ASSIGNMENT

Course Name- Advance Corporate Financial

Management
Module 3 – Receivables Management

1.Explain Credit Management Through Credit Policy Variables?

The important dimensions of a firm’s credit policy are credit standards, credit
period, cash discount and collection effort. These variables are related and
have a bearing on the level of sales, bad debt loss, discounts taken by
customers, and collection expenses.

Let’s discuss them one by one:

Credit standards:
A firm has a wide range of choice in this respect. At one and of the spectrum, it
may decide not to extend credit to any customer, however strong his credit
rating may be. At the other end, it may decide to grand credit to all customers
irrespective of their credit rating. Between these two extreme positions lie
several positions, often the more practical ones.

In general, liberal credit standards tend to push sales up by attracting more

customers. This is, however, accompanied by a higher incidence of bad debt
loss, a larger investment in receivables, and a higher cost of collection. Stiff-
credit standards have opposite effects. They tend to depress sales, reduce the
incidence of bad debt loss, decrease the investment in receivables, and lower
the collection cost.

Credit period:
The credit period refers to the length of time customers are allowed to pay for
 their purchases. It generally varies from 15 days to 60 days. When a firm does
not extend any credit, the credit period would obviously be zero. If a firm
allows 30 days, say, of credit, with no discount to induce early payments, its
credit terms are stated as “net 30”.

Lengthening of the credit period pushes sales up by inducing existing

customers to purchase more and attracting additional customers. This is,
however, accompanied by a larger investment in receivables and a higher
incidence of bad debt loss. Shortening of the credit period would have
opposite influences: It tends to lower sales, decrease investment in
receivables, and reduce the incidence of bad debt loss.

Cash discount:
Firms generally offer cash discounts to induce customers to made prompt
payments. The percentage discount and the period during which it is available
are reflected in the credit terms. For example, credit terms of 2/10, net 30
mean that a discount of 2 per cent is offered if the payment is made by the
tenth day; otherwise, the full payment is due by the thirtieth day.

Liberalizing the cash discount policy may mean that the discount percentage is
increased and/or the discount period are lengthened. Such an action tends to
enhance sales (because the discount is regarded as price reduction), reduce
the average collection period (as customers pay promptly), and increase the
cost of discount.

Collection Effort:
The collection programmed of the firm, aimed at timely collection of
receivables consisting of – monitoring the state of receivables, dispatch of
letters to customers whose due date is approaching, telegraphic and
telephonic advice to customers around the due date, threat of legal action to
overdue accounts and legal action against overdue accounts.

2.Write Example of Marginal Analysis in the Manufacturing Field?

 Marginal analysis is an examination of the additional benefits of an activity
compared to the additional costs incurred by that same activity. Companies
use marginal analysis as a decision-making tool to help them maximize their
potential profits. Marginal refers to the focus on the cost or benefit of the
next unit or individual, for example, the cost to produce one more widget or
the profit earned by adding one more worker.

Example of Marginal Analysis in the Manufacturing Field:

When a manufacturer wishes to expand its operations, either by adding new

product lines or increasing the volume of goods produced from the current
product line, a marginal analysis of the costs and benefits is necessary. Some
of the costs to be examined include, but are not limited to, the cost of
additional manufacturing equipment, any additional employees needed to
support an increase in output, large facilities for manufacturing or storage of
completed products, and as the cost of additional raw materials to produce
the goods.

Once all of the costs are identified and estimated, these amounts are
compared to the estimated increase in sales attributed to the additional
production. This analysis takes the estimated increase in income and
subtracts the estimated increase in costs. If the increase in income
outweighs the increase in cost, the expansion may be a wise investment.

For example, consider a hat manufacturer. Each hat produced requires

seventy-five cents of plastic and fabric. Your hat factory incurs $100 dollars
of fixed costs per month. If you make 50 hats per month, then each hat
incurs $2 of fixed costs. In this simple example, the total cost per hat,
including the plastic and fabric, would be $2.75 ($2.75 = $0.75 + ($100/50)).
But, if you cranked up production volume and produced 100 hats per month,
then each hat would incur $1 dollar of fixed costs because fixed costs are
spread out across units of output. The total cost per hat would then drop to
$1.75 ($1.75 = $0.75 + ($100/100)). In this situation, increasing production
volume causes marginal costs to go down.
3.Describe Discriminate Analysis?

Discriminant analysis is statistical technique used to classify observations into

non-overlapping groups, based on scores on one or more quantitative
predictor variables.

For example, a doctor could perform a discriminant analysis to identify

patients at high or low risk for stroke. The analysis might classify patients into
high- or low-risk groups, based on personal attributes (e.g., cholesterol level,
body mass) and/or lifestyle behaviours (e.g., minutes of exercise per week,
packs of cigarettes per day).

Two-Group Discriminant Analysis

A common research problem involves classifying observations into one of two

groups, based on two or more quantitative, predictor variables. When there
are only two classification groups, discriminant analysis is really just multiple
regression, with a few tweaks.

 The dependent variable is a dichotomous, categorical variable (i.e., a

categorical variable that can take on only two values).

 The dependent variable is expressed as a dummy variable (having values of 0

or 1).

 Observations are assigned to groups, based on whether the predicted score

is closer to 0 or to 1.

 The regression equation is called the discriminant function.

 The efficacy of the discriminant function is measured by the proportion of

correct assignments.

