RECEIVABLES MANAGEMENT

Introduction

Accounts receivables refer to the dues owed by the customers for goods purchased from
the firm or services rendered by the firm in the ordinary course of business. Accounts receivable
implies futurity, i.e., cash will be received future though uncertain. Sales cannot be done for cash
alone and credit is inevitable in the modern business units, which is the basis for receivables.
Thus, the receivables arise when a firm sells its products or services on credit and does not receive
cash immediately. It is a marketing technique by granting trade credit to protect its sales from the
competitors and attract the potential customers to buy its products at favourable terms. The
customers from whom receivables have to be collected in the future are known as debtors. These
debtors constitute about one-third of current assets in Indian industrial units. Since, a substantial
amount is tied-up in this segment of current assets, a careful analysis and proper management is
very much essential. In cash sales there will not be any risk, whereas in credit sales risk is there, as
the seller receives payment later for delivery of goods affected today. In the credit business, it is
not only the uncertainty element but also depreciated value of the money, which will receive, in
the later date.

Credit management is risky and it is known as riding on a double-edged sword. If credit is

not given sales will not increase, which is allowed as a chance of bad debts. Hence, every firm has
to be careful in credit sales and credit extension. As such a prudential financial manager has to be
optimum in deciding the quantum of credit, standards and procedures as well as terms of credit.
The impact of credit business on the wealth of the firm is shown in figure 12.1.

Corporate Wealth Maximization

Financial Management

Accounts receivable
Management

Investments in Terms of
Accounts Receivables Credit
Credit
Standards

Figure 12.1 Credit impact on wealth Maximization of shareholders

12.2 Objectives of Receivables Management:

The main aim of credit management is not to maximize the sales, nor to minimize risk of bad
debts, but it is to manage its credit in such a way that sales are expanded to such an extent to
which risk remains within an acceptable limit. In order to attain the maximize the value of the
firm, it should manage its trade credit to:

(i) obtain the optimum volumes of sales for which the efficient and effective credit
management helps the firm to retain the old customers and attract new customer.

(ii) Control the cost of credit and keep it at minimum, which are associated with
trade credit in the form of administrative expenses, bad debts losses and
opportunity cost of funds tied up in receivables.

(iii) Maintain investment in debtors at an optimum level, by extending liberal credit,

sales and profits increase but increased investment in debtors also result in
increased cost and therefore, make a trade off between costs and benefits.
12.3 Issues of Receivable Management:

The management of receivables is a very critical area in the total working capital management
as it can be very costly and time-consuming activity. The efficient receivables management results
ample opportunities for a firm to achieve advantages through improvements in customer service,
cash management and reductions in costs. The management of receivables can be divided into:
(i) Credit Policy
(ii) Credit Analysis
(iii) Collection Policy

12.3.1. Credit policy: It covers the questions concerning terms of credit, credit limits, cash
discounts, etc. A business firm is not required to accept the credit policies employed by
its competitors, but the optimal credit policy cannot be determined without considering
competitors’ credit policies. A firm’s credit policy has an important influence on its
volume of sales, and thus on its profitability. Therefore, a firm should have a well
expressed and written credit policy for the purpose of attaining the efficiency in cash
flow, clarity of objectives, good customers’ relations, employee empowerment, etc.

(i) Goals of Credit policy: The following are the goals of a firm’s credit policy:

(a) Marketing Tool: Firms use credit policy as a marketing tool for increasing its sales or to
retain old customers in a competitive environment. In a growing market situation, it is
used as a marketing strategy to increase the firm’s market share.
( b) Sales Maximization: The credit policy of a firm also used for maximization of sales by
following a very lenient credit policy and would sell on credit to everyone. But in practice
the firms do not follow very loose credit policy just to maximize sales, because this
raising of sales further increases the costs. Therefore, the firm has to analyze its credit
policy in terms of both return and costs of additional sales.
(c) Pride of Relationships with Customers: The credit policy is used for sometimes as a pride to
build long-term relationships with its dealers/customers or to reward them for their loyalty.
In some occasions, the customers are not able to operate without sanctioning the credit.
Sometimes firms continue by giving credit because of past practice rather than industry
practice.

