Receivable

management
 Meaning of Receivable
Management:
Receivable management refers to the
decisions a business makes regarding its
overall credit and collection policies and the
evaluation of individual credit applicants.
Receivables management proves for a firm,
both an asset and a problem:
An asset: Promise of a future cash flows.
Problem: Need to obtain financing while
waiting for the future cash flows.
1. Financial motive:- seller charge a higher price
when selling on credit.
2. Operating motive:- extending credit to nullify the
impact of variable or uncertain demand.
3. Contracting cost motive;- sales contracting costs
between buyer and sellers are reduced for buyer
because they can impact the quantity and quality of
goods prior to payment and reduce the payment if
some goods are defective and missing.
Seller have less employee or third party theft because
goods are less liquid than cash and collection is not
made at the time of delivery.
  Factors in Determining
Receivable Policy……….

cost Benefit

Costs are:
 collection cost…..

 Capital cost…..

 Delinquency cost….

 Default cost or bad debts losses….

  Costs:-
 Collection costs:- money is spent in
preparing and mailing reminders, hiring
personnel or agencies to get payment, in
acquiring credit information and in generally
maintaining and operating a credit
department.
 Capital costs:- the firm must raise funds to
finance credit, for the firm must pay its
employee, its supplier and all other who
manufactured or distribute the product while
waiting for the customer to pay for the
product.
 -cost of new long term debts.
 Delinquency costs:- the failure of the
customer to pay on time on time adds
collection costs above those associated with a
normal collection.
 Default cost or bed debts costs:- the firm
incur costs when the customer fails to pay at
all. In addition to the collection costs, capital
costs, and delinquent costs incurred up to this
point, the firm loses the cost of the goods sold
but not paid for.
  Benefit
 The firm incurs benefit from the account
receivables policy which must be weighted
against the cost in order to determine the
profitability of any particular account
receivable policy. The benefit are the increase
sales and profit anticipated because of more
liberal policy.

 M= TR- TC
if increase investment in account receivable the
firm operating on a cash and carry policy. And
profit is determined by
M1= TR1-TC1
 Determining the


Appropriate Receivable
policy…..
 In this section we will discuss the relationship
between the components of a company credit
policy and the costs and the benefits associated
with providing credit.
 The credit granting sequence are as follow:
1. Analysis Of Credit Standards
2. Analysis Of Credit Term
3. Seasonal Dating
4. Delinquency And Default
5. Marginal analysis
6. Evaluating the credit applicant
 Order and credit request received

Material change in
New or increased credit limit customer status redo credit investigation
Size of n
proposed
credit limit
o check new A/R
total vs. credit limit
large medium small

In depth credit Moderate Minimal

investigation Credit Credit
payment investigation Investigation

Record Extend
disposition credit

Set up post account

Customer
payment received

Update A/R
•Credit standards have a significant influence on sales
as trade credit is one of the many factors that influence
the demand for a firm’s product.
•The relaxation of credit term involve certain costs and

the enlarge administrative expenses and increase

probability of bad debt, and the cost of additional
investment in receivable resulting from increased sales
and a slow average collection period.
•There is also the profitability of additional sales,

additional demand for the product and the required

return on investment.
A company’s credit term specify a credit period
and cash discount rate where a cash discount is
offered.
The credit period is the period elapsing b/w the
date when the purchasing company receives its
statement of account and the date when
payment is due.
The cash discount period is the period elapsing
b/w the date when the purchasing company
receives its statement of account and the date
when the cash discount is foregone.
The cash discount rate expresses, in effect, the
•A firm doing seasonal business has
to provide credit sales in unseason.
When the firm provide credit
automatically the level of investment
in receivable will increase with the
comparison of the level of
receivables in the season; because in
season firm will sell goods on cash
basis only.
•for example- refrigerators, air-
 Delinquency costs are those expenses
associated with that portion of total sales which
remain uncollected and they force the company
to spend an additional amount per account in
an attempt to collect. We can express total
delinquent costs as follows:
DC =AC(N+N11)(Ps)
where DC = total delinquency cost
N = the number of units sold
N1 = the number of additional units sold
to the customers because of the
discount
 In addition to the delinquency cost, we also
have to deduct the default cost (FC) which
arises when the firm gives up trying to collect
on the account and charges the entire cost of
the goods sold as an expense. We can express
the cost of goods (C) that have to be written off
as follows:
FC = C(N+N1)(Ps).
 Marginal analysis involves a systematic
comparison between the marginal return and the
marginal costs from a change in the discount
period, the risk class of the customer, or the
collection process.
 The change should be accepted if marginal return
from a proposed change in the management of
account receivable is greater than the marginal
costs on additional investment.
 Sources of credit information:-
1. Financial statement:- financial statement for past few
years the firm can analyse the applicant’s financial
stability, liquidity, debt capacity and profitability.
2. Bank reference:- it may be possible for the firm’s
bank to obtain credit information from the applicant's
bank. An estimate of the firm’s cash balance is
provided.
3. Trade checking:- a company can ask other supplier
about their experience with an account.
4. Credit bureaus:- the service of credit bureaus are
required in the advanced countries to get a
comprehensive and correct information about the
applicant.
 After having collected the required information about
applicant from different sources, the information
should be analyzed to determine the credit
worthiness of the prospective customer.
 Traditional approach
 Heuristic approach
 In this approach 5 dimensions are used for credit
analysis and decision:-
 It refers to the capital base and capital structure of
the company. If the applicant is a person then capital
refers the personal assets value of financial reserve
value of the customer.
 What are the firm’s financial strength?

