Meaning & Definitions Aspect of Credit Management Objectives of Accounts Receivables Management Advantages of Trade Debtors Management Costs of

Transcription

1 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

2 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.

3 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.

4 Objectives of Receivable Management 1. To increase the volume of sales. 2. To settle trade debts without loss. 3. To achieve the target return on investments 4. To create an essential part of competitive business 5. To maintain adequate capital of the firm 6. To create additional source of finance 7. To promote international trade transactions 8. To facilitates liberal credit transactions 9. To ensure credit worthiness of a concern

5 Advantages of Receivable Management 1. Liberalized credit policy helps to increase the sales 2. Credit policy helps to meet competition 3. It increases operating profits 4. It minimizes bad debts without taking stringent measure 5. It facilitates adequate working capital 6. It gives guidance to management for effective planning 7. Credit sales helps to attract customers 8. It helps to make effective co-ordination between finance, production, sales, profit and cost

6 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. Capital Cost Default Cost Costs Delinquency Cost Administration Cost Collection Cost

7 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. Credit Period Credit Standard Cash Discount Period Dimensions Credit Analysis Cash Discount Credit Terms

8 Illustrations: Following are the details regarding the operation of a firm during a period 12 months. Sales Selling Price per Unit Variable Cost Price per Unit Total Cost per Unit Rs.24,00,000 Rs.20 Rs.14 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 firm s required return on investment 25%.

9 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 = Cost of Additional Sales = Total cost of New Sales = New Average Cost per unit = 1,20,000 units x Rs.18 = Rs.21,60,00 30,000 units x Rs.14 = Rs.4,20,000 (1,20, ,000 ) = Rs.25,80,000 New Total Cost of Sales = Rs.25,80,000 New Total Sales in units 1,50,000 units = Rs.17.2 per unit

10 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, Additional Investment in Receivables = New Investment Existing Investment New Investment = Rs.4,30,000 Existing Investment = Rs.21,60,000 = Rs.1,80, 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

11 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.

12 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.

13 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

14 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

15 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.

16 Illustration: Calculate Debtors Turnover Ratio from the following information. Rs. Sales 7,00,000 Sundry Debtors as on ,00,000 Sundry Debtors as on ,00,000 Bills Receivables as on ,00,000 Bills Receivables as on ,00,000 Sales Return 2,00,000 Cash Sales for the year ,00,000

17 Solution Debtors Turnover Ratio = Net Credit Sales = Average Accounts Receivables = Net Credit Sales Average Accounts Receivables Total Sales [ Credit Sales + Sales Return] = Rs.70,00,000 [ 10,00, ,00,000] = Rs. 58,00,000 = = Opening Receivables + Closing Receivables 2 [7,00, ,00,000] + [9,00, ,00,000] 2 9,00, ,00,000 2 = Rs.10,50,000 Inventory Turnover Ratio = Rs.58,00,000 = Rs.10,50, times

18 Illustration: From the following information calculate (a) Debtor s Turnover Ratio (b) Debt Collection Period Total Sales Cash Sales Sales Return Opening Accounts Receivables Closing Accounts Receivables Rs.10,00,000 Rs.2,50,000 Rs.50,000 Rs.1,00,000 Rs.1,50,000 Solution: Debtors Turnover Ratio = Net Credit Sales = Net Credit Sales Average Accounts Receivables Total Sales [ Credit Sales + Sales Return] = Rs.10,00,000 [ 2,50, ,000] = Rs. 7,00,000

19 Solution Average Accounts Receivables = = Debtors Turnover Ratio = = Debt Collection Period = = = Opening Receivables + Closing Receivables 2 1,00, ,50,000 = Rs.1,25,000 2 Rs.7,00,000 Rs.1,25, times Avrg. A/c s Receivables x Month or in year Net Credit Sales for the year Rs.1,25,000 x 12 Months Rs.7,00, Months

20 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 seller s 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

21 Types of Factoring Invoice Factoring Bulk Factoring Undisclosed Factoring Full Factoring Types of Factoring Advance Factoring Recourse Factoring Maturity Factoring