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FM II CH-4-1

The document discusses receivables management, including defining receivables as amounts owed from credit sales, the costs associated with maintaining receivables, and factors that influence receivable sizes. It also outlines the dimensions of receivables management, such as forming credit policies, executing those policies, and formulating collection policies to balance costs, sales, and risks of bad debts.

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55 views12 pages

FM II CH-4-1

The document discusses receivables management, including defining receivables as amounts owed from credit sales, the costs associated with maintaining receivables, and factors that influence receivable sizes. It also outlines the dimensions of receivables management, such as forming credit policies, executing those policies, and formulating collection policies to balance costs, sales, and risks of bad debts.

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Fãhâd Õró Âhméd
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We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER FOUR

RECEIVABLES MANAGEMENT
Meaning of Receivables
• It is amounts owed to the firm as a result of sale of goods or services in
the ordinary course of business.
• claims of the firm against its customers.
• Receivables are also one of the major parts of the current assets of the
business concerns. It arises only due to credit sales
• to customers, hence, it is also known as Account Receivables or Bills
Receivables.
• Management of account receivable is defined as the process of making
decision resulting to the investment of funds in these assets which will
result in maximizing the overall return on the investment of the firm.
Costs of Maintaining Receivables
1. Cost of Financing Receivables. receivables are financed from the
funds supplied by shareholders for long term financing and through
retained earnings. The concern incurs some cost for collecting funds
which finance receivables.
2. Collection Cost. This cost incurred in collecting the receivables from
the customers to whom credit sales have been made.
3. Bad Debts: The amounts which the customers fail to pay are known
as bad debts.
Factors Influencing the Size of Receivables
• Size of Credit Sales
• Credit Policies
• Terms of Trade
• Expansion Plans
• Relation with Profits
• Credit Collection Efforts
• Habits of Customers
Receivables Management
Receivables management is the process of making decisions relating to
investment in trade debtors/account receivable
Receivables is necessary to increase the sales and the profits of a firm.
But at the same time investment in this asset involves cost and always a
risk of bad debts too.
The objective of receivables management is to take a sound decision as
regards investment in debtors.
Dimensions/component of Receivables Management
1.Forming of Credit Policy. A credit policy is related to decisions such as credit
standards, length of credit period, cash discount and discount period, etc.
A)Quality of Trade Accounts/Credit Standards
The quality of trade accounts should be decided. A finance manager has to
match the increased revenue with additional costs. The credit should be
liberalized only to the level where incremental revenue matches the
additional costs. so that credit facilities are extended only up to that level.
The optimum level of investment in receivables should be where there is a
tradeoff between the costs and profitability. On the other hand, a tight credit
policy increases the liquidity of the firm. Thus, optimum level of investment in
receivables is achieved at a point where there is a tradeoff between cost,
profitability and liquidity.
Dimensions/component of Receivables Management
(b)Length of Credit Period: length of credit period means the period
allowed to the customers for making the payment.
• The length of credit period determine the volume of investment in
receivables. More/extended credit time is allowed to increase sales to
existing customers and also to attract new customers.
(c) Cash Discount: Cash discount is allowed to speed up the collection
of receivables. but it has it own cost mean that it should be allowed
only if its cost is less than the benefit.
(d)Discount Period: collection of receivables is influenced by the
discount period extending of discount period will result in late
collection of funds
2. Executing/Implementing Credit Policy

After formulating credit policy it should be properly executed under the


following procedures.
(a) Collecting Credit information: enough information should be
collected for proper analysis about the financial position of the
customers is possible. The information may be available from
financial statements, credit rating agencies, reports from banks,
firm’s records etc.
(b) Credit Analysis: To find out the credit worthiness of potential
customers and also to see whether they satisfy the standards of the
concern or not. To determine the degree of risk associated with the
account, the capacity of the customer borrow and his ability and
willingness to pay.
2. Executing/Implementing Credit Policy
(c) Credit Decision: After analyzing the credit worthiness of the
customer, the finance manager has to take a decision whether the
credit is to be extended and if yes then up to what level.
(d) Financing Investments in Receivables and Factoring:
A business can finance fund through two ways which are bank and other
agencies the former simply will credit the amount to the party after
deducting discount and will collect the money from customers on due
date. the later can buy receivables and pay cash for them/ converting
sales invoices into ready cash. This facility is known as factoring.
Procedures of factoring

1.factor firm makes an analysis of the credit worthiness of potential


customers and set the credit limit and term of credit
2.Preparation of sales documents which contain the instructions to make
payment directly to factor who is responsible for collection.
3.When the payment is received by the factor on the due date the factor
shall deduct its fees, charges etc and credit the balance to the firm’s
accounts.
4.factor firm may also provide advance finance to selling firm
Benefits and Cost of Factoring
Benefits of Factoring
• Better Cash Flows
• Better Assets Management
• Better Working Capital Management
• Better Administration
• Better Evaluation
• Better Risk Management
Cost of Factoring
• factor firm charges substantial fees and commission
• advance finance provided by factor firm would be available at a higher interest
• A factor is in fact a third party to the customer who may not feel
• Factoring considered as a symptom of financial weakness.
3. Formulating and Executing Collection Policy
Strict collection policy. This policy will :
• early collection of dues.
• reduce bad debt losses.
• increased collection costs.
• reduce the volume of sales
Lenient policy .This policy will :
• increase the collection period
• more bad debt losses.
• A customer not clearing the dues for long period
• Reduce repetition of order because customer has to pay earlier dues first

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