MANAGEMENT OF Dr. NEERAJ CHITKARA RECEIVABLESDr. Neeraj ChitkaraAssistant ProfessorSamalkha Group of InstitutionsEmail- firstname.lastname@example.org
INTRODUCTIONThe term receivables refers to debt owned to the firm by the customers resulting from the sale of goods Dr. NEERAJ CHITKARA or services in the ordinary course of business. There are the funds blocked due to credit sales.Receivables management refers to the decision a business makes regarding to the overall credit, collection policies and the evaluation of individual credit applicants.Receivables Management is also called trade credit management.
OBJECTIVES OF RECEIVABLES MANAGEMENT The objective of Receivables Management is Dr. NEERAJ CHITKARAto promote sales and profits until that point isreached where the return on investment in furtherfunding receivables is less than the cost of fundsraised to finance that additional credit i.e. cost ofcapita.
TRADE CREDIT VS. CONSUMER CREDITTrade Credit It occurs when one business sells goods to another business. Dr. NEERAJ CHITKARAConsumer Credit It occurs when a business sells goods to an individual. Trade credit terms are more liberal than consumer credit terms. A company may offer credit on open account or trade bill as documentation of the debt. Forms of Bank CreditCash credits/overdrafts, loans, Purchase/discount bills, letter credit, working capital term loans.
DIFFERENCE BETWEEN TRADE CREDIT &BANK CREDITSr. Attribute Trade Credit Bank CreditNo. Dr. NEERAJ CHITKARA Length of Relatively short usually Ignore1 Terms 30,60 or 90 days Security Usually Unsecured Higher standards for2 unsecured loans , otherwise secured. Amount Smaller larger3 Involved Resource Goods or Services Money4 transferred Extent of Extensive, when size of In-depth analysis5 analysis transaction is large regarding safety and collectability
MOTIVES FOR EXTENSION OF TRADE CREDITS Financial Motive Seller charge a higher price when selling on credit. Operating Motive Dr. NEERAJ CHITKARA Here suppliers respond to variable demand by the way in which they extend trade credit instead of using more costly response such as installing extra capacity building or depleting inventories of forcing customers to wait in line. Contracting Cost Motive Buyers can inspect the quantity as well as quality prior to payment. Pricing Motive If change in selling price is not possible due to oligopoly or govt. norms then by extending credit seller can charge varying amounts to their customers.
COST & BENEFITS OF MAINTAINING RECEIVABLES Cost of Receivables Collection Costs : Dr. NEERAJ CHITKARA i.e. for maintenance of credit & collection department, expenses incurred for obtaining information about credit-worthiness of potential customers. Capital Cost/ Cost of Financing Delinquency Costs: i.e. cost of financing for an extended period, cost of extra steps to be taken to collect overdue e.g. reminders, legal charges etc. Default Costs E.g. Bad debts etc.
BENEFITS OF RECEIVABLES Increased Sales Anticipated Profits Dr. NEERAJ CHITKARAA liberal policy can take two forms: Sales Extension Sales Retention
DETERMINATION THE APPROPRIATE RECEIVABLESPOLICYOur aim is to derive a techniques which the company can apply in order to determine an optimum credit Dr. NEERAJ CHITKARA policy. We can gain a greater appreciation for the credit granting process if we know the sequence of events initiated when a business makes a credit sales. While determining the credit policy the firm has to decide the following two things: Whether or not to extend credit to a customer. How much credit to extend.
The following steps must be taken in determining the appropriate receivables policy: Credit Standards: The term credit Dr. NEERAJ CHITKARA standards represent the basic criteria for the extension of credit to customers. The quantitative basis of establishing credit standards are: Credit Ratings Credit References Average Payment Periods Financial Ratios
CONT….. Here we have to find the trade-off between benefit and cost to the firm as a whole, so Dr. NEERAJ CHITKARA we have divided the overall standards into two parts i.e. Tight or restrictive Liberal or non-restrictive We have to check what happens to the trade-off between cost and benefit if these standards are relaxed or tightened.
