Receivable

Management

Chapter 6
At the end of the chapter, students are expected to be able to:

Discriminate the credit selection process from the quantitative procedure fro
evaluating changes in credit standards.

Evaluate cash discount changes, credit terms and credit monitoring in improving
a firm’s performance.

Learning
Compute account receivable that could be freed from operations.

Objectives
Appreciate how accounts receivables policies help the management in improving
a firms’ profitability.

Make decisions involving accounts receivable management.

 Concept of Receivables
Receivables represent the
amount of money to be collected
from individuals or firms.
Frequently, it arises from the sales of
merchandise or the performance of
services, and granting of loans to
officers, employees and
stockholders.
 There are Two general classes
of Receivables
1. Trade receivables – these refer to claims
arising from the sale of merchandise or
services in the ordinary course of business
operations the usual types of receivables are
accounts receivable and notes receivable.
2. Non-trade receivables – these represent claims
arising from sources other than the sale of
merchandise or services in the ordinary course
of business.
Factors that affect the size of Receivables
1. Terms credits – the level of accounts receivable depends
on the length of the term credit.
2. Paying practices of the customers – firms with customers
who prolong payments are expected to have a higher
level of receivables.
3. Collection policies – firms with lenient collection policy
have higher levels of receivables than firms with a stricter
collection policy.
4. Volume of credit sales – firms that mostly grant sales on
credit have a higher level of receivables.
•It is the process of
determining , handling, and
administering accounts
receivable related to sales and
credit policies.
(Block et al., 2006)

•Accounts receivable used as

a test for liquidity , is only
correct as long as the
company’s collectibles are
normal.
 Float on Receivables

- Float is one of the factors that

influence the accounts receivable.
- Float exists from the time goods
are sold or services are rendered
on account.
- Cash sales create no float to the
company since cash is
immediately received in exchange
for the goods or services.
 The granting of
trade credit is a
consideration that
must be well
studied.
 Example 1

GUM Corporation sells on term of net/30. On the

average , its account are 30days past due. Annual amount
is based on sales are P 150,000. What is the average
accounts receivable?

Formula:
Average Account Receivable (AAR)
= Collection Period x Credit Sales
360 Days
Example #2
- The cost of given product is 45% of the
selling price and the carrying cost is 10% of the
selling price. On average, accounts are paid in 60
days subsequent to the date of Sale. The Sale
average is P120, 000 per month. What is the
Investment on Receivable

Formula:
Investment on Receivable (IoR)
= Credit Sales x (Product Cost + Carrying Cost)
Example #3
- A Company has Accounts Receivable
of P900,000. The average
manufacturing cost is P45% of the
Credit Sales. The Profit margin
before tax is 12%. The carrying cost
of inventory is 5% of the credit sales
and the sales commission is 10%.
What is the investment on Account
Receivable (IoR)?
Example #4
- If the Company’s credit sales is
P180, 000. the collection period is 90
days, and the cost is 75% of the
credit sales.
Required:
a. What is the Average Account
Receivable and,
b. Average Investment in Account
Receivable?
Firms invest in accounts receivable
through trade credits for the
following purposes :

1. To increase the current sales volume,

firms granting trade credit like to
achieve growth by increasing its
customer base. By granting credit, they
will be able to entice old and new
customers to buy the products.
2. To retain the current sales, to prevent
the company from losing its current
customers to the competitors.
Cost of granting Trade Credit
1. Bad debt expense. Bad debts are accounts receivable with
the possibility of non-collection by the firm selling goods
or services.
Example:
In 2023, FLT Company has a current annual sale of
P12,000,000 with bad debt expense at 5% of sales. The
owner, desiring to increase profit , decided to grant trade
credit to increase the firm’s current sales. The expected sales
upon implementation is P20,000,000. With the granting of
trade credit, the bad debt expense is also expected to increase
by 3% . if the firm’s variable cost is 60% on sales, how much
is the advantage or disadvantage of granting trade credits?
Cost of granting Trade Credit
Formula:
Name of the Company
Income Statement
Date
Sales P XX
Less: COGS ( XX)
Contribution Margin P XX
Less: Bad Debts (XX)
Net Income P XX
 FLT COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2023
 Cost of granting Trade Credit

2. Variable and fixed costs. As sales increase , variable costs also

increase. This is natural as long as these costs are properly
accounted for as variable costs.

Example:
FLT’s current sales volume is 10,000 units with the selling price
of P110 per unit. The firm is planning to increase its sales by granting a
trade credit. Once implemented, the firm is expected to increase its sales
by 5,000 units. The normal capacity of the firm is 12,000 units, of which
the fixed cost is P 250,000. any production in excess of the normal
capacity of the firm would result in an additional cost of P5 per unit. The
bad debt expense rate is at 5% and 9% for sale units of 10,000 and 15,000
respectively. If the variable cost is 70%, what is the advantage or
disadvantage of increasing the sales to 15, 000 units.
 Cost of granting Trade Credit
Answer:
FLT COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 202
FLT COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2023FLT COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2023
 Cost of granting Trade Credit
3. Cost of Capital
 The cost of funds invested in the accounts receivable
also increases.
 The concept of cost of capital in the accounts
receivable is the same as the concept of placing money
in special time deposit .
Example
If P1,000,000 will earn 12% per annum , it
becomes the benchmark in other investment activities.
Less than 12% return is no longer acceptable.
 Cost of granting Trade Credit
4. Cash Discount
 It is normally given to entice prompt
payment of obligations.
 Firms that have excess money usually
avail of this cash discount .
 If used by the customers, the net
income will decline due to a deduction
of cash discount from the invoice price.
 Credit Policy
 The desire to increase profitability
through granting of trade credits to
customers must be carefully planned.
 The firm’s credit policy influences its
sales, cost of sales, and profits. Firms
with relatively lax credit policy tend to
have a higher volume of sales due to a
higher baseline of customers.
Components of Trade Policy
1.Term credit
2.Credit standards
3.Collection policy
 Components of Trade Policy

