RECEIVABLES MANAGEMENT

Receivables constitute a significant portion of the current assets of a firm. But, for
investments in the receivables, a firm has to incur certain costs. There is also a risk of bad
debts also. It is therefore very necessary to have a proper control and management of
receivables.

Meaning of Receivables: Receivables represents amount owed to the firm as a result of sale
of goods or services in the ordinary course of business these are the claims of firm against its
customers and form a part of the current assets. Receivables are also known as accounts
Receivables; trade Receivables, customer Receivables, etc. the Receivables are carried for the
customers. The period of credit and extent of Receivables depend upon the credit policy
followed by the firm. The purpose of maintaining or investing in Receivables is to meet
competition, and to increase the sale and profits of the business.

Costs of maintaining Receivables:

1. Cost of Financing Receivables. When a firm maintains receivables, some of the firm’s
resources remain blocked in them because there is a time lag between the credit sale to
customer and receipt of cash from them as payment. Whether this additional finances is met
from its own resources or from outside, it involves a cost to the firm in terms of interest (if
financed from outside) or opportunity costs (if internal resources are used).

2. Administrative costs. When a company maintains receivables, it has to incur

additional administrative expenses in the form of salaries to clerks who maintain records of
debtors, expenses on investigating the creditworthiness of debtors etc.

3. Collection costs. These are costs, which the firm has to incur for collection of the
amount at the appropriate time from he customers.

4. Defaulting cost: When customers make default in payment not only is the collection
effort to be increased but the firm may also have to incur losses from bad debts.

Meaning and Objectives of Receivables Management

Receivables management is the process of making decision relating to investment in trade

debtors. Certain investment in Receivables is necessary to increase the sales and profits of a
firm. But at the same time investment in this asset involves cost consideration also. Further
there is always risk of bad debts too. Thus the objective of Receivables management is to
take a sound decision as regards investment in debtors. In the word of Bolton, S.E. “The
objective of Receivables Management is to promote the sales and profits until that point is
reached where the return on investment in further funding of Receivables is less than the cost
of funds raised to finance that additional credit”.
Dimensions of Receivables Management

Receivables management involves the careful consideration of the following steps:

1. Forming of Credit Policy

2. Executing the Credit Policy

3. Formulating and Executing Collection policy

Forming of Credit Policy: A credit policy is related to decision such as Credit standards,
length of credit periods, cash discount and discount period.

1. Credit standards: The volume of sales will be influence by the credit policy of the
concern. By liberalizing the credit policy the volume of sales can be increased resulting into
increased profits. The increased volume of sales is associated with the certain risks also. It
will result in enhanced costs and risk of bad debts and delayed receipts. The increase in
number of customers will increase the clerical work of maintaining the additional accounts
and collecting of information about the credit worthiness of the customers. On the other hand,
extending the credit only to credit worthy customers will save the cists like bad debts losses,
collection costs, investigation costs etc. the restriction of credit to such customers only will
certainly reduce sales volume, thus resulting n reduced profits. The credit should be
liberalized only to the level where incremental revenue matches the additional costs. This the
optimum level of investment in receivables is achieved at a point where there is a trade off
between the cists, profitability and liquidity

2. Length of Credit period: Length of Credit period means the period allowed to the
customers for making the payment. The customers paying well in time may also be allowed
certain cash discounts. There are no bindings on fixing the terms. The length of credit period
and quantum of discount allowed determine the magnitude of investment in receivables. A
firm may allow liberal credit terms to increase the volume of sales. The lengthening of this
period will mean blocking of more money in receivables, which could have been, invested
somewhere else to earn income. There may be an increase in debt collection costs and bad
debts losses too. If the earnings from additional sales by Length of Credit period are more
than the additional costs then the credit terms should le liberalized. A finance manager should
determine the period where additional revenues equates the additional costs and should not
extend credit beyond this period as the increases in the cost will be more than the increase in
revenue.

