Topic- Management of Receivables. Subject- Working Capital Management

1. MANAGEMENT
OF
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RECEIVABLES
Dr. Neeraj Chitkara
Assistant Professor
Samalkha Group of Institutions
Email- neer.chitkara@gmail.com

2. INTRODUCTION
The 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.

3. OBJECTIVES OF RECEIVABLES MANAGEMENT
The objective of Receivables Management is
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to promote sales and profits until that point is
reached where the return on investment in further
funding receivables is less than the cost of funds
raised to finance that additional credit i.e. cost of
capita.

4. TRADE CREDIT VS. CONSUMER CREDIT
Trade Credit
It occurs when one business sells
goods to another business.
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Consumer 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 Credit
Cash credits/overdrafts, loans, Purchase/discount bills,
letter credit, working capital term loans.

5. DIFFERENCE BETWEEN TRADE CREDIT &
BANK CREDIT
Sr. Attribute Trade Credit Bank Credit
No.
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Length of Relatively short usually Ignore
1 Terms 30,60 or 90 days
Security Usually Unsecured Higher standards for
2 unsecured loans ,
otherwise secured.
Amount Smaller larger
3 Involved
Resource Goods or Services Money
4 transferred
Extent of Extensive, when size of In-depth analysis
5 analysis transaction is large regarding safety and
collectability

6. MOTIVES FOR EXTENSION OF TRADE CREDITS
 Financial Motive
Seller charge a higher price when selling on
credit.
 Operating Motive
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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.

7. COST & BENEFITS OF MAINTAINING RECEIVABLES
Cost of Receivables
 Collection Costs :
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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.

8. BENEFITS OF RECEIVABLES
 Increased Sales
 Anticipated Profits
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A liberal policy can take two forms:
 Sales Extension
 Sales Retention

9. DETERMINATION THE APPROPRIATE RECEIVABLES
POLICY
Our aim is to derive a techniques which the company
can apply in order to determine an optimum credit
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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.

10. The following steps must be taken in
determining the appropriate receivables
policy:
 Credit Standards:
The term credit
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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

11. CONT…..
Here we have to find the trade-off
between benefit and cost to the firm as a whole, so
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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.

12. The following factors are considered while
deciding the credit standards:
 Collection Costs
 Investment in receivables or average collection
period
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 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

13. 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
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 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

14. ANALYSIS OF CREDIT INFORMATION
 Quantitative
i.e. ratio analysis of liquidity, profitability &
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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.

15. THE 5 C’S OF CREDIT ANALYSIS
1. Capital
 Aggregate Liquidity position
 Total Dept position
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2. Character
 Willingness to pay the debts
3. Collateral
4. Capacity
 Management capacity to run the business
 Physical Capacity
5. Condition
 Economic condition of applicant
 Industry condition in general

16. 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
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receivables.
Components of Credit Terms
 Credit Period
 Cash Discount
 Cash Discount Period
These 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.

17. COLLECTION POLICIES
The next step involved in the receivables
management is collection policies. They refer to the
procedures followed to collect accounts
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receivables after the expiry of the credit period.
Components of Collection Policies
 Degree of collection efforts
i.e. strict, lenient
The effect on receivables management of the above
degrees with example.
 Type of collection efforts
 Letters
 Telephone Calls
 Help of collection agencies
 Legal action

18. 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
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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

19. CONT…
The logic behind this approach of credit policy
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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.

20. 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
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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 requirements
Degree of dependence Discount
<25% 0%
25-50% 5%
.50% 10%

21.  Paying Habits
Payment during discount period 10%
Payment during credit period 5%
Late Payment (-)5%
 Duration of the Business
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Less than 3 years 0%
3-10 years 5%
More than 10 years 10%
 Profit Margin
If margin is less than 5% 0%
 Current Ratio
 Total debt to asset ratio
 Inventory turnover Ratio
 Qualitative Factor

22. DISCRIMINANT ANALYSIS
Discriminant Analysis is a computer based technique
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for predicting whether a new credit applicant will
prove to be good or bad credit risk.

23. SEQUENTIAL DECISION ANALYSIS
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