1. Term Credit
This establishes a firm’s
proposal on how the goods
and services are to sold.
This includes the credit period
and the cash discount.
 Credit Period

 Credit period is the length of time in which the

credit sales are allowed.
 The credit period varies from one industry to
another. However, the firms belonging to the
same industry have the prerogative to lengthen
or shorten their credit period depending on their
objective.
 Firms with longer credit periods have a higher
level of accounts receivable than firms with
shorter credit periods.
 Cash Discount
These are given to customers to entice
prompt payment.
It is a deduction from the accounts
receivable provided that the customer paid
its obligation within the discount period.
The discount period is the length of time
in which the cash discount is offered.
If the customer did not pay within the
discount period, the entire amount of the
obligation will be paid at the end of the
credit period.
 Components of
Trade Policy
2. Credit Standard
It is when a firm sells on credit, it must
determine the nature of the customer's
credit risk on the basis of prior records
of payment.
Financial stability, current net worth,
and other variables necessary to arrive
at a sound decision.
 1. Character, this refers to the moral and ethical
quality of the individual who is responsible for
paying the loan, it is generally based on past
The five Cs’ of credit records.

credit 2. Capacity, it is the applicant’s ability to pay off

the credit extended
3. Capital, it is the level of financial resources
available to the company seeking the loan.
4. Conditions, these are the current general and
industry-specific economic states, and any
unique situation surrounding a specific
transaction.
5. Collateral, it consists of assets pledged by the
customer. It also includes the economic value
of these assets in the case of default.
Sources of credit information

It is expected that when a firm tries

to loosen its credit standards, new
sets of prospective customers will
start flanking to get orders.
And when it decides to do so, the
firm has to choose whether or not
to give trade credit to these
customers.
 Some sources of credit information that the company may
use in making a sound decision.
1. Financial statements – it is not unethical for companies to ask for
the customer’s financial statement, especially if they are not too
familiar with the customer's company.
2. Credit-rating agencies – reports from credit-rating agencies is
another important source of credit information. These credit-
rating agencies sell information to subscribers containing the
credit performance of many companies from different industries .
3. Commercial banks – another good source of credit information is
commercial banks. As a form of service to their clientele, banks
give credit information to their customers.
4. Trade checking – trade checking could be done by asking the
prospective customer their list of suppliers.
 Components of
Trade Policy
3. Collection Policy
It refers to the guidelines on handling
receivables in terms of monitoring and
collection.
 The process usually starts by sending a
billing statement when the due date is
near.
 When payment is not received on the
due date, another letter is sent to inform
the debtor that its account is not yet paid.
 Evaluating
Receivables Management
- In assessing the receivables of the firm, the following
factors are to be considered.
1. Ratio of accounts receivable to net credit sales – this is used
as a determinant to see if the company is too lenient or too
strict in implementing its credit and collection policies. If
the ratio is high, it means the firm is lenient. If the ratio is
low, it means the company is strict.
2. Receivable turnover – this formula tells how fast the
accounts receivable are converted into cash. The higher
receivable turnover, the faster the collection of cash.
3. Average collection period – it refers to the number of days
of sales in the accounts receivable.
 Average Collection Period

Average collection period = Average accounts receivable x 360 days

Net credit sales
Or
= 360 days
Accounts receivable turnover
4.Aging of accounts receivable
The aging of the accounts receivable one way of identifying clients who are
paying their obligation within the prescribed credit term.
This monitoring technique uses a schedule that indicates the percentage of
the total accounts receivable balance that have been outstanding for a
specified period of time. The account receivable are aged accordingly and
are properly classified into either” not due” or “past due”.
The classifications are:
a. 1 to 30 days
b. 31 to 60 days
c. 61 to 90 days
d. 91 to 120 days
e. 121 to 180 days
f. 181 to 360 days
g. more than one year
 Desired level of Receivables.

If a company desires to

maintain a certain level of
accounts receivable, the
formula is (Mejorada,2000):
Receivable Collection Period, It refers to the length of time to
determine how will the account receivable convert into cash.
Example:
FLI Company would like to maintain a balance of
P150,000 in its accounts receivable account. If the company
has a credit sale of P3,500,000 a year, what should be the
required collection period of FLI be?

Formula:
 Lesson Assessment
Sarah Co’s expected is considering a plan to ease its credit terms in order to
generate greater revenues. Last year, Sarah Cos’ sold 2, 000, 000 units at a prive
and variable costs of P20 and P15 respectively.
Assumptions
• its average collection is 20 days and its percentage of bad debts is 2%.
• required retuen on investment is 10%.
• Co will ease its credit terms, the firm anticipating the sales will increase to 2,
500, 000 units without a change in price and variable cost.
• However, the collection period is expected to increase to 30 days and bad debts
expense to increase by 3%.
Required:
1. What is the average investment in account receivable?
2. What is Sarah Co’s expected increase in bad debts expense?
3. what is the opportunity of cost in increased account receivable
4. what is the future average investment in account receivable?
5. what is the marginal profit from increased sales?
6. what is the net profit for the credit decision at hand?