3. Cash discount: cash discount is allowed to expedite the collection of receivables. The
funds tied up in receivables are released. The concern will be able to use the additional funds
received from expedited collection due to cash discount. The discount allowed involves cost.
The finance manager should compare the earnings resulting from released funds and the cist
of the discount. The discount should be allowed only if its cost is less than the earnings from
additional funds. If the funds cannot be profitably employed then discount should not be
allowed.
4. Discount period: The collection of receivables is influenced by the period allowed for
availing the discount. The additional period allowed for this facility may prompt some more
customers to avail discount and make payments. For example, if the firm allowing cash
discount for payments within 7 days now extends it to payments within 15 days. There may
be more customers availing discount and paying early but there will be those also who were
paying earlier within 7 days will now pay in 15 days. It will increase the collection period of
the concern.

Executing the Credit Policy: The evaluation of credit applications and finding out the credit
worthiness of customers should be undertaken.

1. Collecting the Credit information: The first step in implementing the credit policy will
be to gather the information about the customers. The information should be adequate enough
so that the proper analysis about the financial position of the customers is possible. The type
of the information can be undertaken only up to a certain limit because it will involve cost.
The cost incurred on collecting this information and the benefit from reduced bad debts losses
will be compared. The credit information will certainly help in improving the quality of
receivables but the cost of collecting information should not increase the reduction of bad
debt losses. The information may be available from the financial statements of the applicant,
credit rating agencies; reports from the banks, firm’s records etc. a proper analysis of
financial statements will be helpful in determining the creditworthiness of customers. Credit
rating agencies supply information about various concerns. These agencies regularly collect
the information about the business units from various sources and keeps the information up to
date. Credit information may be available with the banks also. The banks have their credit
departments to analyze the financial position of customers. In case of old customer,
businesses own records may help to know their credit worthiness. The frequency of
payments, cash discount availed may help to form an opinion about the quality of the credit.

2. Credit analysis: After gathering the required information, the finance manager should
analyze it to find out the credit worthiness of potential customers and also to see whether they
satisfy the standard of the concern or not. The credit analysis will determine the degree if risk
associated with the account, the capacity of the customers to borrow and his ability and
willingness to pay.

3. Credit Decision: The finance manager has to take the decision whether the credit is to
be extended and if yes up to which level. He will match the creditworthiness of the customers
with the credit standard of the company. If the customer’s creditworthiness is above the credit
standards then there is no problem in taking a decision. In case the customer’s are below the
company’s standards then they should not be out rightly refused. Therefore they should be
offered some alternatives facilities. A customer may be offered to pay on delivery on goods;
invoices may be sent through bank and released after collecting dues.

4. Financing Investments in receivables and Factoring: Receivables block a part of

working capital. Efforts should be made so that the funds are nit tied up in receivables for
longer periods. The finance manager should make the efforts to get the receivable financed so
that working capital needs are met in time. The banks allow the raising of loans against
security of receivables. Banks supply between 60-80% of the amount of receivables of
dependable parties only. Then quality will determine the amount of loan. Beside banks, there
may be other agencies, which can buy receivables and pay cash for them known as factoring.
The factor will purchase only the accounts acceptable to him. The factoring may be with or
without recourse. If it is without recourse then any bad debts loss taken up by the factor but if
it is with recourse then bad debts loss will be recovered from the seller. The factor may
suggest the customer for whom he will extend this facility.

Formulating and executing Collection Policy. The collection of amount due to the
customers is very important. The concern should devise the procedures to be followed when
accounts become due after the expiry of credit period. The collection policy termed as strict
and lenient. A strict policy of collection will involve more efforts on collection. This policy
will enable the early collection of dues and will reduce bad debts losses. The money collects
will be used for other purpose and the profits of the concern will go up. A lenient policy
increases the debt collection period and more bad debts losses. The collection policy should
weigh the various aspects associated with it, the gains and looses of such policy and its
effects on the finances of the concerns. The collection policy should also devise the steps to
be followed in collecting over due amounts. The steps should be like:

a) Personal request through telephone

b) Personal visit to customers

c) Taking help of collecting agencies

d) Taking legal action etc.

INVENTORY MANAGEMENT

Introduction: Every enterprise needs inventory for smooth running of its activities. It serves
as a link between production and distribution processes. There is generally a time lag
between the recognition of needed and its fulfillment. The greater the time, higher the
requirement of inventory. Thus it is very essential to have proper control and management of
inventories.

Meaning of Inventory

The inventory means stock of goods, or a list of goods in manufacturing concern, it may
include raw material, work in progress and stores etc. it includes the following things:

1. Raw materials are those basic inputs that are converted into finished product through
the manufacturing process. Thus, raw materials inventories are those units, which have been
purchased and stored for future production.
2. Work-in-process inventories are semi-manufactured products. They represent
products that need more work before they become finished products for sale.

