This document discusses key aspects of managing accounts receivable, including: 1) Credit management examines the tradeoff between increased sales from granting credit and costs like financing receivables and risk of nonpayment. 2) Components of credit policy include terms of sale, credit analysis to distinguish good vs bad customers, and collection policies. 3) Credit analysis involves gathering customer financial information and payment history to assess creditworthiness using methods like the five C's of credit and credit scoring.

1. Chapter
McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
9
Management of
Accounts Receivable

2. 2
1)Credit Management: Key
Issues
• Granting credit increases sales
• Costs of granting credit
• Chance that customers won’t pay
• Financing receivables
• Credit management examines the trade-off
between increased sales and the costs of
granting credit

3. 3
2)Components of Credit Policy
• Terms of sale
• Credit period
• Cash discount and discount period
• Type of credit instrument
• Credit analysis – distinguishing between
“good” customers that will pay and “bad”
customers that will default
• Collection policy – effort expended on
collecting receivables

4. 3
The Cash Flows from Granting
Credit
Credit Sale Check Mailed Check Deposited Cash Available
Cash Collection
Accounts Receivable

5. 5
Terms of Sale
• Basic Form: 2/10 net 45
• 2% discount if paid in 10 days
• Total amount due in 45 days if discount not
taken
• Buy $500 worth of merchandise with the
credit terms given above
• Pay $500(1 - .02) = $490 if you pay in 10 days
• Pay $500 if you pay in 45 days

6. 6
Example: Cash Discounts
• Finding the implied interest rate when
customers do not take the discount
• Credit terms of 2/10 net 45
• Period rate = 2 / 98 = 2.0408%
• Period = (45 – 10) = 35 days
• 365 / 35 = 10.4286 periods per year
• EAR = (1.020408)10.4286
– 1 = 23.45%
• The company benefits when customers
choose to forgo discounts

7. 7
3)Credit Analysis
• Process of deciding which customers receive
credit
• Gathering information
• Financial statements
• Credit reports
• Banks
• Payment history with the firm
• Determining Creditworthiness
• 5 C’s of Credit
• Credit Scoring

8. 8
Credit Information
• Financial statements
• Credit reports with customer’s payment
history to other firms
• Banks
• Payment history with the company

9. 9
Five Cs of Credit
• Character – willingness to meet financial
obligations
• Capacity – ability to meet financial
obligations out of operating cash flows
• Capital – financial reserves
• Collateral – assets pledged as security
• Conditions – general economic conditions
related to customer’s business

10. 10
Credit Scoring
•Credit scoring is a credit selection method
commonly used with high-volume/small-dollar
credit requests;
•relies on a credit score determined by applying
statistically derived weights to a credit
applicant’s scores on key financial and credit
characteristics.

11. 11
4)Monitoring Accounts Receivable
•Credit monitoring is the ongoing review of a firm’s
accounts receivable to determine whether customers are
paying according to the stated credit terms.
• If they are not paying in a timely manner, credit monitoring
will alert the firm to the problem.
• Slow payments are costly to a firm because they lengthen
the average collection period and thus increase the firm’s
investment in accounts receivable.
• Two frequently used techniques for credit monitoring are
average collection period and aging of accounts receivable.

12. 12
Average Collection Period (ACP)
•The average collection period has two components:
(1) the time from sale until the customer places the payment in
the mail and
(2) the time to receive, process, and collect the payment once it
has been mailed by the customer. The formula for finding the
average collection period is:
•Assuming receipt, processing, and collection time is constant, the
average collection period tells the firm, on average, when its
customers pay their accounts.

13. 13
Aging Schedule
•An aging schedule is a credit-monitoring technique
that breaks down accounts receivable into groups on the
basis of their time of origin; it indicates the percentages
of the total accounts receivable balance that have been
outstanding for specified periods of time.
Age of Account Amount % of total value of AR
0-10 days RM51,000 49%
11-60 days 26,000 25%
61-80 days 21,000 20%
Over 80 days 6,000 6%
104,000 100%

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5)Collection Policy
• Monitoring receivables
• Keep an eye on average collection period
relative to your credit terms
• Use an aging schedule to determine
percentage of payments that are being made
late
• Collection policy
• Delinquency letter
• Telephone call
• Collection agency
• Legal action

15. 15
Credit Collection

16. 16
6)Credit Policy Changes
• Revenue Effects
• Delay in receiving cash from sales
• May be able to increase price
• May increase total sales
• Cost Effects
• Cost of the sale is still incurred even though the cash
from the sale has not been received
• Cost of debt – must finance receivables
• Probability of nonpayment – some percentage of
customers will not pay for products purchased
• Cash discount – some customers will pay early and
pay less than the full sales price

17. 17
• The cost of debt
• Cost of short term borrowing
• The probability of nonpayment
• The cash discount