Credit management is the process of controlling and collecting payments from customers.

This is the function within a bank or company to control credit policies that will improve revenues and reduce financial risks. A credit manager is a person employed by an organization to manage the credit department and make decisions concerning credit limits, acceptable levels of risk and terms of payment to their customers. In companies, the role of Credit manager is variable in its scope. Credit managers are responsible for:

Controlling bad debt exposure and expenses, through the direct management of credit terms on the company's ledgers. Maintaining strong cash flows through efficient collections. The efficiency of cash flow is measured using various methods, most common of which is Days Sales Outstanding (DSO). Ensuring an adequate Allowance for Doubtful Accounts is kept by the company. Monitoring the Accounts Receivable portfolio for trends and warning signs. Enforcing the "stop list" of supply of goods and services to customers. Determine credit ceilings. Setting credit-rating criteria. Setting and ensuring compliance with a corporate credit policy. Obtaining security interests where necessary. Common examples of this could be PPSA's, letters of credit or personal guarantees. Initiating legal or other recovery actions against customers who are delinquent.

Average collection period:

Definition of 'Average Collection Period'

The approximate amount of time that it takes for a business to receive payments owed, in terms of receivables, from its customers and clients. Calculated as:

Where: Days = Total amount of AR = Average amount of Credit Sales = Total amount of net credit sales during period

days accounts

in

period receivables

For example, suppose that a widget making company, XYZ Corp, has total credit sales of $100,000 during a year (assume 365 days) and has an average amount of accounts receivables is $50,000. Its average collection period is 182.5 days. Due to the size of transactions, most businesses allow customers to purchase goods or services via credit, but one of the problems with extending credit is not knowing when the customer will make

cash payments. Therefore, possessing a lower average collection period is seen as optimal, because this means that it does not take a company very long to turn its receivables into cash. Ultimately, every business needs cash to pay off its own expenses (such as operating and administrative expenses).

The average collection period formula is the number of days in a period divided by the receivables turnover ratio. The numerator of the average collection period formula shown at the top of the page is 365 days. For many situations, an annual review of the average collection period is considered. However, if the receivables turnover is evaluated for a different time period, then the numerator should reflect this same time period. For example, if the receivables turnover for one year is 8, then the average collection period would be 45.63 days. If the period considered is instead for 180 days with a receivables turnover of 4.29, then the average collection period would be 41.96 days. By the nature of the formula, a company will have a lower receivables turnover when a shorter time period is considered due to having a larger portion of its revenues awaiting receipt in the short run.

How is the Average Collection Period Formula Derived?

In order to understand the concept of the average collection period formula, one must first look at the accounts receivables turnover formula of

The average collection period formula can be rewritten as the numerator, 365 days, times the inverse of the denominator. This would result in the formula

The 2nd portion of this formula is essentially the % of sales that is awaiting payment. The % of sales awaiting payment is then used as the % of time awaiting payment throughout the period. From here, the % of time awaiting payment is converted into actual days by multiplying by 365. It is important to consider that a company that has seasonal sales will affect the outcome when using this formula. For example, a company that sales mostly at the beginning of the period may show none or very little payments awaiting receipt. Also, a company who sales mostly towards the end of the period may show a very high amount of receivables. Alterations of the formula may be required to adjust for each company.

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Formulas related to Average Collection Period: Receivables Turnover

Debtor collection period

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{{unreferenced|date= The term Debtor Collection Period indicates the average time taken to collect trade debts. In other words, a reducing period of time is an indicator of increasing efficiency. It enables the enterprise to compare the real collection period with the granted/theoretical credit period. Debtor Collection Period = (Average Debtors / Credit Sales) x 365 or 360( = No. of days) (average debtors = debtors at the beginning of the year + debtors at the end of the year, divided by 2 or Debtors + Bills Receivables) Credit Sales are all sales made on credit (i.e. excluding cash sales) A long debtors collection period is an indication of slow or late payments by debtors. The multiplier may be changed to 12 (for months) or 52 (for weeks) if appropriate.

