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Receivables Management: Pepared By: Priyanka Gohil

The document discusses receivables management and provides details on: 1) The meaning and purpose of receivables, as well as the operating cycle and costs associated with maintaining receivables. 2) Key aspects of a company's credit policy including credit standards, credit period, cash discounts, and collection programs. 3) Formulas for calculating the impact of changes to credit policy variables on sales and profits. 4) Examples of applying the formulas to analyze potential policy changes.

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Sunil Pillai
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377 views23 pages

Receivables Management: Pepared By: Priyanka Gohil

The document discusses receivables management and provides details on: 1) The meaning and purpose of receivables, as well as the operating cycle and costs associated with maintaining receivables. 2) Key aspects of a company's credit policy including credit standards, credit period, cash discounts, and collection programs. 3) Formulas for calculating the impact of changes to credit policy variables on sales and profits. 4) Examples of applying the formulas to analyze potential policy changes.

Uploaded by

Sunil Pillai
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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RECEIVABLES MANAGEMENT

Pepared by:
Priyanka Gohil
Meaning of Receivable

Amounts due from customers, when goods


are sold on credit, are called trade debits
or receivables.

When goods are sold on credit, finished


goods get converted into receivables.
PURPOSE OF RECEIVABLES

1. To increase total sales


2. To increase profits
3. To meet increasing competition
Operating cycle

ACCOUNTS
CASH
RECEIVABLES

FINISHED RAWMATERIAL
GOODS INVENTORY

WORK-IN-
PROCESS
Costs associated with maintaining
receivables:

1. Capital cost
2. Administration cost
3. Delinquency cost
4. Bad- debts or default cost
Credit policy

The credit policy of a company can be regarded as a king of


trade-off between increased credit sales leading to increase in
profit and the cost of having larger amount of cash locked up
in the form of receivables and the loss due to the incidence of
bad debts.
The various variables associated with credit policy are:
1. Credit standards
2. Credit period
3. Cash discount
4. Collection program
1. Credit standards

The term credit standards refer to the criteria for


extending credit to customers. The basis for
setting credit standards are
a. Credit rating
b. References
c. Average payment period
∆P= ∆S(1-V)-K ∆I-bn ∆ S
Where,
∆P= Change in profit
∆S=Increase in sales
V=Variable costs to sales ratio
K=Cost of capital
∆ I=Increase in receivables investment
∆S * Average Collection Period (ACP)*V
360
bn = Bad debts loss ratio on new sales
I-V= Contribution to sales ratio
EX. The existing sales of Laxmi company are Rs. 2 crore. The current
customers are drawn from companies having ‘high’ or ‘good’ credit
rating. With partially liberalized credit standards the company’s sales
are likely to go up by Rs. 24 lakh, the mix of new customers being 67
percent and 33 percent from the groups rated ‘fair’ and ‘limited’
respectively. The average collection period is likely to be 45 days and
the incidence of bad debt losses 10 percent for the new customers.
The contribution to sales ratio for Laxmi company is 20 percent and
the cost of funds is 15 percent.
24,00,000 * 0.2 - 0.15 * 24,00,000/360 * 45* 0.8
– 0.1* 24,00,000
= 4,80,000-36,000 -2,40,000
=2,04,000
2. Credit period

Credit period refers to the length of time allowed


to its customers by a firm to make payment for
the purchases made by customers of the firm.
EX. Credit period of ‘net 20’.
∆P= ∆S(1-V)-K ∆I-bn ∆ S
Where,
∆I=(ACPN-ACPo)[So] + V (ACPN) ∆S
360 360
∆ I= Increase in investment
∆P= Change in profit
∆S=Increase in sales
V=Variable costs to sales ratio
I-V= Contribution to sales ratio
ACPN= New average credit period ( after increasing credit period)
ACPo= Old average credit period
EX. Radha company’s existing sales are Rs. 180 lakh. It is currently
extending a credit period of ‘net 30 days’ to its customers. The
company’s contribution to sales ratio is 20 percent and the cost of
funds is 15 percent. The company is contemplating to increase its
sales by Rs.16 lakh to be achieved b means of lengthening the
existing period to ‘net 45 days’. The bad debt losses on additional
sales is expected to be 5 percent. Should the company go in for a
policy change or not?
 = (45-30) [180/360] + 0.8* 45* 16/360
 = 7.5 +1.6
 9.1 lakh
 P= 16 (0.2)-0.15 * 9.1 – 0.05 * 16
 =3.2 – 1.365 – 0.8
 1.035 lakh
3. Cash discount

Firms offer cash discounts to induce their


customers to make prompt payments.