(ii) Types of Credit Policies:

The credit policy will never be balanced unless managed with all precautions. A
rider on horse if not careful will get slipped. Similarly, if the credit policy is not
carefully designed, it will end- up in losses. The credit policies are different types.

a) Liberal credit policy

b) Stringent credit policy
 c) Optimum credit policy

(a) Liberal credit policy: Under this policy, the firm is ready to sell more on credit so as to
maximize the sales. Profits will increase in liberal credit policy as a result of increased
sales. More sales by way of liberal credit policy would also give rise to bad debts and
losses there upon.

(b) Stringent credit policy: The firm is highly careful in extending credit to customers. The
financial manager through rigid standards often sacrifices profitable sales opportunities and
profits in the name of rigid and cautious credit norms. Therefore, the objective of profit
maximization is partially fulfilled.

(c) Optimum Credit Policy: Optimum Credit policy is one, which maximizes the
firm’s value. To achieve this goal the evaluation of investment in receivables should
involve the estimation of incremental operating profit; investment in receivables; estimation of the
rate of return of investment; comparison of the rate of return with the required rate of return Sales
increase by credit extension is associated with bad debt costs, because of defaulting accounts.
Though return on credit sales increases firm’s returns, simultaneously firm’s liquidity is affected
because of slow recovery of debts and at times no recovery of some of the debts

The analysis of the determination of optimum credit policy involves analysis of

opportunity cost of lost contribution and credit administration costs and bad debt losses. These two
costs behave contrary to each other. Figure 15.1 depicts the trade off between stringent and lenient
credit policy. It can be seen from the figure that as the firm moves from tight to loose credit
policy; the opportunity cost declines, but the credit administration costs and bad-debt-losses
increase. The optimum credit policy lies at a point where these two lines intersect with each other,
at which the costs of credit policy are minimum.

Trade – off

Profitability

Cost and Benefits

Liqudity

Tight Credit  Credit policy → Liberal credit

Figure 12.2 Optimum level of credit

 Thus, the ultimate objective of a business firm is wealth maximization of shareholders,
which is possible only when financial management is executed on sound lines. Accounts
receivables management is one of the critical functional areas of financial management. A
business firm may be so good in many other areas, like production, finance, marketing, etc. But,
the firm will be a failure if it fails to collect cash and it does not matter even if does not sell on
cash, provided its credit policy is sound.”

Thus, an optimum credit policy covers the following aspects:

i) Investment in receivables

ii) Terms of credit

iii) Credit Standards

(i) Investment in receivables: Financial manager has to offer certain sales on credit,
which means the credit sales is financed by the firm. Firms if rich in cash, credit extension is
desirable. If firms are not strong financially, finance has to be obtained from outside which means
inviting interest burden that goes to reduce profitability of the firm. So, financial manager has to
reduce the capital tied up on credit sales.

(ii) Terms of credit: If credit terms are not competitive it will affect sales and
consequently the shareholders’ wealth. Here terms refers to what is the price if sold for cash,
otherwise, what is the credit period and cash discount, how much percentage for how many days
are the issues. Like wise the financial manager has to decide as and when situation arises.

(iii) Credit standard

Credit standards have a bearing on sales of the firm. These standards refer to minimum
requirements for the evaluation of credit worthiness of a customer. The company may be liberal
or strict in defining the requirement in getting credit. The standards imposed by the company are
to assess the credit worthiness of customers. As long as company’s profitability is higher, it can
lower credit standards, which it would adversely, affect the sales.

