Working Capital and Cash

Management
FM 13- STRATEGIC FINANCIAL MANAGEMENT
Working capital

• the difference between the firms current asset and current liabilities.
• It is used as a measure to check the liquidity of the firm.
Example: FLT and associates has the following assets and liabilities :
FLT and Associates
Balance Sheet
December 31,2011
Assets liabilities and Stockholder Equity
Current asset Current Liabilities
Cash P20,000 Account payable P24,000
Accounts receivable 60,000 Interest payable 6,000
Inventory 84,000 P164,000 Salaries Payable 10,000 P40,000

Non- Current Asset Long- Term Liabilities

Equipment P180,000 Mortgage Payable 100,000
Investment in Bonds 72,000 252,000
Stockholders equity 276,000
Total Asset P416,000 total liabilities and Stockholder Equity P416,000
The working capital is computed as:

Current asset
Cash P20,000
Accounts receivable 60,000
Inventory 84,000 P164,000
Current liabilities
Accounts payable P24,000
Notes payable –short term 6,000
Accrued expenses payable 10,000 40,000
Working Capital P124,000
Working Capital Management
• Concerned with the efficient and effective utilization of working
capital to attain the predetermined objectives of the company relative
to profitability of operation, liquidity of financial resources, and
minimization of risk and company cost.
• Regulates various types of current assets and current liabilities.
• The goal of management is to maintain a cash level at a minimum
without putting the company at risk.
• The top management determines how much investment should be
made in current assets.
Working Capital Policies
• Matching policy- the policy works in arrangement where the current
assets of the business are used to perfectly match the current liabilities.
Total asset
fluctuating current asset
Short term Liabilities

permanent C/A long-term liabilities of equity financing

Fixed current assets

time
• Aggressive policy- has a high risk and, often, high return to company.
The purpose of adapting an aggressive policy is to take the
opportunity of having a lower interest charge for short-term liabilities
instead of long-term liabilities.
total asset

fluctuating current assets short-term liabilities

permanent current assets long-term liabilities

fixed current assets

time
• Conservative policy- has the lowest risk and lower return.