The following factors are considered while deciding the credit standards: Collection Costs Investment in receivables or average collection period Dr. NEERAJ CHITKARA Bad debts expenses Sales Volume The effects of relaxed or tightened credit standards can be proved with an example in two manners. Long-Term approach Short-Term/ Marginal Approach
CREDIT ANALYSIS & DECISION The second aspect of the receivables policy is credit analysis and investigation. Two basic steps are involved in the credit investigation process i.e. Obtaining credit information Analysis of credit information Dr. NEERAJ CHITKARA Obtaining credit information Internal Sources Filling up of various forms Trade references Internal records External Sources Financial Statements Bank references Trade references Credit Bureau reports
ANALYSIS OF CREDIT INFORMATION Quantitative i.e. ratio analysis of liquidity, profitability & Dr. NEERAJ CHITKARA debts capacity, Trend analysis of over a period of time to reveal the financial strength. Qualitative i.e. references from other suppliers, bank references and special bureau reports.It must be clear that the main purpose of credit analysis is to assess the credit worthiness of the customers.
THE 5 C’S OF CREDIT ANALYSIS1. Capital Aggregate Liquidity position Total Dept position Dr. NEERAJ CHITKARA2. Character Willingness to pay the debts3. Collateral4. Capacity Management capacity to run the business Physical Capacity5. Condition Economic condition of applicant Industry condition in general
CREDIT TERMS The terms under which goods are sold on credit are referred as credit terms. These relate to the payment of the amount under the credit sales. Thus, credit terms specify the repayment terms of Dr. NEERAJ CHITKARA receivables. Components of Credit Terms Credit Period Cash Discount Cash Discount PeriodThese components are usually written in abbreviations such as 2/10 net 30.The effect of these components on the receivables management can be proved with the help of an example.
COLLECTION POLICIESThe next step involved in the receivables management is collection policies. They refer to the procedures followed to collect accounts Dr. NEERAJ CHITKARA receivables after the expiry of the credit period. Components of Collection Policies Degree of collection efforts i.e. strict, lenientThe effect on receivables management of the above degrees with example. Type of collection efforts Letters Telephone Calls Help of collection agencies Legal action
MARGINAL ANALYSIS It involves a systematic comparison between the marginal returns and the marginal cost from a change in the discount period or the collection Dr. NEERAJ CHITKARA process. The change should be accepted if the marginal return from a proposed change in the management of accounts receivables is greater than the marginal cost on additional investments in the receivables. Process of Marginal Analysis Determine the marginal benefit Determine required rate of return on marginal investment Compare marginal benefit with required return
CONT… The logic behind this approach of credit policy Dr. NEERAJ CHITKARA is to examine the incremental or marginal benefit and cost or required rate associated with any change in credit policy. If the change promises more profit than costs the change should be made or vice-versa.
HEURISTIC APPROACH This approach is based on a manufacturing company’s actual experience. To establish a credit limit and grant credit the following factors need to be Dr. NEERAJ CHITKARA considered. The formula or procedure described here has the weight of managerial experience and infusion behind it and therefore is heuristic in nature.The factors which should be considered are as follows Credit requirementsDegree of dependence Discount <25% 0% 25-50% 5% .50% 10%
Paying HabitsPayment during discount period 10%Payment during credit period 5%Late Payment (-)5% Duration of the Business Dr. NEERAJ CHITKARALess than 3 years 0%3-10 years 5%More than 10 years 10% Profit MarginIf margin is less than 5% 0% Current Ratio Total debt to asset ratio Inventory turnover Ratio Qualitative Factor
DISCRIMINANT ANALYSISDiscriminant Analysis is a computer based technique Dr. NEERAJ CHITKARA for predicting whether a new credit applicant will prove to be good or bad credit risk.
SEQUENTIAL DECISION ANALYSIS Dr. NEERAJ CHITKARA