Credit Receivables Mngt

8/3/2019 Credit Receivables Mngt

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Receivables Management

Semester II


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Objective of Credit Policy

The objective of credit policy is to promotesales up to that point where profit is

maximized There will be net increase in operating

profit only when the cost of extendedcredit period is less than the incrementaloperating profit/residual income


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Credit Policy Variables

In establishing an optimum credit policy,the financial manager must consider thefollowing important decision variables

which influence the level of receivables:1. Credit Standards

2. Credit Terms

Cash DiscountCredit Period

3. Collection Efforts


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Role of Credit Standards

Credit standards are criteria to decide towhom credit sales can be made and howmuch

Credit standards influence the quality offirms customers

time taken by customers to repay credit

obligationdefault rate


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The time taken by customers to repay

debt can be determined by comparingaverage collection period (ACP) withaverage payment period of the customer

Default risk can be measured in terms of

bad-debt losses ratio the proportion ofuncollected receivable. The estimate ofprobability of default can be determinedby evaluating the character, i.e.,

willingness of customer to pay; customersability to pay and prevailing economicand other conditions


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Types of customers

Firm may categorize customers into threekinds:

good accounts

bad accounts

moderate accounts


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Role of Credit Terms The conditions for extending credit sales are

called credit terms Credit terms include:cash discountcredit period Cash discounts are given for receiving

payments earlier than the normal creditperiod

The length of time for which credit isextended to customers is called the creditperiod


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Factors Determining Credit Period

Industry Norms

Objective of the Firm

Default Ratio and Bad-debt Losses


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Objectives of Collection Policy

Cause increase in sales

Prompt and regular collection

Speed up the collection of dues Keep down collection costs and bad

debts within limits

Maintain collection efficiency


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Firm should lay-down clear cut collection

procedures for past dues or delinquentaccounts

The collection procedure should be clearly

defined in such a manner that theresponsibility to collect and follow upshould be clearly defined

A firm needs to continuously monitor

and control its receivables to ensure thesuccess of collection efforts


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Factoring Factoring involves an outright sale of

receivables of an organization to a financialinstitution or private agency, called factor

A factor specializes in management of tradecredit

Factors collect receivables and also advancecash against receivables to solve the client

firms liquidity problem For providing their services, they charge

interest on advance and commission forother services.


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Functions of Factor

1. Financial Assistance: Factors providefinancial assistance to the client byextending advance cash against book

debts.2. Credit Administration: Sales ledger

administration and credit management

services to his clients, by maintaining theledger of customers of clients, taking allfollow-up actions, etc.


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3. Protection: Protection against default in

payment by debtors, by initializing legalactions at an early time.

4. Credit collection: When individual book

debts become due from the customer, thefactor undertakes all collection activitythat is necessary. He guards the interestof his client, by developing better

strategy against possible defaults bycustomers of his client; etc.

Credit Receivables Mngt

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