WCM

Thursday, April 20, 2023

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WCMWCM

Receivables Management and Factoring


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TopicsTopics

• Nature and Goals of Credit Policy

• Optimum Credit Policy• Credit Policy Variables• Credit Evaluation of Individual

Accounts• Monitoring Receivable


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Nature of Credit PolicyNature of Credit Policy

• Investment in receivable depends on:– volume of credit sales– collection periodThese two depend on the credit policy

• Credit policy: three decision variables– credit standards- type of customer– credit terms-duration of credit– collection efforts-actual collection period


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Goals of Credit PolicyGoals of Credit Policy

• Marketing tool for sales expansion: - competition - company’s bargaining power - industry practice• Maximisation of sales Vs. incremental profit

– production and selling costs (FC increases, if capacity is added)- with loosening of CP, opportunity cost of lost sales comes down, but cost of admin. and bad debt loss increases- Trade off

– administration costs (supervision & collection cost rise)– bad-debt losses


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Cont…Cont…Change in salesChange in costChange in contributionLoose credit policy: Increases contribution (reduces

opportunity loss) Admin cost [credit investigation and

supervision cost & collection costs] rise Bad debt loss rises


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Costs of credit policyCosts of credit policy Cost of admin &

Bad debt losses

Costs &Benefits

Opportunity loss

Tight Credit policy Loose


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Optimum Credit PolicyOptimum Credit Policy

• Estimation of incremental operating profit IOP

• Estimation of incremental investment (II)in receivable

• Estimation of incremental rate of return (IRR)- IOP/ II

• Comparison of incre-mental rate of return with required rate of return (RRR)

• Optimum credit policy: IRR = RRR

Marginal cost of capital

Marginal rate of return

Tight Creditpolicy

Loose

Costs & Return (%)


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Incremental cost-benefit analysisIncremental cost-benefit analysis

Change in cont. (lost cont. due to tightening of CP) = change in sales X PV ratio

Change in OP= change in cont- avoidable cost of bad debt and admin. cost associated with a loose policy

Investment in debtors = credit sales per day X average collection period

Find the incremental rate of return: Change in OP(1-tax rate) / Investment in debtors

Sheet-2


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Credit Policy VariablesCredit Policy Variables•Credit standards- criteria for choosing

customer- trade off between incremental return and cost

•Credit analysis– collection period– default rate : bad debt loss %

•Character- willingness to pay•Capacity-ability to pay•Condition-economy’s impact on ability to

pay•collateral


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Cont……..Cont……..

– customer categories• good accounts• bad accounts• marginal accounts (in between good and

bad)

– Creditworthiness-numerical credit scoring• ad hoc approach (scoring on a scale of

factors with due weightage)• simple discriminant approach• multiple discriminant approach


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Multiple-discriminant Multiple-discriminant analysisanalysis

Altman:Z = 0.012 (NWC/TA) + 0.014(RE/TA) + 0.033(EBIT/S) + 0.006 (MV/D) +

0.010(S/TA)Z > 2.675MV=Book value of equityD=Book value of debt


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Credit Policy VariablesCredit Policy Variables

Credit-Granting DecisionCredit-Granting Decision

Credit-granting Decision

CREDIT GRANTINGDECISION

NO CREDIT GRANT CREDIT

PAYMENTRECEIVED

BENEFITPV OF FUTURE

NET CASHFLOWS

PAYMENTNOT RECEIVED

COSTPV OF LOST

INVESTMENT

NET PAYOFFPV OF

(BENEFIT - COST)

NO PAYOFF


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Credit Policy VariablesCredit Policy Variables

• Credit terms– credit period– cash discount (compare after tax cost of discount

with opportunity of reduced investment in debtors)

• Collection policy and procedures– regularity of collections– clarity of collection procedures– responsibility for collection and follow-up– case-by-case approach– cash discount for prompt payment


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Credit Evaluation of Credit Evaluation of CustomersCustomers

• Credit information– financial statements– bank references– trade references

• Credit investigation and analysis– analysis of credit file– financial analysis– analysis of business and management

• Credit limit• Collection efforts


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Monitoring ReceivableMonitoring Receivable

• Collection period• Aging schedule• Collection experience matrix


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Collection experience Collection experience matrixmatrix

Sales and receivables Rs. In lacs Month July Aug Sept. Oct. Nov Dec.Sales 400 410 370 220 205 350Receivables July 330 Aug 242 320 Sept 80 245 320 Oct 0 76 210 162 Nov 0 0 72 120 160 Dec 0 0 0 40 130 285


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Cont….Cont…. Rs. in lacs Month July Aug Sept. Oct. Nov Dec.Sales 400 410 370 220 205 350Receivables % July 82.5 Aug 60.5 78.0 Sept 20.0 59.8 86.5 Oct 0 18.5 56.8 73.6 Nov 0 0 19.5 54.5 78.0 Dec 0 0 0 18.2 63.0 81.4

Moving down the diagonals tells the collection experience

WCM

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