Following are the effects of lowering the credit standards.

a) Rise in sales
b) Rise in collection period
c) Rise in accounts receivables
d) Rise in bad debts

e) Increase in servicing costs of accounts receivables

Illustration 12.1
Quality Ribbons limited is engaged in the manufacturing of nylon ribbons each price total
at Rs. 100/-. Variable cost per unit is Rs. 60/-, fixed cost of the company are Rs. 16 lakhs
(annually). Last year sales are 8000 units. The company is contemplating to relax credit standards
as a result expecting 10 per cent increase in sales, collection period is likely to go up from 30 to 45
days and bad debts are expected to be 2% and collection expenses to go up by Rs. 50,000/-.
Company pays a commission of 10% (not included in variable cost). After the tax the rate of
return is expected as 15% while corporate tax is 50%. Now you have to recommend, should
company relax credit standards. ?

Solution
Additional sales (Rs) 8000 X 100 = 800000
Variable cost (Rs) 8000 X 60 = 480000
Gross margin (Rs) = 320000

Other costs

Bad debts expenses 800000 X 2% = Rs. 16000

Commission 800000 X 10% = Rs. 80000
Collection expenses Rs. 50000 146000

Profit before tax 174000

Tax 50% 87,000

Profit after tax 87,000

Effects of changes
A/R collection X sales per day
A/R before changes = 30 X 80,00,000 360 = 666667
A/R after change 45 X 4,00,000 Ó 360 = 11,00,000
Increase in investment of A/R = 4,33,333
Required return of additional investment = 4,33,333 X 15% = 65,000
But profit estimated above ----> 87,000
Hence, the proposal is acceptable

(iv) Determinants of Credit Policy

The following are the factors deciding the credit.

a) Competition
b) Producers capacity
c) Buyers condition
d) Marketing techniques
e) Trade practice.

a) Competition: Competition is the important factor why seller makes credit sales.
Producers always wish, to leave the goods from the factory premises as early as
possible.

b) Producers’ capacity: The more the producers’ financial capacity the more credit
they allow to customers.
c) Buyers’ needs: Buyers do wish to get on credit even if the prices are slightly high. It
has become common habit to buy more if credit is easily available.
d) Buyers’ status: Buyers feel credit as if it a status. They buy more even though the
price is slightly higher.

e) Marketing technique: Companies use credit as a technique to maximize its sales and
push the sales, to make more turnover and thereby more profit.
f) Trade practice: Credit has become a tradition both for production and buyers. So the
practice is continued.

The following are the various steps for designing a sound credit policy.
i) evolve well-defined credit plan and program.
ii) conduct periodical trade enquiries from other customers
iii) analyze the financial statements of customers to know their financial position.
iv) conduct periodical review and up- date ratings of the existing customers.
vi) apply the tools and techniques to weed out the bad ones in letter and spirit
vii) make a credit policy with clear and unambiguous to all the concerned.
viii) keep and maintain personal contacts with the existing customers.
x) maintain the collection departments occasionally.
xi) seriously look into accounts of the long pending debtors.
xiii) train- up sales force to pay an eye on collections.
xiv) send invoices and remainders periodically.
xvii) set and re-set credit limits from time to time to customers
xviii) optimize investment in accounts receivables.
xix) establish and maintain the credit standards.

xx) minimize the cost of credit with selective customers

 12.3.2 Credit Analysis: After establishing the credit policy, the firm should conduct the credit
analysis for evaluating the capabilities of the customers. The credit analysis would broadly
divided into two steps, i.e., obtaining credit information, and analysis of credit information. It is
on the basis of credit analysis that the decision to grant credit to a customer as well as the
quantum of credit would be taken. The credit information may provide some insights about the
creditworthiness of the customer with respect to the character, capacity, capital, condition, cost
and collateral.

Besides establishing a credit policy, a firm should develop procedures for evaluating
credit applicants. The first step in the credit analysis is obtaining the credit information. The
sources of information broadly divided into internal and external. The internal source of
information is derived from the records of the firms contemplating an extension of credit. On
the other hand the information available from external sources are financial statements of the
customer, bank references, trade references credit bureau reports, etc.

