X1 Managing ReceivablesPayables - 2023

Financial Management
BAC 5006
Managing Receivables &
Payables
Week 9 – Lecture 1 & 2
Lecturers: Assoc.Prof. Do Hong Nhung (PhD)
Managing accounts receivable
Total credit cost
• The main cost of offering credit is the interest rate.

• The value of interest charged on an overdraft to fund
the period of credit.
• The interest lost on the cash not received and
deposited in the bank.
• An increase in profit from extra sales resulting from
offering credit could offset this cost.
Slide
2
Sensitivity: Internal
Credit control policy
Factors should be considered:

 The administrative costs of collecting debts.
 The procedures for controlling credit (IT systems).
 The amount of extra capital required to finance credit (increased
the production cost).
 The cost of additional finance required for increase accounts
receivables.
 Additional expenses (i.e. cost of extra work to pursuing slow
payers).
 The effect of easing credit which might encouraging bad debts.
Customer history analysis
•Individual account receivable can be assessed using
Credit rating system
• The overall level of accounts receivable can be monitored using
Aged account receivable listing Credit utilisation report
Extension of credit (you need to assess)
•The extra sales that a more generous credit policy would stimulate.
•The profitability of extra sales.
•The extra length of accounts receivable turnover.
•The required rate of return on investment in a additional credit.
Slide 4
Valuing Accounts Receivable
Under percentage of receivables basis, management establishes a
percentage relationship between the amount of receivables and
expected losses from uncollectible accounts.
Illustration 8-6
SO 3 Describe the methods used to account for bad debts.

Collecting amounts owing policy

•The benefits of action to collect debts must be greater than the costs
incurred.
• The debts collecting debts is a two stage process:
If the payments become overdue

they should chased by making :
•Having a greed credit terms with customer.
➢Telephone call.
•Issuing invoices and receiving payments.
➢Personal approach.
•Queries are resolved.
➢Notification of debt collection section.
•Monthly statement issued.
➢Hiring external debt collection agency.
➢Instituting legal action to cover debts.
Slide
6
The objectives of managing receivables
The optimum level of trade credit extended
represents a balance between two factors:
1. Profit improvement from sales obtained by
allowing credit;
2. The cost of credit allowed.
Managing Accounts Receivables
Establishing a credit policy
 The amount of credit?
 For how long?
 Which customers?
 Any protection of payment?
Four key aspects:
1. Assess creditworthiness.
2. Credit limits.
3. Invoice promptly and collect overdue debts.
4. Monitor the credit system.
Early settlement discounts

This may be applied to:
 Shorten average credit period .
 Reduce the investment in accounts receivable (interest cost saved should exceed the cost of
discount allowed).
 Advantages VS. Disadvantages?
Calculate:
✓ Profits foregone by offering discount
✓ Interest charge changes because customer paid at different times and sales change
Slide
9
Cost of offering credit = Value of interest charged on an
overdraft to fund the period of credit or Interest lost
on cash not received
 Cost of financing receivables =

 receivable balance x interest (overdraft) rate
 Receivable balance =
 sales x (receivable days / 365 days)
Example 1
Example 1
Example 2
P Co has sales of £20m for the previous year,
receivables at the year end were £4m, and the cost
of financing receivables is covered by an overdraft
at the interest rate of 12% pa.
Required
a) Calculate the receivables days for P Co.
b) Calculate the annual cost of financing receivables.
Example 2
Solution
a) Receivable days=(Receivables/sales) x365days
= (4m/20m) x 365 = 73days.
b) Cost of financing receivables = receivable

balance x interest (overdraft) rate
= 4m x 12% = £480,000
Example 3
Managing A/R – Extension of credit
Example 3
Solution
Example 3
Solution
A/R Management – Bad debt
risk
Solution
Cost of discount Page 93 textbook
Continuing the case of P Co.

receivables at the year end were £4m, and the cost
of financing receivables is covered by an overdraft
at the interest rate of 12% pa.
Required
a) Calculate the receivables days for P Co.
b) Calculate the annual cost of financing receivables.
It is now considering offering a cash discount of 2%
for payment of debts within 10 days.
Required:
(a) What’s the cost of discount for P co.?
(b) Should it be introduced if 40% of customers will
take up the discount?
https://www.online-calculator.com/scientific-calculator/
Solution
a) Applying the formula,
T = 73 – 10 = 63 days,
d = 2, therefore
Annual cost of discount =
= 12.41%
Should the new scheme be adopted? Any hidden assumption made?
Solution
b) If only 40% customers will take up the discount,
Value of receivables in new scheme
= sales x (receivable days / 365 days)
= 20m x (10/365) x 40% + 20m x (73/365) x 60%
= £2.62m
Saving in interest pay = (4m -2.62m) x 12% = £170,000

Less Cost in discount = 40% x 20m x 2% = £160,000
 Net saving = £10,000
Factoring
Factoring – the outsourcing of the credit control
department to a third party.
 Advantages
➢ Saving in staff time/admin costs
➢ New source of finance to help liquidity
➢ Frees up management time
➢ Supports a business when sales are rising
 Disadvantages
➢ Can be expensive
➢ Loss of direct customer contact goodwill
Example of Factoring
Factoring – example 2
Continuing the case of P Co.

