Unit 5

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RECEIVABLES

MANAGEMENT
RECEIVABLES

 Account receivables are amounts owed to the


business enterprise, usually by its customers.
 Sometimes it is broken down into trade
accounts receivables, the former refers to
amounts owed by customers,
 and the latter refers to amounts owed by
employees and others.
Objectives behind going for credit sales :

a. Achieving growth in sales


b. Growth in profit /or maintaining same
level of profits.
c. Competition
Characteristics of receivables

 Risk
 Futuristic
 Economic value of goods is transferred
to customers on the date of sale but the
company will receive the economic
value only after the expiry of credit
period.
RECEIVABLES MANAGEMENT
 RM is the process of making decisions relating to
investment in trade debtors
 The term Receivables Management may be defined as
collection of steps and procedure required to properly
weigh the cost and benefits attached with the credit
policies
 The receivables management consists of matching the
cost of increasing sales (Particularly credit sales) with
the benefits arising out of increased sales with the
objective of maximizing the return on investment of
the firm
Different costs associated with RM :

1. Capital cost
a. Interest on funds borrowed
b. opportunity cost.
2. Collection costs- Creation and maintenance of
credit departments, accounting records, reminder
letters.
3. Delinquency cost- failure of customers to pay on
due date. (legal charges)
4. Default costs – (irrecoverable): Cost of default by
customers
Dimensions of RM

 Credit policy
 Credit Evaluation/Credit Analysis
 Control of account receivables
Credit policy
 Credit Policy is the determination of credit
standards and credit analysis.
 It determines-
a) Whether or not to extend credit to a customer
b) How much credit to extend.
Credit policy variables

 The major controllable decision variables include


the following:
1. Credit standards and analysis
2. Credit terms
3. Collection policy and procedures
1.Credit standards_-
 Credit standards are the criteria which a firm
follows in selecting customers for the purpose of
credit extension.
 Some companies may follow tight credit standards
and some companies may follow loose credit policy
 It is a trade off between incremental return and
incremental costs
 It may include-
1. Credit Ratings
2. Average Payment Period
3. Financial Ratios
Lenient(Liberal) credit policy
 Goods are sold to the customers whose
creditworthiness is not up to the mark.
 Very liberal credit terms

Merits
a. Increase in sales
b. Higher profits

Demerits
c. Bad debt loss
d. Liquidity problem
Stringent credit policy
 Sells goods on credit on a highly selective basis.
 The customers who have proven creditworthiness and
financially sound.

Merits
a. Less bad debts
b. Sound liquidity position

Demerits
c. Less sales
d. Less profit
Credit Terms
 Credit Terms specify the repayment terms
required of credit customers/ receivables.
 Credit Terms have 3 components-
1. Credit Period
2. Cash Discount
3. Cash discount period
 the quality of the customer depends on the time taken
by customers to repay credit obligation and the
default rate.
 Default risk is the likelihood that a customer will fail
to repay the credit obligation.

 5 C’s in selecting Customer for credit


a. Characteristics – willingness to pay
b. Capacity – ability to pay
c. Capital - financial soundness
d. Collateral
e. Condition – prevailing economic and other
conditions
The credit period
 The length of time for which credit is extended to
customers is called credit period.
 For ex- net 30 days, net 45 days etc
Cash discounts

 It is a reduction in payment offered to customers


to induce them to repay credit obligations within a
specified period of time, which will be less than
normal credit period.
 For ex- 2/10 net 30 days means 2% discount will
be granted if the customer pays within 10 days.
Collection policy

 It should lay down clear-cut collection


procedures.
 It ensure prompt and regular collection
Credit evaluation
 Credit Analysis
Credit Analysis involves obtaining credit
information and evaluation of credit applicants.
1. Traditional credit analysis
2. Numerical credit analysis
3. Discriminate analysis
1. Traditional credit analysis
 Analysis of customer in terms of 5 C’s
 To get the information on 5 C’s a firm may relay on:
i. Financial statements
ii. Bank reference
iii. Experience of the firm
iv. Price and yield on securities
SEQUENTIAL CREDIT ANALYSIS

Should
credit be
granted?

