thenthecustomermustbeinvoiced.Itisessential
thattheinvoiceissentoutquicklyandaccurately.Thereceiptofyourinvoiceisthefirstindicationa
companygetsoftheefficiencyofyourdebtcollectionsystem.Iftheinvoicetakesalongtimetoarriveand
isnotaccurate,thenyouraccountsreceivabledepartmentwillbeviewedasinefficientandcustomers
mayseektoexploitthisperceivedweaknessanddelaypayment.
Furthermore,ifaninvoiceisinaccuratesomecustomerswilltakethisasanopportunitytoclaimthatthere
isadisputeontheaccountand,therefore,stoppaymentofallinvoicesuntilthedisputeisresolved.
Havingsentouttheinvoicequicklyandaccurately,themethodsacompanycouldusetoensure
customerspayinatimelyfashioninclude:
monthlystatementsthesecanbeproducedquicklyandeasilybyanycomputerisedsalesledgersystemandsentto
customers.Exactlyhowmuchimpacttheyhaveishoweverdebatable
chasingletterstheseshouldbedirectedtoaspecificpersonpreferablyatareasonablyseniorlevel.However,
preparingandsendingtheselettershasacostand,likethemonthlystatements,theirimpactisoftenlimited
chasingphonecallsthesecanoftenhaveagreatimpactasallbusinesseshavetoanswerthetelephoneand,
hence,theyhaveanuisancevaluewhichcangenerateresults.Acreditcontrollerwhoregularlycontactsasuitably
seniorpersonattheircustomerswithoverdueamountsandpolitely,butfirmly,demandspaymentcanoftenachieve
goodresults
personalapproachapersonalapproachfromaseniorpersoninthecompanytoaseniorpersonatthecustomercan
oftenyieldresults.Thisisquitecommonintradeswherethepersonalrelationshipwithclientsisimportant.For
instance,thisoftenoccursinprofessionalaccountancyandlegalfirms
stoppingsuppliesthisisacashcollectiontoolthatmustbeusedwithcare.Iftheproductbeingsoldisbuilt
specificallytothecustomersdesign,andyouaretheonlysupplierwhocurrentlymakestheproduct,thenitisa
powerfultoolas,intheshortterm,youaretheonlysupplierand,hence,paymentislikelytobeforthcoming.However,
inthelongertermitisalwayspossibleforthecustomertotrainupanalternativesuppliertomaketheproduct.Ifthe
productisagenericproductthatcouldbepurchasedfrommanysuppliers,thenquiteobviouslythisisaweaktoolthat
issimplylikelytoleadtothelossofthecustomer
legalactionthisiscostlyandislikelytoleadtothecustomerbeinglost
externaldebtcollectionagencyaswithlegalactionthisiscostlyandislikelytoleadtothelossofthecustomer.

Manylargerbusinesseshavetheirowninhousedebtcollectiondepartmentsthatcanbeusedbefore
externaldebtcollectionagenciesareusedorlegalactionistaken.Therehavebeeninstanceswhere
companiesrecentlysufferedreputationaldamage.Theyhadbrandedtheirinhousedebtcollection
departmentsinsuchawaythatthecustomerbelievedthatithadbeenreferredtoanexternaldebt
collectionagencyand,hence,wasscaredintomakingpayment.