receivables at the year end were £4m, and the
cost of financing receivables is covered by an
overdraft at the interest rate of 12% pa.
Required
a) Calculate the receivables days for P Co. (73
days)
b) Calculate the annual cost of financing
receivables.
Factoring - Example 2
– Cost of factoring (Continuing of P Co case)
A factor has offered a debt collection service which
should shorten the receivables collection period on
average to 50 days. It charges 1.5% of turnover but
should reduce administration costs to the company by
£150,000.
Required:
a) Should P Co hire the factoring facility?
b) In addition, the factor has offered a finance provision of
80% of the debt immediately. They charge 14% but this is
expected to save an additional £50,000. What is the
overall cost of this service?
Solution
a) Without factoring=
Cost of finance Receivables = 4m x 12% = £480,000
With factoring=
Cost of finance Receivables = 20m x (50/365) x 12% = £328,767
Factoring charge = £20m x 1.5% = £300,000
Savings in admin = £150,000
Total cost of factoring =
Cost of finance Receivables 328,767
Factoring charge 300,000
Less savings in admin charges. 150,000
Total cost of factoring £478,767
Therefore, net saving of factoring = 480,000 – 478,767
= £1,233
Cách 2
 Factor charge: 20m* 1.5% = (300,000)
 Reduce administration cost = 150,000
 Reduce interest paid to bank
 In the past, average A/R = 4m
 Present, average A/R = 20m*50/365 = 2.739726m
 Save interest cost = (4m-2.739726m)*12% = 1,260273m*12%
= 151,232
Conclusion:
Save = 150,000 + 151,232 = 301,232
Factor Charge = 300,000
=> Net income = Net save = 1,232
Solution
b) If factor provides finance,
Cost of finance receivables = 80% x (50/365) x 20m x 14% + 20% x
(50/365) x 20m x 12% = 372.602
Factor charge = £300,000
Savings in admin = 150,000+50,000 = £200,000
Total cost of factoring = £472,602
Therefore, net saving in factoring = 480,000 – 472,602
= £7,398
Invoice discounting
• Is the purchase (by the provider of the discounting services) of

trade debts at a discount.
• It enables the company to raise working capital.
Managing foreign accounts receivable
Exporters have to address the problems of

• larger inventories
• accounts receivable
• an increased risk of bad debts due to the transportation time
• additional paperwork involved in sending goods abroad.
Slide
35
Managing Accounts Payable
 Under trade credit a firm is able to obtain goods (or services)

from a supplier without immediate payment, the supplier
accepting that the firm will pay at a later date.
 Again there is a balancing act between liquidity and
profitability.
 A delay of payment to suppliers could cause problems.
 Suppliers will normally offer early settlement discounts which
ensures prompt payment.
Managing Accounts Payable
 Costs of taking credit:

 Higher price than purchases for immediate cash settlement.
 Administrative costs.
 Restrictions imposed by seller.
 Foreign exchange losses.
 Costs of not taking credit:

 Financing cost.
 Lost purchasing power.
 Inconvenience – paying at the time of purchase can be inconvenient.
Managing accounts payable
Effective account payable policy

Includes:
➢Seeking satisfactory credit terms from suppliers.
➢Getting credit extended during the period of cash shortage.
➢Maintaining good relations with suppliers.
The cost of lost early payment discount
The cost of lost cash discount can be calculated by comparing

the saving from the discount with the opportunity cost of
investing the cash.
Slide
38
Example – Account payable with
early settlement discount
 One supplier has offered a discount to Box Co of 2%
on an invoice for £7,500, if payment is made within
one month, rather than the three months normally
taken to pay. If Box’s overdraft rate is 10% pa, is it
financially worthwhile for them to accept the
discount and pay early?
Solution
Method 1:
Saving in early settlement discount = 2% x 7,500 = £150
Finance cost of 2-month overdraft = 10% x (2/12) x 7,500 =
£125
Net saving = 150 – 125 = £25
Therefore, Box co should accept the discount.
Method 2:
Annual cost of early settlement =
= 12.88%
Therefore it is cheaper to use overdraft at 10% to pay early
and Box should accept the discount offer.
Receivables & Payables
Managing foreign trades
 Export credit risk
1) Insolvent customers
2) Bank failure
3) Unconvertible currencies
4) Political risk
 Foreign exchange risk
1) Buying from abroad in a foreign currency
2) Denominating sales to export customers in a foreign
currency.
The relationship between the effective inventory management and accounts receivable
Effective management for inventory means;

 Ensure sufficient liquid resources to continue in business.
 Increase the overall profitability.
 Minimize the total days for cash operating cycle and
operating cycle.
 Minimize total costs (holding cost & ordering cost).
 Ordering the EOQ to minimize the cost.
 Maintain the effective minimum inventory levels (re-
ordering level, minimum inventory level, buffer safety
level and average inventory).
Effective management for accounts receivable
means;
➢ Ensure sufficient liquid resources to continue in
business.
➢ Increase the overall profitability.
➢ Minimize the total days for cash operating cycle and
operating cycle.
➢ Minimize total credit costs (interest rate, interest
charged on an overdraft & interest lost on cash not
received and deposited in the bank).

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Financial Management

Total credit cost

• The main cost of offering credit is the interest rate.

Factors should be considered:

• The overall level of accounts receivable can be monitored using

Aged account receivable listing Credit utilisation report

Extension of credit (you need to assess)

SO 3 Describe the methods used to account for bad debts.

Collecting amounts owing policy

If the payments become overdue

Early settlement discounts

 Cost of financing receivables =

b) Cost of financing receivables = receivable

Continuing the case of P Co.

P Co has sales of £20m for the previous year,

Should the new scheme be adopted? Any hidden assumption made?

Saving in interest pay = (4m -2.62m) x 12% = £170,000

Continuing the case of P Co.

• Is the purchase (by the provider of the discounting services) of

Managing foreign accounts receivable

Exporters have to address the problems of

 Under trade credit a firm is able to obtain goods (or services)

 Costs of taking credit:

 Costs of not taking credit:

Effective account payable policy

The cost of lost cash discount can be calculated by comparing

Effective management for inventory means;

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