Management of Accounts Receivable

Meaning & Definitions

Aspect of Credit Management
Objectives of Accounts Receivables Management
Advantages of Trade Debtors Management
Costs of Maintaining Accounts Receivables
Formulation of Credit Policies
Illustrations on Credit Standard
Credit Term
Credit Analysis
Functions of Credit Manager
Control of Accounts Receivables
Illustrations
Factoring of Receivables

Meaning and Definitions

Granting credit to promote sales is very
powerful instrument now a day. The money due from
customers is known as, Sundry Debtors or Trade
debtors or Accounts Receivables". In working
capital management S. Debtors stands next to cash and
inventory.
According to Receivable Management, the term
Accounts Receivables is define as , debt owned to the
firm by customers arising from sale of goods or
services.

Aspects of Credit Management

A firms business in accounts receivables depends on its
sell on credit and collection policies. In order to gain
success in accounts receivables management, it is essential
to get aware of different aspects of credit management.
1. Objectives of Accounts Receivables Management
2. Advantages of Trade Debtors Management
3. Costs of Maintaining Accounts Receivables
4. Formulation of Credit Policies
5. Execution of Credit policies
We shall now look each one of them in brief.

Objectives of Receivable Management

1.
2.
3.
4.
5.
6.
7.
8.
9.

To increase the volume of sales.

To settle trade debts without loss.
To achieve the target return on investments
To create an essential part of competitive business
To maintain adequate capital of the firm
To create additional source of finance
To promote international trade transactions
To facilitates liberal credit transactions
To ensure credit worthiness of a concern

Advantages of Receivable
Management
1.
2.
3.
4.
5.
6.
7.
8.

Liberalized credit policy helps to increase the sales

Credit policy helps to meet competition
It increases operating profits
It minimizes bad debts without taking stringent measure
It facilitates adequate working capital
It gives guidance to management for effective planning
Credit sales helps to attract customers
It helps to make effective co-ordination between
finance, production, sales, profit and cost

Costs of Maintaining Accounts

Receivables
While granting
credit to increase
sales and maintaining
accounts receivables
certain costs are
borne by concern.
Those are depicted in
aforesaid chart.

Default
Cost

Capital
Cost

Delinquency
Cost
Costs

Administration
Cost

Collection
Cost

Formulation of Credit policies

The term credit
policy refers to a firm
contains guidelines for
determining quality of
trade accounts to be
accepted, the length of
credit period etc. The
important dimensions of
credit policy are shown
in diagram.

Cash
Discount
Period
Credit
Period

Cash
Discount

Dimensions
Credit
Standard

Credit
Terms
Credit
Analysis

Illustrations:
Following are the details regarding the operation of a firm during a period 12
months.
Sales
Rs.24,00,000
Selling Price per Unit
Rs.20
Variable Cost Price per Unit
Rs.14
Total Cost per Unit
Rs.18
Credit Period allowed to customers one month.
The firm is considering a proposal for a more liberal extension of credit which
will result in increasing the average collection period from one month to two
months. This relaxation is expected to increase the sales by 25% from its
existing level.
You are required to advise the firm regarding adoption of the new credit policy.
Presuming that it firms required return on investment 25%.

Solutions:
Relaxing Credit Standards : Profit Vs Retired Return:
Computation of New Sales =

Present Sales + Additional Sales

Present Sales

1,20,000 units x Rs.20 = Rs.24,00,000

Additional Sales in Units

25% of Present Sales

Additional Sales in Volume =

30,000 units x Rs.20 per unit = Rs.6,00,000

Total of New Sales

Rs.24,00,000 + Rs.6,00,000 = Rs.30,00,000

Computation of New Total Cost :

New Total Cost

= Present Total Cost + Cost of Additional Sales

Present Total Cost of Sales = 1,20,000 units x Rs.18 = Rs.21,60,00

Cost of Additional Sales

= 30,000 units x Rs.14

= Rs.4,20,000

Total cost of New Sales

= (1,20,000 + 30,000 )

= Rs.25,80,000

New Average Cost per unit =

=

New Total Cost of Sales = Rs.25,80,000

New Total Sales in units 1,50,000 units
Rs.17.2 per unit

Average Investment in Receivables after Credit Standards Relaxation :

Total of annual New Sales in units

New Total Sales

Selling Price per Unit

Rs.30,00,000 = 1,50,000 units

Rs.20

Cost of Sales

Rs.25,80,000

Average Collection Period

2 months

Amount Invested in Receivables

Rs.25,80,000 x 2 = Rs.4,30,000
12

Additional Investment in Receivables =

New Investment Existing Investment

New Investment

Rs.4,30,000

Existing Investment

Rs.21,60,000 = Rs.1,80,000
12

Additional Investment in Receivables =

Rs.4,30,000 Rs.1,80,000 = Rs.2,50,000

Profitability of Additional Sales

Additional Units Sold x Contribution per Unit

Additional Unit Sold

30,000 units

Contribution per Unit

Selling Price per Unit Variable cost per Unit

Rs.20 Rs.14 = Rs.6

Profitability of Additional Sales

30,000 x Rs.6

Return on of Additional Investment

In Receivables

Profitability of Additional Sales

x 100
Additional Investment in Receivables

Rs.1,80,000

X 100

Rs.2,50,000
=

72 %

Comment:
The required return on investment is only 25% while the actual return on
additional investment in receivables come to 72%. The proposal should,
therefore be accepted.

