Fin man 7 receivable management

Financial Management
Class #7
…………………………………………………………………

Jimmi Sinton
Te a c h i n g S e r i e s

6-14 Receivable Management

Topics
Materials
Covered
… … … … …… arti penting investasi pada
piutang
prinsip pemberian kredit
Please read pengukuran efisiensi piutang
each material
anggaran pengumpulan piutang
before class
and rehearse it
after class

J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management


Accounts Receivable
Management
average collection period – the average length of time
from a sale on credit until the payment becomes usable funds
to the firm.

The collection period consists of two parts:
the time period from the sale until the customer
mails payment, and
the time from when the payment is mailed until the
firm collects funds in its bank account.

T e a c h i n g


Accounts Receivable Management:
Changing Credit Standards

• The firm sometimes will change its credit standards to improve
its returns and generate greater value for its owners.

Effects of relaxation of Credit standards

Variable Direction of change Effect on profit

Sales volume Increase Positive
Investment in accounts receivable Increase Negative
Bad-debt expense Increase Negative

T e a c h i n g


Key Ratios in Receivables Management
Changing Credit Standards
Net Sales
Receivable Turnover =
Average Account Receivables

365
Days Sales Uncollected =
Receivables Turnover

365
Turnover of Account Recevables = Average Collection Period

Total Variable Cost of
Average Investment annual Sales
=
In accounts Receivables Turnover of
Account Receivables
T e a c h i n g


Changing Credit Standards Example
Dodd Tool, a manufacturer of lathe tools, is currently selling a
product for $10/unit. Sales (all on credit) for last year were
60,000 units. The variable cost per unit is $6. The firm’s
total fixed costs are $120,000.

Dodd is currently contemplating a relaxation of credit
standards that is anticipated to increase sales 5% to 63,000
units. It is also anticipated that the ACP will increase from 30
to 45 days, and that bad debt expenses will increase from 1%
of sales to 2% of sales. The opportunity cost of tying funds
up in receivables is 15%.

Given this information, should Dodd relax its credit
standards?
T e a c h i n g


Additional Profit Contribution from Sales

Analysis of Relaxing Credit Standards
Additional Profit Contribution from Sales

Old Sales Level 60,000 Price/Unit $ 10
New Sales Level 63,000 Variable Cost/Unit $ 6
Increase in Sales 3,000 Contribution Margin/Unit $ 4
Additional Profit Contribution from Sales (sales incr x cost margin) $ 12,000

T e a c h i n g


Cost of marginal investment in A/R:
Total variable cost of annual sales
Under present plan: ($6 x 60,000 units) = $360,000
Under proposed plan: ($6 x 63,000 units) = $378,000

Turnover of account receivables
365
Under present plan: = 12.2
30

365
Under proposed plan: = 8.1
45

T e a c h i n g

Average investment in account receivables
$ 360,000
Under present plan: = $ 29,508
12.2

$ 378,000
Under proposed plan: = $ 46,667
8.1
Average investment under proposed plan 46,667
- Average investment under present plan 29,508
Marginal investment in accounts receivables 17,159
x Required return on investment 0.15
Cost of marginal investment in A/R 2,574
Cost of Marginal Debts
Under proposed plan: (0.02x$10/unitx63,000 units) = 12,600
Under present plan: (0.01 x $10/unitx60,000 units) = 6,000
Cost of marginal debts 6,600
T e i m mni g S e ni t o n
Jachi S ir e s Financial Management


Effects on Dodd Aditional Profit contribution from sales
[3,000 units x ($10-$6)] 12,000
Tool of a
Relaxation of Cost of marginal investment in A/R
$ 360,000
Credit Standards Under present plan:
12.2
46,667

$ 378,000
Under proposed plan: 29,508
8.1
Marginal investment in A/R 17,159
Cost of marginal investment in A/R (0.15 x $17,159) (2,574)

Cost of Marginal Debts
Under proposed plan: (0.02x$10/unitx63,000 units) 12,600
Under present plan: (0.01 x $10/unitx60,000 units) 6,000
Cost of marginal debts (6,600)

Net profit from implementation of proposed plan 21,174

T e a c h i n g


Accounts Receivable Management

Character:
The applicant’s record of meeting past obligations.
Capacity:
The applicant’s ability to repay the requested credit.
Capital:
The applicant’s debt relative to equity.
Collateral:
The amount of assets the applicant has available for
use in securing the credit.
Conditions:
Current general and industry-specific economic
conditions.
T e a c h i n g


Finding the Optimum Level of Accounts
Receivable
• Accounts Receivable represent your money sitting in
someone else’s bank account. It earns you nothing!
• So, if the firm does grant credit, how do we minimize
the impact on cash flow
• Firm’s credit policies must be reviewed and evaluate the
impact of any proposed changes in policies based on the
NPV of incremental cash flows due to the proposed
changes

T e a c h i n g


Sale are generally stated in the form X / Y, n Z
This means that the customer can deduct X
percentage if the account is paid within Y days;
otherwise, the full amount must be paid within Z
days.

Example: 2/10 n 30

The company offers a 2% discount if the invoice
is paid in 10 days. Otherwise,
Balance due in 30 days.

T e a c h i n g


Old Policy; 2/10, n30
35% of customers pay in 10 days
ACP=(.35x10)+(.62x30)+(.03x100)=25.1 days

New Policy; 2/10, n40
35%of customers pay in 10 days
ACP=(.35x10)+(.60x40)+(.05x100)=32.5 days
(If sales are $1M per day, this will cost $7.4M!)
T e a c h i n g


Analysis of Accts. Receivable Changes
to Credit Policy
Develop pro forma financial statements for each
policy under consideration.
Use the pro formas to estimate incremental cash
flows by comparing forecasts to current policy cash
flows.
Use the incremental cash flows to estimate the NPV
of each policy change.
Choose the policy change that maximizes the value of
the firm (highest NPV).

T e a c h i n g


Analysis of Accts. Receivable
CHANGES
Example:
ABC Corp is considering a credit policy change from
offering no credit to offering 30 days credit with no
discount
Why might they do this?
Increase sales
Increase market share
What costs will the firm incur as a result?
Cost of carrying accounts receivable
Potential increase in bad debts
Credit analysis and collection costs
T e a c h i n g


Assume the Net Incremental Cash Flows associated with
ABC’s new credit policy are as follows: (They lose one
month of cash flow which they will have to borrow)
External financing (Init. Invest) = $28,000 t=0
Increase in sales = $30,000
Increase in COGS = $15,000
Increase in Bad Debts = $3,000
increase in Other Expenses = $5,000
Increase in Interest Expense = $500
Increase in Taxes = $2,600
Total Incr. Operating Cash Flow = $3,900/yr.
T e a c h i n g


Calculate the NPV of the change (k = 12%):
PV of the expected inflows of $3,900 per year
from t = 0 to infinity (perpetuity)
= $3,900/.12
= $32,500
NPV = PV of inflows - initial investment
= $32,500 - $28,000
= $4,500
Since NPV > 0, ABC should undertake the credit
policy change
Note: If they keep the $28,000, cash flow at 12% = $3,360

T e a c h i n g


Methods of Collection
Most firms use some of the following:
Send reminder letters.
Make telephone calls.
Send in big Gene
Hire collection agencies.
Sue the customer.
Settle for a reduced amount.
Write off the bill as a loss.
Sell accounts receivable to factors.

T e a c h i n g

Fin man 7 receivable management

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