3. Managing Receivables
1. Collecting sales receipts as quickly as possible to reduce the cost of financing
the receivables balance
2. Extending the credit period to customers to encourage additional sales
Managing receivables is effectively a balancing act between:
Costs associated with receivables and their management: -
i. Irrecoverable receivables i.e. when debts go bad
ii. Finance costs i.e. the finance cost of offering credit to customers
iii. Administration costs i.e. the costs of staffing a credit control department
iv. Loss of sales revenue and contribution i.e. the impact that a credit control
policy will have upon revenue – a reduction in credit period may lose
customers
4. Credit Control Department - Responsibilities
1. Assessing customer’s credit risk
To minimise the risk of bad debts occurring, a company should investigate the
creditworthiness of all new customers (credit risk), and should review that of existing
customers from time to time, especially if they request that their credit limit should be
raised.
Information about a customer’s credit rating can be obtained from a variety of
sources.
5. Credit Control Department - Responsibilities
1. Assessing customer’s credit risk (cont.)
These include:
• Bank references – These tend to be fairly standardised in the UK, and so are not
perhaps as helpful as they could be.
• Trade references – Suppliers already giving credit to the customer can give useful
information about how good the customer is in paying bills on time.
• Published information – The customer’s own annual accounts and reports will
give some idea of the general financial position of the company and its liquidity.
• Credit reference agencies – Agencies such as Dunn & Bradstreet publish general
financial details of many companies, together with a credit rating. They will also
produce a special report on a company if requested.
• Company’s own sales record – For an existing customer, the sales ledgers will
show how prompt a payer the company is, although they cannot show how able
the customer is to pay.
6. Credit Control Department - Responsibilities
2. Agreeing Terms
Once it has been decided to offer credit to a customer, the company needs to set
limits for both the amount of credit offered and the time taken to repay.
3. Collecting payment
An effective administration system for debtors must be established:
• Be strict with the credit limit
• Send invoices promptly
• Systematically review debtors e.g. aged debtor analysis
• Chase slow payers
7. Managing Receivables
As well as effective administration of the credit control department there are other
policies a company can adopt to manage its receivables.
These are:
1. Offering early settlement discount
• A common policy in reality is to offer a discount to customers who pay within a
certain period of time
• A business offering this would hope that the benefits of recovering the receivable
earlier would outweigh the cost of offering the discount
2. Using the services of a debt factoring company
• This involve using a specialist debt collecting company that will manage your
sales ledger (i.e. receivables) for a fee
• Again the benefits should outweigh the costs of adopting this approach
8. Managing Receivables
We’ll now look at a number of examples that consider changes to receivables policy
and the impact upon the costs to the company.
Example 1 – Increasing admin expenditure and changing credit period
Tomtom Co is a company that manufacturers running watches. Tomtom’s customers currently
take an average of 90 days to settle invoices and approximately 1% of invoices are
irrecoverable. Annual sales are $10 million and Tomtom’s credit control department costs
$80,000 per annum.
Tomtom is considering employing 2 additional credit controllers. It is estimated that this new
policy would increase credit control department costs to $130,000 per annum, reduce the
average length of time that customers take to settle invoices to 70 days and reduce irrecoverable
receivables to 0.5% of credit sales.
Working capital is financed by a bank overdraft with and interest rate of 8%.
Required:
Determine whether the new policy would be beneficial to Tomtom Co.
9. Managing Receivables
Example 1 – Increasing admin expenditure and changing credit period - Answer
When answering a question like this always compare the cost of the current policy
with the cost of the new policy.
Cost of the current policy:
$
Admin costs:
Irrecoverable debts:
Finance cost of receivables:
Receivables =
Finance cost =
Total cost
10. Managing Receivables
Example 1 – Increasing admin expenditure and changing credit period - Answer
Cost of the new policy:
$
Admin costs:
Irrecoverable debts:
Finance cost of receivables:
Receivables =
Finance cost =
Total cost
11. Managing Receivables
Example 1 – Increasing admin expenditure and changing credit period - Answer
$
Current total cost
Vs.
New total cost
12. Managing Receivables
We’ll consider the same information as example 1 and consider a different proposed
policy.