 What are its weakness?

To assess the capital dimension the credit analyst

considers the data obtain from the applicant’s
financial statement.
 Ratio analysis can be quite sophisticated.
 It is the prime C in as much as it means the moral
integrity and willingness to make the full payments
on the due date because, there may be cases,
where the buyer may be able to pay but may not
have the good intention to do so.
 it means offering assets as a pledge against
providing credit. It act as a cushion. The assets
generally may be security deposits of bank sureties,
these are movable.
 it means the ability of prospective customer to pay.
In other words customer capacity as the financial
capability to make the payment on due date. It may
be ascertained from the net cash position, after
assessing the cash inflows and cash outflows.
 The term condition here refers to the economic
conditions and climate providing at the material
time, which may have favorable or unfavorable
impact on the financial position and prospects of
the prospective customer.
 No analytic framework
 No link to shareholder wealth maximization
 No consistency of analysis
 This approach described here is based on a
manufacturing company’s actual experience, the
formula or procedure described here has the weight
of managerial experience & intuition behind it &
therefore is heuristic in nature.
 To established a credit limit and grant credit, the
following factors need to be considered.
 Credit requirement
 Pay habits
 Year of business
 Profit margin
 Current ratio
 Total debt to asset ratio
 Inventory turnover
1. Credit requirement:- this factor is measure of the
applicant’s dependency on the creditor.
2. Pay habits:- it is the second factor. It is a measure of
the ability & willingness to pay.
3. Year of business:- it is a measure of ability of the
firm to pay. Less than 3 years in business has not
effect on increasing the limits.
4. Profit margin:- zero percent is contributed to the
credit limit if margins are less than 5%. In case the
margin is more 14%, 10% to be contributed to the
credit limit.
5. Current ratio:- a current ratio of 2.2:1 is considered
to be a good indication of ability to pay & help in
contributing 10% towards the credit limit.
6. Total debt to asset ratio:-it represent the
ability to pay.
7. Inventory turnover:- a lower inventory
turnover implies low efficiency & vice versa.
 Discriminant analysis is a computer based
technique for predicting whether a new credit
applicant will prove to be good or bad credit
risk.
 To perform a discreminant analysis, suppose
the credit analyst has gone back through past
credit customers and selected two groups:
 Those that proved to be good
 Those that proved to be bad ones, either
because they defaulted or because they are
slow-pays.
 Assume that the analyst has n piece of
information (x1,x2,………,xn) about each
customer from the original credit applications.
 The objective of discriminant analysis is to

find a set of numerical weights a1, a2,

……………, an, such that when the weighted
sum or credit score,
 I= a1x1+ a2x2+……….+anxn

Is formed, the I’s for the good account will be

different as possible, from the I’s for the bad
ones.
 The objective of discriminate analysis is to
maximize:
 Ib-Ig
 ¬I

Bad
accou
Ig-Ib Good
-nts accounts

overlap
 Originally applied to credit problem by
professor mehta, sequential decision analysis
rests on the promise that information is
costly. Rather than perform a complete
analysis on every credit applicant.
 Mehta observed that it is frequently more
economical to divide the analysis into several
stages, ranges from very inexpensive.
 At each stage the credit analyst must decide
whether to grant credit, or seek additional
information.

 Grant credit
Seek more information

Refuse credit

Grant credit
Poor
5% Seek more information
Refuse credit

Grant credit

Seek more information

Refuse credit
 We see that 60% of all credit applicant are
former customer with whom the company has
a good credit experience,
 5% are poor former customer

 35% are new customer.

For each branch start from stage 1, that analyst

must decide whether to grant credit, seek
more information, or refuse credit.
 At every stage benefit & cost are analyzed & if
benefit exceed cost then we move ahead
otherwise terminates the proposal.
 Cost of failure include variable cost & default
cost.
 Expected profit= P(contribution to profit)-(1-p)
(cost of failure)