In nutshell, the following are the various steps involved the credit analysis of the
customers.
i) Get the financial data and analyze them
ii) obtain the bank and trade references
iii) refer the past records of the business
iv) Take the opinion of sales personnel
v) Get the credit assessment of the CRISIL, ICRA, etc.
vi) Ask customers to supply information substantiating his credit worthiness
vii) determine the credit worthiness of the customers
viii) take a decision to grant or not to grant credit to them
x) Send goods on trial basis before establishing market relations

The company willing to grant credit would enquire about the ‘prospective debtor’
in the market and know about the inventions and plans from the speeches of the Chairman. With
the help of the credit analysis, the customers are selected
The following are the 5 elements that go into credit analysis in identifying a sound customer:
a) Capital
b) Character
c) Collateral
d) Capacity
e) Conditions
f) Past experience

a) Capital: The customers’ repayment capacity depends upon his capital adequacy. In business
one’s financial position can be assessed by checking several ratios, especially liquidity and
turnover ratios and also funds flow analysis These exercises will help to reveal the
customer’s capital sufficiency and financial position of the business.
b) Character: The customers should cooperate and have to pay the debts timely. Many a firm
do not cooperate even though they have funds. Some firms even though they have ‘will’ to
pay quickly are unable to meet due to lack of funds. Here character also plays role in
deciding the repayment capacity. Hence, the character of a customer shall be enquired and
investigated by collecting information about his earlier performance of payments or

c) Collateral: The term collateral refers to the funds obtained by showing the assets as security
if the customers failed to pay the creditors recover the credit amounts from the proceeds of
the collateral assets. If a firm has more secured financing it implies that the firm is less
creditworthy.

d) Capacity: Capacity refers to the personnel, technology and entrepreneurial abilities of a

firm. The firm’s ability and willing to pay the debts depends upon capacity. This capacity
can be understood from the recognition of the customer in the market or industry.

e) Past experience: While choosing a customer one has to look into not only the above aspects
but also his history. How he has made payments previously. There fore it is better to verify
old records, particularly when the customer asks for credit extension. Also it is desirable to
know how he has made payment to others has he involved in legal issues previously? Has he
caused troubles to others? Such enquiries and credit investigation will help in letter serving
the customers.

12.3.3 Collection Policy: The third area involved in the receivable management is collection
policies. The firm should follow a well laid down collection policy and procedure to collect dues
from its customers. The collection policies cover two aspects, i.e., the degree of effort to collect
the over dues, and type of collection efforts. The collection policies may be classified into strict
and liberal. The effects of tightening the collection policy would be to decline in sales, debts,
collection period, interest costs and increase in collection costs and whereas, the effects of a
lenient policy would be exactly the opposite.

Firms should be practical in their approach in collecting credit sales through regular
correspondence, personal calls, telephone contacts, etc. The sudden reminders will not make
the collection programs effective unless they take a follow up action and maintain personal
relations. If the collection policy is not effective the company will incur large expenses and
fail to be ‘fund - rich’. So firms should trade –off between cost of collection and bad debt
losses. A stitch in right time will save lot. The following diagram shows the relationship
between losses due to bad debts and collection expenses.

Illustration: 12.2

From the earlier example - quality ribbons are proposing 2/10 net 3 - and company
expects collection period would fall to 18 days from 10 days.
 Solution:
Loss of revenue 30,00,000 X 60/100 X 2/100 = 96,000
A/R before discount 30 X 80,00,000 / 360 = 6,66,667
A/R after discount 18 X 80,00,000 / 360 = 4,00,000
Release of investment = 2,66,667
Return on funds released = 2,66,667 X 15% = 4,00,000 (approx)
Loss of revenue (96,000) is more than
Return on such funds i.e., = 2,66,667 X 15 % = 40,000
Since, revenue loss (96,000) is more than return on such funds Rs. 40.000/-, the
Proposal is not desirable.