The biggest difference between discriminant analysis and standard regression

analysis is the use of a categorical variable as a dependent variable. Other than
that, the two-group discriminant analysis is just like standard multiple
regression analysis. The key steps in the analysis are:

 Estimate regression coefficients.

 Define regression equation, which is the discriminant function.

 Assess the fit of the regression equation to the data.

 Assess the ability of the regression equation to correctly classify

observations.

 Assess the relative importance of predictor variables.

Multiple Discriminant Analysis

Regression can also be used with more than two classification groups, but the
analysis is more complicated. When there are more than two groups, there are
also more than two discriminant functions.

For example, suppose you wanted to classify voters into one of three political
groups - Democrat, Republican, or Independent. Using two-group discriminant
analysis, you might:

 Define one discriminant function to classify voters as Democrats or non-

Democrats.

 Define a second discriminant function to classify non-Democrats as

Republicans or Independents.

The maximum number of discriminant functions will equal the number of

predictor variables or the number of group categories minus one - whichever
is smaller.

With multiple discriminant analysis, the goal is to define discriminant functions

that maximize differences between groups and minimize differences within
groups. The calculations to do this make use of canonical correlation, a

technique that is beyond the scope of this tutorial.

4.Write Limitations of Marginal Analysis?

Marginal analysis derives from the economic theory of marginalism—the

idea that human actors make decisions on the margin. Underlying
marginalism is another concept: the subjective theory of value. Marginalism
is sometimes criticized as one of the "fuzzier" areas of economics, as much
of what is proposed is hard to accurately measure, such as an individual
consumers' marginal utility.

Also, marginalism relies on the assumption of (near) perfect markets, which

do not exist in the practical world. Still, the core ideas of marginalism are
generally accepted by most economic schools of thought and are still used
by businesses and consumers to make choices and substitute goods.
 Modern marginalism approaches now include the effects of psychology or
those areas that now encompass behavioral economics. Reconciling
neoclassic economic principles and marginalism with the evolving body of
behavioral economics is one of the exciting emerging areas of contemporary
economics.

Since marginalism implies subjectivity in valuation, economic actors make

marginal decisions based on how valuable they are in the ex-ante sense. This
means marginal decisions might later be deemed regrettable or mistaken ex-
post. This can be demonstrated in a cost-benefit scenario. A company might
make the decision to build a new plant because it anticipates, ex-ante, the
future revenues provided by the new plant to exceed the costs of building it.
If the company later discovers that the plant operates at a loss, then it
mistakenly calculated the cost-benefit analysis.

That said, inaccurate calculations reflect inaccuracies in cost-benefit

assumptions and measurements. Predictive marginal analysis is limited to
human understanding and reason. When marginal analysis is applied
reflectively, however, it can be more reliable and accurate.

5.Write short note, Control of Accounts Receivables?

Controls over accounts receivable really begin with the initial creation of a
customer invoice, since you must minimize several issues during the creation
of accounts receivable before you can have a comprehensive set of controls
over this key asset. Controls then span the proper maintenance of accounts
receivable, and their elimination through either payment from customers or
the generation of credit memos. The key controls to consider are:

 Require credit approval prior to shipment. You will have problems collecting
accounts receivable if an order is shipped to a customer with a bad credit
rating. Therefore, require the signed approval of the credit department on all
sales orders over a certain dollar amount.
 Verify contract terms. If there are unusual payment terms, verify them
before creating an invoice. Otherwise, accounts receivable will contain
invoices that customers refuse to pay.

 Proofread invoices. If an invoice for a large-dollar amount contains an error,

the customer may hold up payment until you send a revised invoice. Consider
requiring the proofreading of larger invoices to mitigate this problem.

 Authorize credit memos. People who have access to incoming customer

payments could intercept incoming cash and then create a credit memo to
cover their tracks. One step in the prevention of this problem is to require the
formal approval of a manager for credit memos, which are then verified at a
later date by the internal audit staff. Do not take this control to extremes and
require approval for extremely small credit memos - allow the accounting staff
to create small ones without approval, just to clean up small remaining
account balances.

 Restrict access to the billing software. As just noted, someone could

intercept incoming payments from customers and hide the theft with a credit
memo. You should password-protect access to the billing software to prevent
the illicit generation of credit memos.

 Segregate duties. As just noted, no one should be able to handle incoming

customer payments and create credit memos, or else they will be able to take
the money and cover their tracks with credit memos. Therefore, assign these
tasks to different people.

 Review accounts receivable journal entries. Accounts receivable transactions

almost always go through a sales journal in the accounting software that
generates its own accounting entries. Therefore, there should almost never be
a manual journal entry in the accounts receivable account. You should
investigate these entries carefully.

 Audit invoice packets. After invoices are completed, there should be a packet
on file that contains the sales order, credit authorization, bill of lading, and an
invoice copy. The internal audit staff should review a selection of these packets
to verify that the billing clerk properly reviewed all of the supporting
paperwork and correctly generated an invoice.

 Match billings to shipping log. It is possible that items will be shipped without
a corresponding invoice, or vice versa. To detect these situations, have the
internal audit staff compare billings to the shipping log, and investigate any
differences.

 Audit the application of cash receipts. The accounting staff may incorrectly
apply cash receipts to open invoices, perhaps not even applying them to the
accounts of the correct customers. Have the internal audit staff periodically
trace a selection of cash receipts to customer invoices to verify proper cash
application.