total asset
short-term liabilities

fluctuating current asset

permanent current asset long-term liabilities

fixed current asset

time
How is Working Capital Managed?
• Looking at the financial ratios. Financial ratios play a crucial role in
managing working capital.
• Putting up proper internal control. Internal control has a important
part in securing the working capital firm.
• Changing company policies. Policies serve as a guideline in executing
the transactions and activities of the company.
• Preparing the budget. Doing the budget for the entire year is a good
tool to help the company manage its working capital.
Cash Management
• Cash is a current asset used to purchase raw materials, pay for labor,
buy capital asset, and pay for dividends, taxes and obligation.
• Cash management holds on to marketable securities to avoid cash
shortage.
• Cash management is also concerned with the acceleration of cash
receipts and suspension of cash disbursement.
Reason to Maintaining Cash
• Transaction motive. This refers to the intention to meet the minimum
business operation requirement.
• Speculative motive. This leads to the use of cash balances to take
advantage of bargain purchases on material or unusual cash discount.
• Precautionary motive. This results in holding cash for unforeseen
fluctuation in cash inflows and outflows. Maintaining credit lines with
banks is usually done by firms to meet their precautionary needs. The
need for maintaining cash is reduced.
Cash equivalents
• Cash equivalents are short-term, highly liquid investments that are readily convertible to cash.
• These are investment which are so near their maturity dates, making risk inherent to the
investment insignificant.
Example:
A 90 day treasury bill
A 180 day treasury bill purchased within 90 days before its maturity
A 90 day time deposit
A 90 day commercial paper
Long-term commercial paper purchased within 90 days before its maturity
Other money market instruments whose maturity is within three months
Advantages of Holding Cash or Cash
Equivalents
• Taking advantage of the trade discount
• Maintenance of good credit rating
• Favorable business opportunities
• Meeting emergencies
• Capacity to compete
Factors affecting Cash Requirements
• firms policy on cash management. This refers to the amount of cash
firm needs to cover a certain number of days of the business
operations.
• Availability of loans. A firm with good credit standing may hold a cash
balance at low levels without putting the firm risk.
• Forecasted cash inflows and outflows. The difference are determined
by analyzing the collecting and disbursements records of the firm.
• Unpredictable events. Estimating unpredictable events may save a lot
of time and money for the firm.
Possible Placement for Excess Cash
• Savings or current accounts
• Time deposits
• Stocks
• Commercial papers
Controlling cash flows
Controlling cash flows is the main objectives of cash management. Maximizing
the use of cash means minimizing cash outflows and minimizing cash inflows.
Tools for controlling cash flows
• Synchronizing cash flows
• Cash floats
• Payments
• Collections
• Extending cash payments
• Availing of cash discount
• Optimum transaction size
Synchronizing Cash Flows
This is the process in which the cash inflows coincide with the outflows.
A synchronized cash flows is highly dependent on an accurate forecast
of inflows and outflows. A more forecast help the firm minimize its cash
balance since it can immediately determine the time when cash will
actually be needed.
Floats on disbursements
• Floats can exit when the firm issues its own check and sends it to the payee
company.
• The number of days from the issuance of the check to its clearance is known as
float days.
A float can be classified into three categories:
1. Mail float. It is the time the check is issued up to the time the check is received
by the payee.
2. Processing float. It is from the time the check is received by the payee until the
time it is deposited in the payees bank account.
3. Clearing float. It is from the date the check is deposited up to the date the
check is cleared and made available for use.
Accelerating collection of funds by reducing
collection floats
1. Collecting center or agents
Float can be reduced by strategically locating a collection center near
the customer. The collection center can be a firm providing a collection
service, or a bank where payment are made directly to the firms
account. A firm may also consider the possibility of having its own
collecting agents or collecting centers, if it is economically possible to
reduce the collection period in certain area.
Example: Cunanan Corporation has an agreement with Rizal Commercial Banking Corporation
(RCBC) to collect P3,000,000 a day in exchange for a compensating balance of P1,000,000. The firm,
with a significant increase in its customer in the area, is thinking of canceling the agreement and
dividing the service provided by RCBC with ABC bank. With this plan, RCBC will handle the collection
of P2,000,000 with a compensating balance of P800,000. On the other hand, ABC bank handle the
other P1,000,000 collection in exchange for compensating balance of P700,000. With the planned
arrangement with the two banks perform the collection, the firm is expecting to reduce the
collection period by one day. The firms rate of return is 9percent. Should Cunanan Corporation
pursue the division of service between RCBC and ABC bank?
Analysis on the problem as follows:
Amount of cash collection per day P3,000,000 Cunanan Corporation should pursue the plan
Number of days freed in the collection x 1 of dividing the service between RCBC and
Amount of cash freed P3,000,000 ABC bank. Despite the increase in
Less: increase in compensating balance 500,000 compensating balance from P1,000,000 to
Increase in cash flow P2,500,000 P1,500,000, the firm will be able to increase
Rate of return x 0.09 in cash in inflow by P2,500,000 resulting to an
Incremental income P 225,000 incremental income of P225,000 per year.
2. Lockbox system
• a lockbox system is a service whereby checks are mailed to a local PO
box address.
• The checks are picked up daily ( or even multiple times per day) by
the servicing firm.
• The checks are deposited into the local branch bank.
• The balances are electronically transferred to the firms branch of
bank, available for use immediately.
Example:

Cunanan Corporation has average cash receipts of P150,000 per day. Normally, it
takes 7days from the time the check is received for it to be made available as cash.
How much cash is tied up?