Definition Schedule'

of

'Aging

An accounting table that shows the relationship between a companys bills and invoices and its due dates. Often created by accounting software, aging schedules can be produced for both accounts payable and accounts receivable to help a company see whether it is current on its payments to others and whether its customers are paying it on time.

Investopedia explains 'Aging Schedule'

An aging schedule often categorizes accounts as current (under 30 days), 1-30 days past due, 30-60 days past due, 60-90 days past due, and more than 90 days past due. Companies can use aging schedules to see which bills it is overdue on paying and which customers it needs to send payment reminders to or, if they are too far behind, send to collections. A company wants as many of its accounts to be as current as possible. A company may be in trouble if it has a significant number of past-due accounts. Aging schedules can help companies predict their cash flow by classifying pending liabilities by due date from earliest to latest and by classifying anticipated income by the number of days since invoices were sent out. Besides their internal uses, aging schedules may also be used by creditors in evaluating whether to lend a company money. In addition, auditors may use aging schedules in evaluating the value of a firms receivables. If the same customers repeatedly show up as past due in an accounts receivable aging schedule, the company may need to re-evaluate whether to continue doing business with them. An accounts receivable aging schedule can also be used to estimate the dollar amount or percentage of

receivables that are probably uncollectible.

If you have made the decision that your company will offer credit to your customers, the next step is to develop a collections policy. One part of that collections policy is to monitor your receivables by developing an aging schedule for monitoring receivables.
Why an Aging Schedule for Accounts Receivables is Important

An aging schedule is a way of finding out if customers are paying their bills within the credit period prescribed in the company's credit terms. Every day that a customer is late making payment on their account costs your company money from a cash flow point of view, so preparing an aging schedule and acting upon with regard to your collections policy is an important financial management step for a business firm. If you find that a high percentage of your customers are slow in paying their bills, you should reevaluate your credit and collections policies and make some changes.
An Example of an Accounts Receivable Aging Schedule and How to Analyze it

At the bottom of the page is an example of an accounts receivables aging schedule for a hypothetical company. This company has $100,000 in accounts receivable. They offer a discount if customers pay their bills in 10 days, which is the discount period. That's why you see the first line of the aging schedule as 0-10 days. Looking at the table, you can see that 20% of the firm's customers take the offered cash discount. The credit period for this firm is 30 days, so the second line of the aging schedule is 11-30 days. This line of the aging schedule shows how many customers pay their bills on time. For this company, 40% of the customers pay their bills during the credit period but don't take the discount. This means that 60% of the firm's customers pay their bills on time, a combination of the customers that take the discount and those who pay during the credit period. That's only a little over half of the firm's customers who pay their bills on time. For most companies, this is not enough. A full 30% of the company's customers are delinquent with their payments. 20% are 31-60 days delinquent and 10% are 61-90 days delinquent. That is a sizable percentage of delinquent accounts. This company is undoubtedly suffering from a cash flow perspective because of these delinquencies. Their cash flow is probably low and they are having to borrow short-term funds in order to cover these delinquent accounts with regard to their working capital. This means they are paying interest on short-term debt, which hurts their cash flow even more. In addition, it seems that there may be a problem with the company's credit policy, collections policy, or both. The owner needs to re-evaluate the credit and collections policy and see if the policies need to be tightened up. Perhaps they are offering credit to marginal credit customers and that needs to be stopped. Perhaps they are not collecting aggressively enough.

Last, 10% of the company's credit customers are over 90 days past-due on their accounts. Usually, if a customer is between 90-120 days past due on a debt, that bill is seen as uncollectible and as a bad debt. In this example, this company has $10,000 in bad debts out of $100,000 in accounts receivable. This is another sign that something is wrong with the company's credit and/or collections policy. Bad debts are tax-deductible, but companies would rather not have them. This was an example of how you analyze a company's accounts receivables aging schedule. If you offer credit to your customers, this is an issue that you, as a business owner, have to deal with.

Aging Schedule
Age of Account Amount % Total Value of Receivables 0-10 days 11-30 days 31-60 days 61-90 days Over 90 days $20,000 40,000 20,000 10,000 10,000 20% 40% 20% 10% 10%

$100,000 100%