Strong Weak
Character

Capacity Capacity

Strong Strong
Weak Weak
Capital
Capital Capital Capital

Strong Weak Strong Weak


Strong Weak Strong Weak

Excellent risk Dangerous


Fair risk Doubtful risk
risk

How much
credit
should be
granted ?
2. Numerical Credit Scoring
 Identify factors relevant for credit evaluation.
 Assign weight to these factors that reflect there
relative importance.
 Rate the customer on various factors, using a
suitable rating scale.
 For each factor, multiply the factor rating with the
factor weight to get factor score.
 Add all the factor scores to get overall customer
rating index.
 Based on the rating index, classify the customer.
Credit Rating Index
Factor Factor Rating Factor
  weight Score
5 4 3 2 1
   

Past payment 0.30           1.20


Net profit 0.20           0.80
margin
Current 0.20           0.60
Ratio
Debt-equity 0.10           0.40
ratio
Return on 0.20           1.00
equity
Rating index 4.00
3. Discriminate Analysis
 Statistical procedure
 It is a computer based technique for
predicting whether a new credit
applicant will prove to be good or bad
credit risk
Risk Classification Scheme

Risk Description
Class
1 Customer with no risk of default
2 Customer with negligible risk of default
3 Customer with little risk of default
4 Customer with some risk of default
5 Customers with significant risk of default
Control of account receivables:
 Management of receivables
 Employment of regular checks and continuous
monitoring system
 Methods which can be applied for this purpose is:
 Accounting ratios
 Days sales outstanding
 Aging schedule of receivables
 Line of credit
 Collection matrix
FACTORING
INTRODUCTION
 The factoring service was started because the
debts are not collected in time and are
handicapped by lack of sufficient working capital,
the production and expansion of business is
affected

 Vaghul committee, recommended introduction of


factoring services in India to solve the financial
problems of the small scale supplies
 Reserve bank of India then appointed a committee
under the chairmanship of
c.S.Kalyansundaram,former managing director of
the state bank of India and suggested operational
modalities of launching such a service.

 The factoring services have been introduced to


ease the problems of collection of debts and
delayed payments from the debtors.
CONCEPT OF FACTORING
 The word ‘factor’ has been derived from the latin word
“facere” which means to make or do, i.e, to get things
done.

 The webster’s dictionary states that ‘factor’ is an agent as


a banking or finance company, engaged in financing the
operations of certain companies.

 According to financial executive handbook,” the term


describes another specialized and important form of credit
and collection service. It is essentially extra service of
credit protection that differentiates factoring from
accounts receivable account
PROCESS OF FACTORING

CLIENT

2 3 6 1

4
FACTOR CUSTOMER

5
PROCESS :

1. Send invoice to customers


2. The client offers the assigned invoice to the factor
3. The factor makes a pre-payment up to 80% of the value
of the assigned invoice
4. Factor notifies the customer sending a statement of
account.
5. Customer remits the amount due to the factor.
6. Factor makes balance 20% of the invoice value to the
client when the account is collected or on a guaranteed
payment date
What is the difference between bill discounting &
factoring?
BILL DISCOUNTING FACTORING

 1. Finance alone is provided  1.Total services are


2. Advance is made against provided.
    bills. 2. Purchase of Trade Debt
3. Security is provided by    Assignment
4. Charge registered with ROC 3.Purchase of debt for
5. Individual transaction consideration
    oriented 4. Owner of Trade Debt
6. The bill has to be accepted 5. Whole turnover-bulk
by Drawee finance is     provided
6. An all time acceptance
of    notification is
sufficient for all    future
transaction.
TYPES OF FACTORING

 Full service non-recourse factoring


 Full service recourse factoring
1.Advance factoring
2.Maturity factoring
 Bulk/agency factoring
 Non-notification factoring
Advantages
 You maximize your cash flow as factoring enables
you to raise up to 80% or more on your
outstanding invoices.
 Using a factor can reduce the time and money you
spend on debt collection since the factor will
usually run your sales ledger for you.
 You can use the factor's credit control system to
help assess the creditworthiness of new and
existing customers
 Factoring can be an efficient way to minimize the
cost and risk of doing business overseas.
Disadvantages
 Customers may prefer to deal with the company it
is trading with rather than a factor. However, if
the factor's techniques are clearly agreed
beforehand, there will usually be no problem.
 Factoring may impose constraints on the way to
do business. For non-recourse factoring, most
factors will want to pre-approve customers, which
may cause delays.
 Ending a factoring arrangement can be difficult
where the only exit route is to repurchase the sales
ledger or to switch factors and that could cause a
sudden shortfall in your working capital.

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