Computation shall be as follows:

Average cash receipts per day P150,000

Number of days tied up x 7
Amount of cash tied up P1,050,000
Example: Cunanan Corporation has an average of seven days to receive and deposit the checks from
customers. The owner believes that it takes too long for the firm to use the funds to support its
operations. a bank offers its service through the use of a lockbox system. The banker explains that
with the system is place, the expected float time will be reduced to 4 days. The bank charges
P10,000 per month for its overhead cost on the service. Should Cunanan Corporation avail of the
service offered by the bank? How much is the advantage or disadvantage of the lockbox system,
considering the firm average daily collection of P450,000 and the annual rate return of 12 percent in
the market?
The cost-benefit analysis is as follows:
Average cash receipts per day P 450,000
Number of days cash is freed( 7 days -4 days) x 3
Amount of cash freed-up P1,350,000
Rate of return x 12%
Expected return (benefit) P 162,000
Less: cost of the lockbox system (P10,000 x 12) 120,000
Net advantage of availing the lockbox system P 42,000

Since the net advantage is worth P42,000, the Cunanan Corporation should avail of the service
offered by the bank.
3. Concentration banking.

• It is a system decentralizing collection

• According to this system, a large number of collection centers are
established by the firm in different areas.
• System whereby customers make payments to a regional collection
center, which then transfer funds to a principal bank.
Example: a firms monthly average cash balances computed as follows:

Monthly average cash balance

1 P 25,000
2 30,000
3 40,000
4 60,000
Total P155,000
the monthly average cash balance is:
P155,000 = P38,750
4
If the annual interest rate is at 15%, the monthly return earned on the average cash balance is:
P38,750 x 0.15 x 30/360 = P484.48
Extending Cash Disbursement
Ways to Conduct Disbursement
• Playing the float. This is the process of taking advantage of the
clearing system in order to make use of funds in the firms bank
account. Playing the float reflects that the outstanding checks of the
firm not presented to the bank are more than the amount covered by
the bank balance. It is the process of writing a check with no bank
balance covering the check in the hope that in the due date of the
check there will be a balance in the bank.
• Payment by draft. A draft is an unconditional order made in writing
addressed by one person to another, signed by the person giving it,
requiring the receiver to pay on demand or at a fixed or determined
future time a certain sum of money to order or to the bearer. A draft
is issued by the debtor or the creditor. The creditor then presents the
draft to the issuers bank for collection.
• Auto-debit transfer. Is one of the services offered by the bank.
• Debit transfer. The feature of this service are practically the same
as those of auto- debit transfer.
• Stretching of payable. This is the process of extending payments
to suppliers or creditors.
• Centralization of Disbursement. Firm are able to monitor their
payment and satisfy their obligations to the optimum time.
• Use of statistics to predict the amount of check issued. By
looking the historical disbursement of the firm
Example: salary payment of XYZ Company is made every 15th and 30th of the month through
issuances of checks. It pays P5,250,000 per payroll. However, based on the historical clearing of
checks issued on salary; 50 percent will be presented on the day itself, 35 percent five days from the
salary date, and the remaining balance on the tenth day after the salary date. If the interest rate on
market is 12 percent per annum, how much is the incremental income of XYZ Company if the entire
amount is not deposited?

Incremental income from salary date to five days

from salary date (P5,250,000 x 50% x 12% x 5/360) P4,357.00
Incremental income from salary date to tenth day
From salary date (P5,250,000 x 15% x 12% x 5/360) 1,312.50
Total incremental income P5,687,50
Cost of foregoing a cash discount
• Cash discount is categorized under short-term financing.
• Cash discount is offered by suppliers of goods to the purchasers to
encourage them to make an early payment.
• A firm without fully knowing cost of discount will typically take
advantage of a discount offered by the creditor because of the
attached opportunity cost.
formula of cash discount:
Cost of Discount = Discount% x 360
100% - Discount% final due date – discount period

The trade credit is liability arising from credit sales. The seller records it as an account receive and the buyer
records it as an account payable. If the sale is 2l10, n/30, the first 10 days represents the free trade credit and
the remaining 20 days represent the costly trade credit. If the buyer does not pay during the discount period,
the buyer is obliged to pay in the 30th day. The cost of discount is computed as:

Cost of discount = 2.0% x 360 = 36.73%

100% - 2.0% 30 – 10
It can be ascertained that the cost of discount if not availed of will cost the firm 36.73%. The cost of discount
foregone declines as the net period becomes longer in relation to the discount period. Thus, if the term above
has been 2/10, n/45, the cost of discount foregone will have been:

Cost of discount = 2.0% x 360 = 21.0%

100% - 2.0% 45 – 10
When to Avail of Discount?
Ex. ABC Company is considering the discount on the credit term offered by the supplier. The term are 4/10,
n/60. At the time the term is offered, the borrowing rate in the market is 12% per annum. Should ABC
Company avail of the discount offered?

Cost of discount = 4.0% x 360 = 30.0%

100% - 4.0% 60 – 10
Since the cost of borrowing is 12% which is lower than the cost of discount forgone. ABC Company should avail
the discount. Thus, the firm may borrow the bank at the rate of 12% and pay the supplier at a discount rate.
The net advantage of the firm from the discount is 18% (30% - 12%)
Determination optimal transaction size
• William J. Baumol is the first economist to observe that the economic order quantity (EOQ)
applied to inventory management may also be integrated in the management of cash balance
where cash will be considered as a particular type of inventory.
• The cash management model recognize two types of cost relative to the level of working cash
balance.
• There are the transaction cost and the opportunity cost.
• The transaction cost are fixed cost in buying or selling the securities while the opportunity cost
refer to the interest income if marketable securities are obtained.
• The main objective of cash management model is to minimize the transaction cost and the
opportunity cost of retaining cash balances.
Relevant cost = transaction cost + opportunity cost
= FC x CR + I x MS
MS 2
Where:
MS = the amount of marketable securities sold each time the cash balance is replenished
FC = the fixed cost associated with the transaction
CR = the total cash required for the given period of time
I = the rate to return on the marketable securities

The optimum transaction size is

MS = 2(FC)(CR)
I
ex. Astra Corporation experts a cash requirement of P5,000 over a 1 month period in which cash is
expected to be paid constantly. The opportunity interest rate is 15% per annum. The transaction
with each borrowing or withdrawal is P75.

Questions:
What is the optimal transaction size?
What is the average cash balance?
What is the relevant cost of the transaction?

Answer:
Optimal transaction size: MS = 2(FC)(CR)
I
=2(P75)(P5,000)
0.15/12 =P7,746.00
Average cash balance
MS = P7,746 = P3,873
2 2

Total relevant cost

= FC x CR + I x MS
MS 2
= P75 x P5,000 + (0.15/12) x P7,746
P7,746 2
= P48.41 + 48.41
= P96.82

Decision: the entity must borrow or withdraw an amount of P7,746 every time the cash balance is
replenished. The relevant cost in this transaction size will be lowest. If the company withdraw a
bigger amount, the opportunity cost will increase faster than the decrease in transaction cost. On
the other hand if the company withdraws a smaller amount, the transaction cost will grow higher
than the opportunity cost. In both cases relevant cost will be more than P96.82
Receivable Management
Receivable represent the amount of money to be collected from
individuals or firm
Two general classes of receivables
1. Trade receivables. These refer to claims arising from the sale of
merchandise or services in the ordinary course of business
operation.
2. Non-trade receivables. These represent claims arising from sources
other than the sale of merchandise or service in the ordinary course
of business.
Factors that Affect the Size of Receivable
• Term credit. The level of account receivable depends on the length of
the term credit.
• Paying practice of the customers. Firms with customers who prolong
payments are expected to have a higher level of receivables.
• Collection policies. Firms with a lenient collection policy have higher
levels of receivable thus firms with a stricter collection policy.
• Volume of credit e sales. Firms that mostly grant sale on credit have a
higher level receivable.
Accounts Receivable Management
• Account receivable management incorporates is all about ensuring
that customers pay their invoices. Good receivable management
helps prevent overdue payment or non- payment. It is therefore a
quick and effective way to strengthen the company's financial or
liquidity position.
Trade credit. The granting of trade credit is a consideration that has to be a well
studied. Firms grant credits in order to increase the sale volume.
Ex. GUM Corporation sells on tem of net/30. on the average, its accounts are 30 days past due.
Annual credit sales are P150,000. what is the average accounts receivable?
answer: 60 x P150,000 =25,000
360
The P25,000 represent the average accounts receivable and not the investment itself. The
computed amount is based on sales incurred and not on the initial cost outlay of the firm.