12.4 Costs of Credit:

When credit is sanctioned, funds get tied up in it. The main costs associated with trade credit are:
a) Default costs: All the debts will not be recovered; some of the debts are likely to
become bad debts if the credit management is in effective.
b) Delinquency cost: The firms during the recovery of bills incur costs such as legal
expenses, reminder costs, travel, recovery charges, etc. All these will cause additional
burden to the firms.
c) Collection costs: The collection department of the organization will incur expenses
such as telephone, fax, e-mail, correspondence, net charges, stationary, postage, etc.
These costs will be high and they depend upon the amount of debts.
d) Opportunity costs: The debtors delayed will not yield returns and remain as idle
investment, and thereby the firm looses profitable opportunities of re-investment in
business activities.

12.5 Credit Terms:

Another noteworthy aspect of accounts receivables management is deciding credit terms, which
include:
a) Credit period
b) Credit discount
c) Credit limit
d) Collection policy
e) Credit investigation
f) Credit insurance
 (a) Credit period: It is the period allowed by the seller to the customer to pay the bills. The
customer can take advantage and pay conveniently his bills. Here the customers are interested in
getting more credit period. But the firm has to decide optimally the period even if sales increases
proportionately, the relaxation would cost nearly the firm, as the funds will be blocked.

Illustration: 12.3.

Suppose M/s Quality ribbons limited is interested in increasing credit period from 30 to 45
days, expecting 5% rise in sales. The bad debts will be 2.5 per cent of increased sales. The
company would also incur Rs.20, 000 for collection.

Solution : Rs

Increase in sales 4,000 X 100 = 4,00,000

Increase in variable cost = 2,40,000

Increase in gross profit = 1,60,00

Less: bad debts 10,000

Collection charges 20,000

Commission 40,000 = -70,000

Profit before tax = 90,000

Tax (50%) = -45,000

Profit after tax = 45,000

Return investment of A/R = x 100

= 10.38 %
This is less than expected return hence this proposal is rejected

(b) Cash discount: Cash discounts are in the form of discount rate and discount period.
It is an incentive to the customer who pays early which many customers take advantage of
cash discounts. Rarely some firms do not utilize the opportunity due to their funds tied up and
not able to take advantage of as they have no cash balance. Of course this policy would result
in loss of revenue of it. Therefore the management has to balance the benefits and costs before
arriving a decision on cash discount.
 c) Credit limits: Credit sales decision cannot easily be made. While taking credit
decision, besides character and capacity of the customer, the supplier has to decide several
other things such as extent of credit and credit period. Some times, the supplier is asked to
extend credit amount or credit period, for which the customer will not oblige either extra price
or interest rate. Under such circumstances, the supplier has to weigh the profit out of extra
sales against costs on account of such deal. As long as he makes reasonable gain in the deal he
will say yes to extend extra credit period or credit extension.

(d) Collection procedure: Procedure to collect bills from the customers should be
such that the firm has to expedite collection, so that, they have enough funds to meet its
creditors. The firms have to adopt such collection procedures by giving cash discounts for
quick payments and price discounts for cash sales.

(e) Credit investigation: Always the accounts receivables management has to make credit
investigation by approaching personally the prospective customers and also the existing
customers. He has to collect their financial data and do the credit analysis. The firms should
not hesitate to enquirer the customers paying capacity and practices from time to time, which
is of course expensive. Every firm has to investigate about its creditors before going credit;
otherwise the firm has to face lot of difficulties.

(f) Credit Insurance: The debts are covered by credit insurance. Nationalized industries,
government departments and local authorities are considered to be risk free , hence not
included. Another method prevailing is special account policy, in this any business and any
amount is covered.

12.6 Credit control:

The following actions are more helpful to bring the management of accounts receivables
under control.

i) Prompt invoicing: Even after delivery, invoicing is made slowly. This will give
impression to the customers that invoice has not yet reached. After receiving the invoice,
he starts calculating the credit period from the day he has received the invoice. So to
quicken the collection, the suppliers should dispatch invoice immediately.

ii) Open item accounts: In many firms, ways of collections are very slow and many invoices
are turning to be bad debts due to lack of information such as which invoice in which
stage. All the amount of each invoice is not collected at one time. Practically amounts are
made partially and the payment is computed over a period of time. So for effective control
the financial manager should have information invoice-wise, product-wise, division-wise,
etc. and all these particulars be collected month-wise so that follow-up action can be
initiated.
 iii) Personal touch: A credit manager has to be in touch with the customer personally if
possible. Otherwise contact them over-phone at-least, so that the customer will be serious
and clear the pending dues. This kind of follow-up will bring the accounts receivables
under control rather than regular reminders, where the customers act mechanically.

