Factors affecting size of Receivables
Factor # 1. Level of Sales:
The primary factor in determining the volume of debtors/receivables is the level of credit sales. Increase in credit sales means a corresponding increase in debtors, and vice versa. No doubt the level of sales can be used to forecast changes in receivables, i.e., if a firm predicts an increase of 50% in its credit sales for the next period, it will probably experience also an increase of 50% in debtors/receivables.
Factor # 2. Terms of Trade:
A change in credit policy has a direct impact on debtors. Thus, if credit terms are relaxed, it will lead to increase in the amount of debtors, and vice versa.
Factor # 3. Credit Policies:
The level of debtors/receivables balance is closely related with the collection policy of the firm. Practically, credit policy determines the amount of risk that a firm is to undertake in its sales activities.
Policies for Managing Accounts Receivables
Accounts receivable consist of the credit a business grants its customers when selling goods or services.1They take the form of either trade credit, which the company extends to other companies, or consumer credit, which the company extends to its ultimate consumers. The effectiveness of a company’s credit policies can have a significant impact on its total performance. For example, Monsanto’s credit manager has estimated that a reduction of only one day in the average collection period for the company’s receivables increases its cash flow by $10 million and improves pretax profits by $1 million. For a business to grant credit to its customers, it has to do the following:
- Establish credit and collection policies.
- Evaluate individual credit applicants.
Receivables management involves the following aspects:
Forming of credit policy:
- Every company must adopt a credit policy. Credit policy relates to
(a) Quality of Trade accounts or credit standards:
- Volume of sales will be influenced by the credit policy of a concern.
- By liberalizing credit policy, the sales will be increased,
- The increased volume of sales will be increased the cost and risk of bad debts
- Credit to only creditworthy customers will save costs like bad debt losses, collection costs and investigation costs etc
- Quality of trade accounts should be decided so that credit facilities are extended only upto the optimum level.
(b) Length of credit period:
- It means the period allowed to the customers for making the payment
- Customers paying well in time also be allowed certain cash discount.
- Concern fixes its own terms of credit depending upon its customers and volume of sales.
(c) Cash discount:
- Cash discount is allowed to immediate payment of customers
- Discount allowed involves cost
- Financial manager compare the cost of discount and the amount of fund realized
- Discount should be allowed only if its cost is less than the earnings.
(d) Discount period:
- Collection of receivables influenced by the period allowed for availing discount
- Additional period allowed for this facility may prompt some more customers to avail discount and make payments.
Executing credit policy:
- After formulating credit policy proper execution is important.
- Evaluation of credit applications and finding out the credit worthiness of customers should be undertaken
(a) Collecting credit information:
- Collecting credit information about the customers is the first step in implementing credit policy.
- Information should be adequate and proper analysis about the financial position of the customers is possible.
- Sources of collecting credit information are financial statements, credit rating agencies, reports from banks etc.
(b) Credit analysis:
- After gathering information, analyse the creditworthiness of the customer
- Credit analysis will determine the degree of risk associated, the capacity of the customer to borrow and his ability and willingness to pay.
(c) Credit decision:
- After analyzing the creditworthiness of the customer, decision has to take whether the credit is to be extended and then upto what level.
- Match the creditworthiness of the customer with the credit standard of the company.
- If customers creditworthiness is above the credit standards then the credit is allowed.
Formulating and executing collection policy:
- Collection policy be termed as Strict and Lenient.
- Strict policy of collection will involve more efforts on collection
- Such policy will enable early collection of dues and will reduce bad debts losses.
- It may also reduce the volume of sales.
- Some customers may not appreciate the efforts of the concern and may shift to another concern thus causing reduced sales and profits.
- A lenient policy may increase the debt collection period and more bad debt losses.
- Collection policy should devise the following steps:
🙂 Sending a reminder for payments
🙂 Personal request through telephone etc.
🙂 Personal visits to the customers