Ex. The cost of a given product is 45% of the selling price and carrying cost is 10% of the selling
price. On the average, accounts are paid 60days subsequent to the date of sale. The sale average is
P120,000 per month. What is the investment on receivable?
Answer: account receivable
2months x P12,000 = P240,000
investment on receivable
P240,000 x (0.45 + 0.10) = P132,000
The amount of P132,000 represent the cost of investment made on the accounts receivable being
the initial cost outlay made by firm.
Ex. A company has accounts receivable of P900,000. the average manufacturing cost is 45% of the
sales price. The before- tax profit margin is 12%. The carrying cost of inventory is 5% of the selling
price. The sales commission is 10%. What is the investment in the accounts receivable?
Answer:
Manufacturing cost (P900,000 x 45%) P405,000
Carrying cost (P900,000 x 5%) 45,000
Sales commission(P900,000 x 10%) 90,000
Investment in accounts receivable P540,000

ex. IFJKL Company's credit sales are P180,000, the collection period is 90 days, and the cost is 75%
of the sales price, what is the average accounts receivable balance and the average in accounts
receivable?
Answer:
average accounts receivable = P180,000/360 x90days= P45,000
Investment in A/R = 45,000 x 0.75 = P33,750
Firm invest in accounts receivable through trade credits for the
following purposes:

1. To increase the current sales volume.

2. To retain current sales

Possible cost to be expected by the company:
• bad debt expenses – are accounts receivable with the possibility of
non-collection by the firm selling goods or service.
Ex: FLT Company has a current sale of P12,000,000 with bad debt expenses at 5% of sales. The
owner, desiring to increase profit, decided to grant trade credit to increase the firms current sales.
The expected sales upon implementation is P20,000,000. with the granting of trade credit, the bad
debt expenses is also expected to increase by 3%. If the firms variable cost is 60%of sales, how
much is the advantage or disadvantage of granting trade credit?

Current sale expected sale difference

Sales P12,000,000 P 20,000,000 P 8,000,000
Less: variable cost 60% (7,200,000) (12,000,000) (4,800,000)
Contribution margin P 4,800,000 P 8,000,000 P 3,200,000
Less: bad debt expense (600,000) (1,600,000) (1,000,000)
Net income P4,200,000 P6,400,000 P 2,200,000
• Variable and fixed cost. As sale increase, variable also increase.
Example:
FLT current sales volume is P10,000 units. The firm is planning to increase its sales by granting a
trade credit. Once implemented, the firm is expected to increase its sales by 5,000 units. The
normal capacity of the firm is P12,000 units, of which the fixed cost is P250,000. Any production in
excess of the normal capacity of the firm would result in an additional cost of P5 per unit. The bad
debt expense rate is at 5%and 9% for sale units of 10,000 and 15,000, respectively. If the variable
cost is 70%, what is the advantage or disadvantage of increasing the sale to 15,000 units?
current sale expected sale difference
Sales P1,100,000 P1,650,000 P550,000
Less: variable cost (770,000) (1,155,000) (385,000)
Contribution margin P 330,000 P 495,000 P 165,000
Less: bad debt expense (55,000) (148,500) (93,500)
Additional fixed cost (15,000) (15,000)
Net income P 275,000 P 331,500 P 56,500
• Cost of capital. As the level of accounts receivable rises, the cost of
funds invested in the accounts receivable also increase. The concept
of cost of capital in the accounts receivable is the same as the concept
of placing money in a special time deposit. If P1,000,000 will earn
12% per annum, it becomes the benchmark in other investment
activities. Less than 12% return is no longer acceptable. Another
example is when granting trade credit, the accounts receivable
together with inventory will increase in order to meet the increase in
sales. Thus, the firm needs additional financing with cost of capital
equivalent to 15%. For this increased accounts receivable and
inventory acceptable , and incremental to 15% is necessary. Thus, if
the combined increase in accounts receivable and inventory is
equivalent to P100,000, the incremental income should at least be
P15,000.
• Cash discount. Is normally given to entice prompt payment of
obligation.
Ex. Riverbank gave the following data for analysis:
Annual current sales on credit P15,000,000
Collection period 2months
Terms net/30
Rate of return 15%