12.7 Credit Monitoring: Accounts receivables are monitored through the following
techniques:

i) Aging schedule

ii) Balance of payments pattern

i) Aging Schedule: Aging schedule is a technique to check and regulate the accounts
receivables. According to this method, bills are listed on the basis of due dates. Then the
total sum due from debtors is divided into different age groups. The following illustration
on a hypothetical basis gives further information.

Illustration: 12.4

Comparative statement of aging schedules of account receivables for firm A and B during 2005 -
06
Firm A Firm B
Age Amount Rs. % Amount Rs. %

Billing pending 30 days 10 50 2 10

Bills pending Above 30 days 5 25 3 15

And below 3

Bills pending Above 3 months 3 15 5 25

Below 6 months

Bills pending Above 6 months 2 10 10 50

and below 1 year

Total 20 100 20 100

From the above illustration both A and B firms appear to be equally strong since both firms
claim that their A/R are same. But when their bills are wise categorized on age basis, it is
 evident that 50 % of the total A/R of firm B are kept not collected for reasons beyond the
imagination (only 25 % of the bills are 3 months only) Thus firm B, is weak and A is
strong (75 % of the bills are 3 months old) in liquidity.

ii) Balance of payments pattern: In this method out of the total sales made in month
wise payments received will be shown separately. It will reveal the extent of bills pending
and yet to be received. This will help collection departments to know how it has received
so far and how much is pending so, far and further measures can be taken for the delay in
payment if delay is made. The following hypothetical illustration will explain the method.

Illustration: 12.5 Payment conversion matrix

For analyzing the payments pattern for several months the following matrix is helpful.

Month Sale Jan Feb Mar April May Jun July Aug Sept Oct

Jan 1,00,000 10,000 40,000 30,000 20,000

Feb 80,000 21,000 28,000 22,000 9,000
Mar 1,20,000 18,000 48,000 25,000 29,000
April 1,60,000 19,500 72,500 38,000 30,000
May 2,00,000 20,000 72,000 60,000 48,000
June 1,60,000 14,500 56,000 49,00040,500

Total 10,000 61,000 76,000 1,09,5001,26,500 1,53,500 46,000 97,00040,500

Looking at the conversion matrix one can judge whether the collection is improving, stable or
deteriorating. Customers are identified as:
i) Reliable customers,
ii) Highly reliable customers,
iii) Risky customers,
iv) Highly risky customers,

12.8 Evaluating the collection department:

Evaluating collection department is a part of accounts receivables management. In this

process, evaluation may be strict or liberal the management will assess the department and it’s
functioning by using several ratios. If management is rigid, collection department will also be
strict in sanctioning credit facilities thereby firm looses futures sales. Otherwise the firm would
involve in bad debts and problems of funds shortage. As such, the experts of the financial
management that every management should be optimum in its evaluation of credit management
and be not foolish feel it.
12.9 Factoring Services:

Customers’ credit is sold to factors that take the responsibility of collecting and charge
for the service rendered. This is called Factoring. The service charges vary from firm to firm and
the extent of undertaking risk of bad debts. Factoring is not same as financial management and
controlling the accounts receivables. In UK Factors not only advance money against the invoices,
but also undertake the responsibility of collecting the debts and also provide services to their
clients.

