Professional Documents
Culture Documents
RECEIVABLES MANAGEMENT
CREDIT MANAGEMENT
OUTLINE
Terms of Payment
Credit Policy Variables
Credit Evaluation
Credit Granting Decision
Control of Accounts Receivable
Credit Management in India
Introduction
Firms
Accounts
TERMS OF PAYMENT
Cash Terms
Open Account
Consignment
Bill of Exchange
Letter of Credit
CREDIT STANDARDS
Liberal
Sales
Stiff
Higher
Lower
Higher
Investment
in receivables
Larger
Collection costs
Lower
Smaller
Higher
Lower
EXAMPLE
Pioneer Limited is considering relaxing its credit standards.
S = Rs.15 million, bn = 0.10, V = 0.80,
ACP = 40 days, k = 0.10, t = 0.4
RI = [15,000,000 (1 0.80) 15,000,000 x 0.10] (1 0.4)
15,000,000
0.10 x
360
x 40 x 0.80
= Rs.766,667
CREDIT PERIOD
Longer
Sales
Shorter
Investment in
Higher
Lower
Larger
Smaller
Higher
Lower
receivables
Bad debts
IMPACT ON RESIDUAL
INCOME OF LONGER CREDIT PERIOD
RI = [S(1 V) - Sbn] (1 t ) k I
INCREASE IN RECEIVABLES
INVESTMENT
S
+ V (ACPn)
360
S0
I = (ACPn ACP0)
360
where:
EXAMPLE
Zenith Limited is considering extending its credit period from
30 to 60 days.
S = Rs.50 million, S = Rs.5 million, V = 0.85,
bn = 0.08, k = 0.10, t = 0.40
RI = [5,000,000 x 0.15 5,000,000 x 0.08] (0.6)
0.10 (60 30) x 50,000,000 + 0.85 x 60 x 5,000,000
360
360
= [750,000 400,000] (0.6) 0.10 [4,166,667 + 708,333]
= 277,500
RI = [S(1 V) - DIS] (1 t ) + k I
RI = [S(1 V) - BD] (1 t ) k I
Capital
Collateral
Strong
Weak
Character
Capacity
Strong
Strong
Weak
Capital
Capital
Strong
Capacity
Strong Weak
Weak
Excellent risk
Fair risk
Weak
Capital
Capital
Strong
Weak
Strong
Doubtful risk
How much
credit
should be
granted ?
Weak
Dangerous
risk
Factor
Past payment
Net profit margin
Current ratio
Debt-equity ratio
Return on equity
Factor
weight
0.30
0.20
0.20
0.10
0.20
Rating
3
2
Rating index
Factor
score
1.20
0.80
0.60
0.40
1.00
4.00
DISCRIMINANT ANALYSIS
Z = 1 Current ratio + 0.1 Return on equity
Current
+
ratio
+
+
+
+
+
+
+
Return on equity
Centre for Financial Management , Bangalore
Risk Class
1
2
3
4
5
Description
Customers with no risk of default
Customers with negligible risk of default (default rate less than 2
percent)
Customers with little risk of default (default rate between 2 percent
and 5 percent)
Customers with some risk of default (default rate between 5 percent
and 10 percent)
Customers with significant risk of default (default rate in excess of 10
percent)
pa
r
e
m
to
Cus
p
it
d
e
cr
fer
f
O
Re f
use
Rev Cost
ys
Custome
r default
(1 p)
cred
it
0
Centre for Financial Management , Bangalore
Cost
EXAMPLE
ABC Company is considering offering credit to a customer.
The probability that the customer would pay is 0.8 and the
probability that the customer would default is 0.2. The
revenues from the sale would be Rs.1,200 and the cost of sale
would be Rs.800.
The expected profit from offering credit, given the above
information, is:
0.8 (1,200 800) 0.2 (800) = Rs.160
REPEAT ORDER
s
5
Pay p = 0.9
1
dit
e
r
c
er
f
f
O
s
Pay
0.9
=
p1
e
Off
dit
e
r
rc
(1
De
fa
p1 )
ult
s
=0
.1
Def
ault
s
(1
p1 ) =
0.05
CONTROL OF ACCOUNTS
RECEIVABLES
Days Sales Outstanding
Ageing Schedule
Collection Matrix
COLLECTION MATRIX
Percentage of Receivables
Collected During the
Month of sales
First following month
Second following month
Third following month
Fourth following month
January
Sales
13
42
33
12
-
February
Sales
14
35
40
11
-
March
Sales
April
Sales
May
Sales
June
Sales
15
40
21
24
-
12
40
24
19
5
10
36
26
24
4
9
35
26
25
5
SUMMING UP
The important dimensions of a firms credit policy are : credit
standards, credit period, cash discount, and collection effort
In general, liberal credit standards tend to push sales up by
attracting more customers. However, this is 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.
Three broad approaches are used for credit evaluation :
traditional credit analysis, numerical credit scoring, and
discriminant analysis.
The traditional approach to credit analysis calls for assessing a
prospective customer in terms of the five Cs of credit, viz.
character, capacity, capital, collateral, and conditions.
Three methods are commonly employed for monitoring accounts
receivable : days sales outstanding, ageing schedule, and
collection matrix.