Receivables Management

Receivables management is also called trade credit management. Term receivables is defined as the debt owed to the firm by customers arising from sales of goods or services in the ordinary course of business. Extension of credit involves risk and cost. Management should weigh the benefits as well as cost.
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Costs
Major categories of costs associated with the extension of credit and accounts receivables are: 1. Collection Cost 2. Capital Cost 3. Delinquency Cost 4. Default Cost

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Collection Cost : They are administrative costs incurred in collecting the receivables from the customers to whom credit sales have been made. It includes: a. Additional expenses on the creation and maintenance of a credit department with staff, accounting, records, postage etc. b. expenses involved in acquiring credit information either through outside specialist agencies or by the staff of the firm itself.
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Capital Cost
Granting credit and creating debtors amount to blocking of firms funds. The interval between the date of sale and the date of payments has to be financed out of working capital. This necessitates the firm to get funds from banks and other sources which comes with a cost. This is called as capital cost.
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Delinquency Cost
This cost arises out of the failure of the customers to meet their obligation when payment on credit sales becomes due after expiry of the credit period. Important component of this cost are: a. Blocking up of funds for an extended period. b. Cost associated with steps that have to be initiated to collect the overdue such as reminders and other collection efforts, legal charges.
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Default Cost
Finally the firm may not be able to recover the overdue because of the inability of the customers. Such debts are treated as bad debts and have to be written off as they cannot be realized. Such costs are known as default costs.

Benefits
Another factor that has a bearing on accounts receivables management is benefits emanating from credit sales. The benefits are the increases sales and anticipated profits because of a more liberal policy. The decision to commit funds to receivables will be based on a comparison of the benefits and costs involved , while determining the optimum level of receivables.
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Credit policy
Credit policy is used to refer to the combination of three decision variables: 1. Credit standards 2. Credit terms 3. Collection policies

Credit Standards
Credit standards are the criteria which a firm follows in selecting customers for the purpose of credit extension. Credit standards influence the quality of firms customers. There are two aspects of quality of the firms customers: 1. Time taken by customers to repay credit obligation 2. The default rate To estimate the probability of default, financial manager should consider three Cs and they are a. Character b. capacity c. condition

On the basis of credit standards Firm may categories its customers in the following three categories: 1. Good accounts 2. Bad accounts 3. Marginal Accounts

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Credit Analysis
Credit analysis is very important as the decisions to grant credit to the customers as well as quantum of credit is based on this. 1. First step in credit analysis is obtaining credit information on the basis of which evaluation of customer will be done. 2. Second step is analysis of credit information
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Obtaining Credit Information

Sources of credit information may be 1. Internal 2. External Internal source is derived from the records of the firm contemplating an extension of credit External sources includes Financial Statement, Bank Reference, Trade Reference, Credit Bureau Reports.
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Analysis of credit information

Information collected should be analyzed to determine the credit worthiness of the applicant. There are no established procedures to analyze the information, procedures to be devised to suit individual needs. Analysis should cover two aspects: 1. Quantitative 2. Qualitative
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Credit Terms
The stipulations under which the firm sells on credit to customers are called credit terms. It includes: a. Credit period b. Cash Discount

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Credit Period
The length of time for which credit is extended to customers is called the credit period. Generally stated in terms of a net date. For examples, if the firms credit terms are net 35, it is expected that customers will repay credit obligation not later than 35 days.
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Cash Discount
Cash discount is a reduction in payment offered to customers to induce them to repay credit obligation within a specified period which will be less than the normal credit period. It is usually expressed as a percentage of sales. Credit terms may be expressed as 2/10,net30. This means that a 2 percent discount will be granted if the customers pay within 10 days, if he does not avail the offer he must make the payments within 30 days.
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Collection policies
The third area involved in accounts receivable management is collection policies. They refer to procedure followed to collect account receivables when after the expiry of credit period they become due. These policies cover two aspects: 1. Degree of collection effort. 2. Type of collection effort.
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