3. Finished goods inventories are those completely manufactured products, which are
ready for sale. Stocks of raw materials and work-in-process facilitate production, while stock
of finished goods is required for smooth marketing operations.

Thus, inventories serve as a link between the production and consumption of goods. The
levels of three kinds of inventories for a firm depend on the nature of its business. A
manufacturing firm will have substantially high levels of all three kinds of inventories, while
a retail or wholesale firm will have a very high level of finished goods inventories and no raw
material and work-in-process inventories. Within manufacturing firms, there will be
differences. Large heavy engineering companies produce long production cycle products.
therefore, they carry large inventories. On the other hand, inventories of a consumer product
company will not be large because of short production cycle and fast turnover. Supplies (or
stores and spares) is a fourth type of inventory is also maintained by firms. Supplies include
office and plant cleaning materials like soap, brooms, oil, fuel, light bulbs etc. These
materials do not directly enter production, but are necessary for production process. Usually,
these supplies are small part of the total inventory and do not involve significant investment.
Therefore, a sophisticated system of inventory control may not be maintained for them.

Purpose of Holding Inventories:

There are three main purposes for holding the inventories:

1. The Transaction Motive: This facilitates the continuous production and timely
execution of sales orders.

2. The Precautionary Motive: This necessitates the holding of inventories for meeting
the unpredictable changes in demand and supply of material.

3. The Speculative Motive: This includes keeping inventories for taking the advantage
of price fluctuations, saving in reordering costs and quantity discounts.

Inventory Management

The investment in inventory is very high in most of the undertakings engaged in

manufacturing, wholesale and retail trade. The amount of investment is sometimes more in
inventory than on other assets. In India, a study of 29 major industries has revealed that the
average cost of the material is 64 paise and the cost of labor and overhead is 36 paise in a
rupee. It is necessary for every management to give proper attention inventory management.

A proper planning of purchasing, handling, storing, and accounting should form a proper
inventory management. An efficient system of inventory management will determine:-

1. What to purchase
2. How much to purchase
3. From where to purchase
4. Where to store
The purpose of inventory management is to keep the stocks in such a way that neither there is
over stocking nor under stocking. The over stocking will mean a reduction of liquidity and
starving for other production processes. On the other hand, under stockings, will result in
stoppage of work. The investment in inventory should be left in reasonable limits.

Objectives of Inventory Management

The main objectives of inventory management are operational and financial. The operational
objectives mean that the materials and spares should be available in sufficient quantity so that
work is not disrupted for want of inventory. The financial objective mean that investment in
inventories should not remain idle and minimum working capital should be locked in it. The
followi8ng are the objectives of inventory management:

1. To ensure the continuous supply of raw material, spare and finished goods so that
the production should not suffer at any time.
2. To avoid both over stocking and under stocking of inventory.
3. To maintain the investment in inventories at the optimum level as required the
operational and sales activities.
4. To keep material cost under control so that they contribute in reducing the cist of
production and overall costs.
5. To eliminate duplication in ordering stocks. This is possible with the help of
centralized purchase.
6. To minimize the losses through pilferages, wastages and damages.
7. To design the proper organization for inventory management.
8. To ensure the perpetual inventory control so that the material shown in the stock
ledgers should be actually lying in the stores.
9. To facilitate the furnishing of data for short term and long term planning and
control of inventory.

TOOLS AND TECHNIQUES OF INVENTORY MANAGEMENT:

Effective inventory management requires an effective control, system for inventories. A

proper inventory control not only helps in solving the acute problem of liquidity but also
increases the profits and causes substantial reduction in the working capital of the concern.
The following are the important tools and techniques in inventory management and control:

