Finance

1. Receivables Management

2. Trade Credit
• Trade Credit happens when a firm sells its
products or services on credit and does not
receive cash immediately.
• Characteristics of Credit Sale:
Involves an element of risk
Based on economic value
Implies Futurity
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3. Why do companies
extend credit

4. Costs and Benefits of
Extending Credit
Costs
• Collection Cost
• Capital Cost
• Delinquency Cost
• Default Cost
Benefits
• Increase Sales
• Attract New
Customers
• Protection from
Competition
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5. Credit Policy
• Credit policy of a firm provides the
framework to determine
Whether or not to extend credit to a
customer
How much credit to extend
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6. Goals of Credit Policy
• Marketing tool
• Maximization of Sales vs. incremental
profit
 Production and Selling Costs
 Administration Costs
 Bad Debt losses
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7. Variables in Credit Policy
• Credit Standards
• Credit Analysis
• Credit Terms
• Collection Policy and Procedures
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8. Credit Standards
• Credit standards are the basic criteria for the
extension of credit to customers. Two types
 Tight or restrictive
 Liberal or non-restrictive
 Implications on the following Factors
 Collection Cost
 Investment in receivables
 Bad debt expenses
 Sale Volume
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9. Credit Analysis
• Credit analysis involves obtaining credit information and
evaluation of credit applicants.
 Obtaining Credit Information
 Internal
 External
 Financial Statements
 Bank References
 Trade References
 Credit Bureau Report
 Analysis of Credit information
 Quantitative
 Qualitative
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10. Credit Analysis: Customer
Aspects
• Two aspects of Quality of Customers:
• Average Collection Period
• Default Rate
• Probability of Default: Three C’s
• Character
• Capacity
• Condition
• Types of Customers
• Good Accounts
• Bad Accounts
• Marginal Accounts
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11. Credit Terms
• Credit terms specify the repayment terms required of credit
customers/receivables. Credit terms have 3 components:
 Credit Period
 Cash Discount
 Cash Discount Period
 e.g. 2/10 net 30
2 signifies the cash discount.
10 represents the time duration (10 days) within which the
customer must pay to be entitled to the discount.
30 means the maximum period for which credit is available.
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12. Credit terms
• Credit period: The length of time for which
credit is extended to customers is called Credit
period.
• Cash Discount: A reduction in payment
offered to customers to induce them to repay
credit obligations
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13. Cost of Discount
Average collection period 40 days
To reduce it firm offers cash discount of 3/10
If balance is Rs. 100 then Annual Financing
Cost is:
AFC = %Discount/(100-%Discount) x 365/(Credit Period – Discount
Period) x 100

14. ABC Ltd. Is offering a cash discount under the
term 3/15, 2/30, net 50. In order to reduce the
average collection period, it has two
alternative policies before it. These are
i) 3.5/12 , 2/30, net 50
ii) 3/15 , 2.5/25, net 50
Evaluate the alternatives and make suggestions

15. AFC =
i) = 3/97 x 365/35 x 100 = 32.25%
ii) = 2/98 x 365/20 x 100 = 37.24%
Alternative-I
AFC = 3.5/96.5 x 365/38 x 100 = 34.84 %
Alternative-II
AFC = 2.5/97.5 x 365/25 x 100 = 37.43%

16. Collection Policies
• Collection policy involves procedures for
collecting accounts receivables when they
are due. Two aspects
• Degree of Collection Effort
• Type of Collection Effort
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17. Degree of Collection Efforts
The collection efforts may be categorized into:
 Strict/Tight
 Lenient

18. Type of Collection Efforts
The steps usually taken are:
 Letters including reminders
 Telephone calls for personal contact
 Personal visits
 Help of Collection Agencies
 Legal Action