EX. A cash discount of 2% if 2/10 net 20.


P= ∆S(1-V)+K ∆I- ∆DIS
Where,
∆S=Increase in sales
V=Variable costs to sales ratio
K=cost of capital
∆I=Savings in receivables management
So (ACP0-ACPN) - V ∆S ACPN
360 360
∆ DIS= Increase in discount cost
=Pn (S0+ ∆S)dn-PoSodo

Where,
Pn= Proportion of discount sales after liberalizing
So= Sales before liberalizing
∆S=Increase in sales
Dn= New discount percentage
Po=Proportion of discount sales before liberalizing
d0 = Old discount percentage
Rama company is presently having sales orf Rs. 108 lakh. Its existing
credit terms are 1/10, net 45 days and the average collection period is
30 days. Fifty percent of customers in terms of sales revenue are
utilizing the cash discount incentive. The contribution to sales ratio of
the company is 20 percent and cost of funds 15 percent. In order to
hasten the collection process further as also to inrease sales, if
possible, the company is contemlating liberalization of its existing
credit terms to 2/10, net 45 days. It is expected that sales are likely to
increase by Rs. 3 lakh and average collection period to decline to 20
days. Eighty percent of customers in terms of sales revenue are
expected to avail themselves of the cash discount under the
liberalization scheme. Should the company increase cash discount?
= 108/360 (30-20) – 0.8 * 3/360 * 20
= 2,86,667

=0.8* 111* 0.02-0.5* 108*0.01


= 1,23,600
DP= 3,00,000 (0.2) + 0.15 * 2,86,667 -1,23,60
= - 20,600
4. Collection programme

The success of a collection programme depends on the collection


policy pursued by the firm.
The collection programmes consists of the following.
1. Monitoring the receivables.
2. Reminding customers about due date of payment.
3. On line interaction through electronic media to customers about the
payments due around the due date.
4. Initiating legal action to recover the amount from overdue
customers as the last resort to recover the dues from defaulted
customers.
 ∆P= ∆S(1-V) -∆BD-K ∆ I - ∆C
Increase in bad debts cost
∆BD= bn (So+ ∆S)-boSo
Increase in investment in receivables
∆ I= So (ACPN-ACPo)+ ∆S *ACPN*V
360 360
Where,
∆P=Change in profits
∆S= Increase in sales
V= Variable cost to sales ratio
K= cost of capital
∆C= Increase in collection expense
The present sales of PK Ltd. Are Rs. 108 lakh, the average
collection period 60 days, bad debt losses 6 percent of sales
and collection expenses Rs. 1 lakh. The company’s cost of
funds is 15 percent. It is contemplating to increase the
collection effort through special programs to reduce the amount
of receivables and the incidence of bad debt losses. Two
separate programs called A and B are under consideration.
Program A is likely to reduce the average collection period to
45 days, decrease bad debt losses to 4 percent of sales and
involve collection expenses of Rs. 3 lakh. Program B is
envisaged to reduce the average collection period of 30 days,
decrease bad debt losses t o3 percenst sales and involve
collection expenses of Rs. 5 lakh. On the assumption that sales
are not likely to get affected, should the company go in for any
programs under consideration?
= 0.04 * 108 – 0.06 * 108
= - 2.16 lakh
As there is no change in sales
= 108/360 * (45-60)
= - 4.5 lakh
=3-1
= 2 lakh
 Program B
 = ( 0.03- 0.06) 108
 = - 3.24 lakh
 = 108/360 * (30-60
 = - 9 lakh
 =5–1
 = 4 lakh
 = 0 + 3.24 + 9 * 0.15 -4
 59,000

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