1. Determination of stock level

2. Determination of safety stock

3. Determination of economic order quantity

4. A.B.C. analysis

5. V E D analysis 6. Inventory turnover ratio 7. JIT Control system

1. Determination of stock level: Carrying too much and too little inventories is detrimental
to the firm. If the inventory level is too little, the firm will face frequent stock outs involving
heavy ordering costs and if the inventory if too high it will be unnecessary tie up of capital.
Therefore an efficient inventory management requires that a firm should maintain an
optimum level of inventory where inventory costs are minimum. Various stock levels are as
follow:

a) Minimum level: This represents the quantity, which must be maintained in hand at
all, times. If stocks are less than the minimum level than the work will stop due to
shortage of material. Following factors are undertaken while fixing minimum
stock level.
b) Lead time: The time taken in processing the order and then executing is known as
lead time
c) Rate of consumption: It is the average consumption of material in the factory.
Minimum stock Level = Re order level – (Normal consumption x Normal reorder
period)
d) Reorder level: Re order level is fixed between minimum and maximum level.
Reorder level = Maximum Consumption x Maximum reorder period
e) Maximum Level: It is the quantity of the material beyond which a firm should not
exceeds its stocks. If the quantity exceed maximum level limit then it will be
overstocking. Maximum Level = Reorder level + reorder quantity – (Minimum
Consumption x Minimum reorder period)
f) Average stock level: Average Stock level = Minimum stock level + ½ of reorder
quantity

2. Determination of the safety stock: Safety stock is a buffer to meet some unanticipated
increase in usage. The usage of inventory cannot be perfectly forecasted. It fluctuates over a
period of time. Two costs are involved in the determination of this stock.

• Opportunity cost of stock out

• Carrying costs

The stock out of Raw Material would cause production disruption. The stock out of finished
goods result into the failure of the firm in competition as the form cannot provide proper
customer service.

3.Economic order quantity: A decision about how much to order has a great gignifi8cance
in inventory management. The quantity to be purchased should be neither small nor big. EOQ
is the size of lot to be purchased which is economically viable. This is the quantity of the
material, which can be purchased at minimum cost. Cost of managing the inventory is made
up of two parts:-
Ordering Costs: This cost includes:
a) Cost of staff posted for ordering of goods
b) Expenses incurred on transportation of goods purchased.
c) Inspection costs of incoming material
d) Cost of stationery, postage, telephone charges.
Carrying costs: These are the costs for holding the inventories. It includes:
a) The cost of capital invested in inventories.
b) Cost of storage
c) Insurance cost
d) Cost of spoilage on handling of materials
e) The loss of material due to deterioration.
The ordering and carrying costs of material being high, an effort should be made to minimize
these costs. The quantity to be ordered should be large so that economy may be made in
transport cost and discounts may also be earned.
Assumptions of EOQ
a) The supply of goods is satisfactory.
b) The quantity to be purchased by the concern is certain
c) The prices of the goods are stable.

EOQ =
Where ,A = Annual consumption in rupees
S = Cost of placing an order
I= Inventory carrying cost of one unit
Ex- A firm buys casting equipment from outside suppliers@Rs.30/unit. Total annual needs
are 800 units. You have with you following further data:
a) Annual return on investment, 10%
b) Rent, insurance, taxes per unit per year, Re.1
c) Cost of placing an order, Rs.100
d) How will you determine the economic order quantity?
Solution:
Annual consumption (A) = 800 units Ordering cost (S) = Rs.100.
Annual consumtion in Rs. = 800 unit x Rs. 30 per unit = Rs. 24,000 Total interest cost = 10%
of 24000 = Rs.2400
Interest cost per unit = 2400 / 800 = Rs.3
Inventory Carrying cost (I) = Interest cost + Rent, insurance, Taxes cost = 3 + 1 = Rs.4 per
unit

EOQ=

= = 200 units
4. A-B-C Analysis: The materials divided into a number of categories for adopting a
selective approach for material control. Under ABC analysis, the materials are divided into 3
categories viz, a B and C. Past experience has shown that almost 10% of the items contribute
to 70% of the value of the consumption and this category is called ‘a’ category. About 20% of
the items contribute 20% of the value of the consumption and is known as category ‘B’
materials. Category ‘C’ covers about 70% of the items of the material, which contribute only
10% of the value of the consumption.

Class No. of items Value of the Items

% %
A 10 70
B 20 20
C 70 10

A B C ANALYSIS helps to concentrate more efforts on category A. since greatest monetary

advantage will come by controlling these items. An attention should be paid in estimating the
requirements, purchasing, maintaining the safety stocks and properly storing of ‘A’ Category,
material. These items are kept under a constant review so that a substantial material cost may
be controlled. The control of ‘C’ items may be relaxed and these stocks may be purchased for
the year. A little more attention should be given toward ‘B’ category items and their purchase
should be undertaken at quarterly or half yearly intervals.