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METHODS OF SPEEDING UP CASH COLLECTION FROM ACCOUNTS

RECEIVABLE
Twokeymethodsofspeedingupcashcollectionfromaccountsreceivableareusingfactoringandusing
earlysettlementdiscounts.Studentsshouldbeconversantwiththesemethodsandtheiradvantagesand
disadvantages.
Furthermore,acommonexamquestionrequiresstudentstoevaluate,in$terms,thenetbenefitorcost
ofaproposednewdebtcollectionpolicy.Alloftheseareasarecoveredintheaforementioned
Receivablescollectiontechnicalarticle.
Additionally,aquestion(potentiallyamultiplechoicequestion)couldrequirethecalculationofthe
percentagecostofofferinganearlysettlementdiscount.Thisisbestexplainedthroughanexample.
Example
Acompanyoffersitscustomers30dayscreditbut,atpresent,customersaretakinganaverageof41
dayscredit.Inordertospeedupcashcollection,thecompanyisconsideringintroducinga1%discount
forpaymentwithin10days.Thecompanyfinancesitsworkingcapitalrequirementusinganoverdraftat
anannualcostof9%.
RequiredCalculatetheannualcostofofferingthediscountandevaluatewhetherornotthediscount
shouldbeoffered.
Solution
Letusassumeacustomerhaspurchasedgoodsandhasbeeninvoiced$100.Ifthecustomertakesthe
discount,thenthecompanywillreceive$99in10daysratherthan$100in41days.Thisislikethe
companyborrowing$99fromthecustomerfor31days(4110)andpaying$1interest.Therefore,the
31dayinterestrateis1/99x100%.Thisneedstobecompoundeduptoanannualrateinthefollowing
way:
(1+1/99)(365/31)1=0.126
Therefore,theannualcostofofferingthediscountcanbesaidtobe12.6%.
Ifthediscountisnotoffered,thecompanywillbeborrowingmoreonitsoverdraftwhileitwaitsforthe
customertopay.
Asthecostofborrowingontheoverdraftisonly9%,thediscountproposedismorecostlyandshouldnot
beoffered.
Pleasenotehowthe30dayscreditofferedisnotrelevantinthecalculations.Suchadditionalinformation,
whichisnotrequired,canbegiveninquestions,especiallymultiplechoicequestionswhereitiscalleda
distractor.Theuseofdistractorsisagoodwayoftestingwhoisreallycertainandconfidentintheir
knowledge.
Thecalculationsabovehavebeencarriedoutfromthepointofviewofthesupplier.Aquestioncouldalso
lookatthesameissuefromthepointofviewofthecustomerandaskforacalculationofthecustomers
costofrefusingthediscount.
Studentsshouldnotethat:
Thecustomerscostofrefusingthediscount=thesupplierscostofofferingthediscount
Hence,intheaboveexample,ifacustomerweretorefusethediscount,thecosttoitwouldalsobe
12.6%.Ifthecustomeristoacceptthediscount,thenthiswilloftenrequireittoborrowextrafundsinthe
formofanoverdraftinordertomaketheearlypayment.Wecanassumethatthecustomersoverdraft
rateisthesameasthesuppliersrateof9%.Thisisareasonableassumption,asifbothcompaniesare
operatinginthesameeconomytheiroverdraftratesarelikelytobesimilar.
Therefore,thecustomerhasachoiceofrefusingthediscountatacostof12.6%oracceptingthe
discountatacostof9%.Hence,thediscountisattractiveandshouldbeaccepted.
Theabovecalculationshavedemonstratedakeyproblemwithsettlementdiscounts.Asinthisexample,if
thediscountisattractivetothecustomeritmaywellbetoocostlytothesupplier.Itisalsothecasethata
discountwhichisattractivetoasuppliermaywellbetoocostlyforthecustomer.
Theformulatorememberforcalculatingthecostofofferingorrefusingadiscountis:
(1+D/(100D))(365/t)1x100%
Where:D=thediscount(2%=2etc.)
t=theperiodbywhichthepaymentisadvancedifthediscountistaken

INVOICE DISCOUNTING
Invoicediscountingisanothermethodacompanycanusetospeedupthereceiptofcashfromits
receivables.Ifacompanyisshortofcash,itcanapproachaninvoicediscounterwhowilllendcash
againstthesecurityofoneorafewinvoicesthatcustomershavestilltopay.
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Forinstance,theinvoicediscountermayadvance75%oftheoutstandingamounts.Insomeinvoice
discountingdeals,theinvoices/debtsarelegallysoldtotheinvoicediscounterandinotherstheyarenot.
Whenthecustomerfinallypays,theinvoicediscounterrecoverstheamountlentandalsoreceives
interestandcharges.
Confidentialinvoicediscountingiswherethecustomerisnotawareofthediscountingarrangementand,
aslongastheypaytheirdebt,theywillneverbecomeawareofit.
Therefore,invoicediscountingissimilartofactoringinthewaythatthefinanceisprovidedand,indeed,
manyfactoringcompanieswillalsoprovideinvoicediscountingservices.However,withinvoice
discountingthecompanycontinuestorunitsownsalesledger.Additionally,whilefactoringisanongoing
arrangement,invoicediscountingconsistsofoneoffdealstocovertemporarycashshortages.
InvoicediscountingcanbeofparticularusetoSMEswhoarestartingtowincontractswithlarge
customers.Whilewinningacontractwithalargecustomercanbegoodnewsforacompany,itcanlead
tocashflowproblems.Thisisbecausethecontractwiththelargecustomerislikelytoinvolvesumsthat
areverysignificanttotheSME,andwhilelargecustomersaregenerallyreliablepayers,theyoftenonly
payafterasignificantdelay.

CONCLUSION
Incombinationwiththeothertwoarticleshighlighted,thisarticleprovidesstudentswiththecore
knowledgerequiredinthisfrequentlyexaminedsyllabusarea,whichformspartofoneofthecoreF9
topics.Atalltimesitshouldberememberedthatthecostsinvolvedinmanagingaccountsreceivablemust
bekeptbelowthebenefitreceivedfromgrantingcredittocustomers.
WilliamParrottisafreelanceFMtutorandseniorFMtutoratMATUganda

Backtotop
Lastupdated:21Jun2016

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