Example 2 – Early settlement discount
Tomtom Co is a company that manufacturers running watches. Tomtom’s customers currently
take an average of 90 days to settle invoices and approximately 1% of invoices are
irrecoverable. Annual sales are $10 million and Tomtom’s credit control department costs
$80,000 per annum.
Working capital is financed by a bank overdraft with and interest rate of 8%.
Required:
Determine whether the new policy would be beneficial to Tomtom Co.
Tomtom Co is now considering an alternative policy. This will involve offering a discount of 2% if
customers settle invoices within 10 days rather than the current average of 90. It is expected
that 30% of customers will take advantage of the discount. There will be no change in the
overall administration cost as a result of the new policy but irrecoverable debts are expected to
fall to 0.75% of sales.
13. Managing Receivables
Example 2 – Early settlement discount - Answer
When answering a question like this always compare the cost of the current policy
with the cost of the new policy.
Cost of the current policy (as before):
$
Admin costs:
Irrecoverable debts:
Finance cost of receivables:
Receivables =
Finance cost =
Total cost
14. Managing Receivables
Example 2 – Early settlement discount - Answer
Cost of the new policy:
$
Admin costs:
Irrecoverable debts:
Finance cost of receivables:
New receivables days
New receivables
Finance cost =
Cost of the discount:
Total cost
16. Managing Receivables – Invoice discounting and Debt factoring
Invoice discounting
Invoice discounting is an advance of funds from a specialist company which is
secured against specific outstanding invoices from specific customers.
The advance is repaid when the customer settles the outstanding invoice and a
finance cost is charged for the advance.
Debt factoring
A debt factoring arrangement involves using a specialist company to provide the
following services:
1. Credit control administration – in return for a fee the debt factoring company is
able to provide full credit control services, including invoicing of your customers.
You are in effect outsourcing your sales ledger!
2. Finance advance – the factoring company can advance a percentage of the face
value of all outstanding invoices e.g. 80%. A finance charge will be made for
this service.
17. Managing Receivables – Invoice discounting and Debt factoring
Debt factoring
• A business could use only the sales administration services or both sales ledger
and a finance advance
• The factoring arrangement should be medium to long-term
• It is particularly useful for fast growing businesses who do not have the
resources to devote to credit control
Non-recourse and with recourse factoring
• Non-recourse means the factoring company takes on any lability for
irrecoverable debt of a previously advanced invoice
• Recourse means that the advance could be reclaimed by the company if the
receivable defaults
• A non-recourse arrangement therefore reduces the risk to the business using the
factoring company – however this will be more expensive
18. As with example 2, we will use the same scenario as example 1.
Example 3 – Debt factoring
Tomtom Co is a company that manufacturers running watches. Tomtom’s customers currently
take an average of 90 days to settle invoices and approximately 1% of invoices are
irrecoverable. Annual sales are $10 million and Tomtom’s credit control department costs
$80,000 per annum.
Working capital is financed by a bank overdraft with and interest rate of 8%.
Required:
Determine whether the new policy would be beneficial to Tomtom Co.
Tomtom Co is now considering using a debt factoring company. The factoring company will
provide full sales ledger administration services for a fee of 1.5% of the annual sales. As a result
Tomtom will reduce its credit control cost to $10,000 per annum. That factor will advance 75% of
invoices on a non-recourse basis. The factor will charge 9% per annum for the advance.
Customers are still expected to take an average of 90 days to settle outstanding invoices.
Managing Receivables – Invoice discounting and Debt factoring
19. Managing Receivables
Example 3 – Debt factoring - Answer
When answering a question like this always compare the cost of the current policy
with the cost of the new policy.
Cost of the current policy (as before):
$
Admin costs:
Irrecoverable debts: 1% x $10M
Finance cost of receivables:
Receivables =
Finance cost =
Total cost
20. Managing Receivables
Example 3 – Debt factoring - Answer
Cost of the new policy:
$
Admin costs:
Irrecoverable debts:
Finance cost of receivables:
Receivables =
Factor finance
=
Overdraft finance
=
Factor fee:
Total cost