5. V E D Analysis: The VED analysis is generally used for spare parts. The requirement and
urgency of spares parts is different from that of the material. Spare parts are classified as Vital
(V), essential (E), and Desirable (D). The vital spares are must for running the concern
smoothly and these must be stored adequately. The non-availability of spare parts will cause
havoc on the concern. The E type of spares is also necessary but their stock may be kept at
low figures. The stocking of D type of spares may be avoided at times. If the lead time of
these spares is less, then stocking of these spares can be avoided. The classification of spares
under these three categories is an important decision. A wrong classification of any spare will
create difficulties for production department. The classification should be left to the technical
staff because they know the need urgency and use of these spares.

6. Inventory Turnover Ratio: This ratio is calculated to indicate whether the inventories
have been used efficiently or not. The purpose is to ensure the blocking of only required
minimum funds in inventory. This ratio is also known as Stock velocity.

Inventory Turnover Ratio = Cost of goods sold

Average inventory at cost

Inventory Conversion period = Days in Year

Inventory Turnover Ratio

7. Just In Time (JIT) Inventory Control System : Just in time philosophy, which aims at
eliminating waste from every aspect of manufacturing and its related activities, was first
developed in Japan. Toyota introduced this technique in 1950's in Japan, how U.S. companies
started using this technique in 1980's. The term JIT refers to a management tool that helps
produce only the needed quantities at the needed time.

Just in time inventory control system involves the purchase of materials in such a way that
delivery of purchased material is assured just before their use or demand. The philosophy of
JlT control system implies that the firm should maintain a minimum (zero level) of inventory
and rely on suppliers to provide materials just in time to meet the requirements.
 CASH MANAGEMENT

Introduction: Cash is the most liquid asset that a business owns. Cash in the business
enterprises may be compare s to the blood in the human body, which gives life and strength to
the human body and the cash imparts life and strength, profits and solvency to the business
organization.

What do you understand by Management of Cash? The modern day business comprises
of numerous units spread over vast geographical areas. It is the duty of the finance manager
to provide adequate cash to each of the units. For the survival of the business it is absolutely
necessary that there should be adequate cash. It is the duty of the finance manager to maintain
liquidity at all parts of the organization while managing cash. On the other hand, he has also
to ensure there are no funds blocked in idle cash. Idle cash resources entail a great deal of
cost in term of interest charges and in terms of opportunities costs. Hence the questions of
cost of idle cash must also be kept in mind by the finance manager. A cash management
scheme therefore, is a delicate balance between the twin objectives of liquidity and costs.

Why we need for cash: The following are the three basic considerations in determining the
amount of cash or liquidity as have been outlined by Lord Keynes:

Motives for Holding Cash

The firm with the following motives holds cash: Transaction Motive

Motives of holding cash Precautionary Motive

Speculative Motive

1. Transaction Motive: Transaction Motive requires a firm to hold cash to conduct its
business in the ordinary course. The firm needs cash to make payments for purchases, wages,
operating expenses and other payments. The need to hold cash arises because cash receipts
and cash payments are not perfectly synchronized. So firm should maintain cash balance to
make the required payment. If more cash is need for payments than receipts, it may be raised
through bank overdraft. On the other hand if there are more cash receipts than payments, it
may be spent on marketable securities.

2. Precautionary Motive: cash is also maintained by the firm to meet the unforeseen expenses
at a future date. There are uncontrollable factors like government policies, competition,
natural calamities, labour unrest which have heavy impact on the business operations. In such
situations, the firm may require cash to meet additional obligations. Hence the firm should
hold cash reserves to meet such contingencies. Such cash may be invested in the short term
marketable securities which may provide the cash s and when necessary.

3. Speculative Motive: To take the advantage of unexpected opportunities, a firm holds cash
for investment in profit making opportunities. Such a motive is purely speculative in nature.
For e.g. holding cash to rake advantage of an opportunity to purchase raw material at the
reduced price on the payment of immediate cash or delay that purchase of material in
anticipation of declining prices. It may like to keep some cash balance to make profits by
buying securities at the time when their prices fall on account of tight money conditions.