Credit Terms
Credit terms means, stipulation under which the firms
sells on credit is extended to a customers. There are three
important components of credit terms. Those are as below;
1. Credit Period : Refers to a period which is extended to buyer
for payment. Normally it is in the range of 15
to 45 days.
2. Cash Discount: A powerful device to speedup the payment.

3. Cash Discount: A period which represents the time in

Period
which a cash discount can be taken for
early payment. Normally it is quoted as
3/10, net30.

Credit Analysis
The main aim of debtors management is to ensure
the minimum investment in accounts receivables and
reducing in percentages of bad debts. To achieve this
finance manager must follow proper procedure of
evaluation of credit process. The same is consist of
following three steps;
1. Gathering Credit Information
2. Analysis of Customers Credit Worthiness
3. Credit Decisions

Functions of Credit Manager

Following are some of the important functions;
Establish appropriate credit policy
Assess customers credit worthiness
Formulation of clear cut credit procedure
Ensure effective credit control system
Effective administration of trade debtors
Establish policy on bad debts
Take legal action incase of default
Give proper response to customers complaints
Make prompt decision about extension of credit

Control of Accounts Receivables

To have a control on trade debtors, following are the
important approaches.
1. Traditional Approach
(a) Ageing Schedule Technique
(b) Days Sales Outstanding (DSO)
2. Modern Approach
(a) Control of Average Collection Period
(b) Determination of Cost of Goods Sold
(c) Control of Discount Facilities
(d) Control of Administrative, collection costs.

Illustration:
Calculate Debtors Turnover Ratio from the following information.
Rs.
Sales
7,00,000
Sundry Debtors as on 1.1.2004
9,00,000
Sundry Debtors as on 31.12.2004
2,00,000
Bills Receivables as on 1.1.2004
3,00,000
Bills Receivables as on 31.12.2004
70,00,000
Sales Return
2,00,000
Cash Sales for the year 2004
10,00,000

Solution
Debtors Turnover Ratio

Net Credit Sales

Average Accounts Receivables

Net Credit Sales

Total Sales [ Credit Sales + Sales Return]

Rs.70,00,000 [ 10,00,000 + 2,00,000]

Rs. 58,00,000

Average Accounts Receivables =

Inventory Turnover Ratio

Opening Receivables + Closing Receivables

2

[7,00,000 + 2,00,000] + [9,00,000 + 3,00,000]

2

9,00,000 + 12,00,000
2

Rs.10,50,000

Rs.58,00,000 = 5.52 times

Rs.10,50,000

Illustration:
From the following information calculate
(a) Debtors Turnover Ratio
(b) Debt Collection Period
Total Sales
Cash Sales
Sales Return
Opening Accounts Receivables
Closing Accounts Receivables

Solution:

Rs.10,00,000
Rs.2,50,000
Rs.50,000
Rs.1,00,000
Rs.1,50,000

Debtors Turnover Ratio

Net Credit Sales

=
Average Accounts Receivables

Net Credit Sales

= Total Sales [ Credit Sales + Sales Return]

= Rs.10,00,000 [ 2,50,000 + 50,000]
= Rs. 7,00,000

Solution
Average Accounts Receivables =
=
Debtors Turnover Ratio

Debt Collection Period

Opening Receivables + Closing Receivables

2
1,00,000 + 1,50,000 = Rs.1,25,000
2

Rs.7,00,000
Rs.1,25,000

5.62 times

Avrg. A/cs Receivables x Month or in year

Net Credit Sales for the year

Rs.1,25,000 x 12 Months
Rs.7,00,000

2.14 Months

Factoring of Receivables
This is among the oldest of financial services for
facilitating trade transactions. Factoring is the method by
which a businessman can pledge the book debts as
collateral to obtain cash. So the factoring can be define
as, a service by which a financial institution accepts to
pay businessman by purchasing the his book debts.
Some of the important functions of Factor are as below;
1. Administration of the sellers sales ledger
2. Undertakes the responsibility of collection
3. Rendering useful advisory services.
4. Offer distinct solution to the working capital problems
5. Supplying necessary information to the clients

Types of Factoring
Invoice
Factoring
Bulk
Factoring

Full
Factoring

Undisclosed
Factoring
Types
of
Factoring

Recourse
Factoring

Maturity
Factoring

Advance
Factoring