12.9.1 Functions of Factoring

a) Finance: The supplier sends the bills to the ‘Factor’ and takes finance by paying an extra of 2
% over bank rate of interest for the period, only from the date of advance to the date of payments
by the customer. The firm will not show such finance as borrowings in their balance sheet, as this
would reduce their borrowing ability from financial institutions. Hence, they show as if the bills
are collected.

b) Risk: Factors by making finance available to their clients are taking credit risk. Factors collect
from customers according to the normal terms of the suppliers. They are not hard –faced some
popular companies do not take the services of Factors.

c) Charges of Factoring: Factoring charges 1 to 2 % for the service they extend on the invoice
value. And it varies from company to company. Factors also refuse some sectors that they do not
know about the inside knowledge of the business. In such cases they only assist in getting the bills
collected.

12.10 Summary

In this lesson, it has been discussed that receivables management is a very important area of
total working capital management. It means that an effective and efficient management of
receivables can contribute a lot for the improvement of the profitability and liquidity of a business
firm. The important dimensions of credit policy are credit terms, credit standards and collection
efforts. In general, liberal credit standards tend to push up sales accompanied by a higher
incidence of bad debt loss, a larger investment of receivables and a higher cost of collection. On
the other hand, a stiff credit policy has opposite effects. In judging the credit worthiness of an
applicant for credit, the basic factors are character, capacity and conditions. This lesson also
covers the discussion on various aspects like credit analysis, credit collection, credit control, credit
monitoring, factoring, etc. The concept of optimal credit policy is also thoroughly discussed with
illustrations. Besides, the evaluation of the credit collection department is also presented.

12.11 Key words

1. Accounts Receivable money owed by debtors or customers

2. Collection Policy it describes the procedures a firm follows in attempting to collect its
accounts receivables.

3. Credit Analysis estimation probability of default for individual customers to determine

who receives credit

4. Credit Period the time given to a buyer to make full payment for credit purchases

5. Credit Policy Norms and guidelines to determine whether and how much credit is to be
extended to a customer.

6. Credit Standards The minimum criterion for the extension of a credit to a customer.

7. Credit Terms The repayment terms extended by a firm to its debtors.

12.12. Self Assessment Questions

1. What are the objectives of Receivables Management? Discuss the importance of
credit policy
2. How do you manage credit policy in an enterprise? Discuss the effects of tight
credit policy
3. Discuss the factors that determine the credit policy of an enterprise? What are the
financial implications of liberalized credit policy?
4. Explain the cost benefit trade-off in Receivable Management
5 Define Factoring. Explain the salient features of factoring.

6. A company sells a product at Rs.40 per unit with the variable cost of Rs.20 per
unit. The total fixed costs amount to Rs.16, 25,000 per annum and the total sales are Rs
1,75,00,000. It is estimated that if the present credit facility of two months were Rs.60, 00,000
could increase double sales The company expects a return on investment of at least 75 % prior to
taxation. Should the company release the credit period?

7. A firm is considering an increase in its credit period from 40 to 60 days. It currently

sells 5,00,000 units at Rs.2 per unit. The average age of receivables is 50 days; the variable costs
per unit is Rs.15.70 and the average cost per unit is Rs.18.70.The change in the credit period is
expected to increase the sales by 3,15,000 units and the average collection period to 80 days.
Assume the required return on investment as 20%, should the firm carryout the proposal. (Assume
360 days year).

8. A company has a 15% required rate of return. It is currently selling on terms of ‘net 10’.
The credit sales of the company are Rs. 12,00,000 a year. The company’s collection period
currently is 60 days. If company offered terms of ‘2/10, net 30’ 60% of its customers will take the
discount and the collection period will be reduced to 40 days. Should the company follow the
changed credit terms?

9.A firm sells 1,40,000 units of a product per annum at Rs.155 per unit. The average cost
per unit is Rs.21.and the variable cost per unit is Rs.38. The average collection period is 65 days
and bad debt losses are 2.3% of sales and the collection charges amount to Rs.65, 000. The firm is
considering the proposal to follow a strict collection policy, which would reduce bad debt losses to
1 % of sales, average collection period to 45 days. It would however reduce sales volume by
10,000 units and increases the collection expenses to Rs.125; 000.The firm’s required rate of
return is 20%. Would you recommend the adoption of new collection policy? (Assume 360 days in
a year)