Riverbank proposes to offer a 3/10, net/discount. The corporation anticipates 25% of its customer
will take advantage of the discount. As a result of the discount policy, the collection period will
decline to 1 ½ months. Should riverbank offer the new term?

Collection period reduced by (60-45) = 15days

Reduction in accounts receivable is: P15,000,000 x 15 = P625,000
360
Expected return (625,000 x 0.15) P93,750
Cost of discount (0.25 x 15,000,000 x 0.03) 112,500
Disadvantage of discount policy P(18,750)
Components of a credit policy
• Term credit
1. Credit period is length of time in which the credit sales are allowed.
Ex. FLT company sold goods amounting to P50,000 to SGT. Term: n/30.
The term n/30 means net of 30 days. The obligation od SGT amounting to P50,000 without a
discount will be paid on the 30th day.
2. Cash discount are given to customers to entice prompt payment.
Ex. FLT company sold P100,000 worth of goods to SGT. The transaction has the following. Term: 2/10,
n/30

The credit term 2/10, n/30 means that the customer is given a 2% cash discount if the obligation is
paid on the 10th day from the invoice date. The amount to be paid by SGT will be P98,000 (P100,000
– [P100,000 x 0.02]). If SGT foregoes the discount, the entire amount of P100,000 will bw paid on the
30th day.
Relaxing term credit
Minimum required = incremental income
rate return incremental working capital requirement

Ex: the current sales volume of FLT traders is P100,000 units per annum. Other data are as follow:
Units selling price P50
Unit variable cost and expenses 30
Fixed cost and expense P1,200,000
Gross profit rate 30%
Term of sales n/30

An increase in sale of 25% is expected if the credit increase to 44 days. Bad debts expenses is
expected to increase by 2% of increase sales. The minimum desired rate of return is 20%. Income
tax is 32%. Inventory is maintained at a level equivalent to 30 days sales. FLT traders uses 360 days
in a year.
Answer:

Incremental net income

current proposed increment
Sale (100,000 x P50) P5,000,000
(100,000 x 125% x P50) P6,250,000 P1,250,000
Less: variable cost
(100,000 x P30) P3,000,000
(100,000 x 125% x P30) P3,750,000 P750,000
bad debts (100,000 x P50 x 125% x 2%) - 125,000 125,000
total variable cost and bad debts 3,000,000 3,875,000 875,000
Contribution margin P2,000,000 P2,375,000 P 375,000
Less: fixed cost 1,200,000 1,200,000 -
Net income P800,000 P1,175,000 P375,000
Incremental working capital requirement
Increase in account receivable: proposal sale (P6,250,000 x 45/360) P 781,250
current (P5,000,000 x 30/360) 416,667
P 364,583

Increase in inventory: proposed (P6,250,000 x70% x 30/360) P364,583

current (P5,000,000 x 70%x 30/360) 291,667
72,916
Total increase: P437,499

Rate return = incremental net income = P375,000

incremental working P437,499
capital
Since the rate of return on the proposed relaxing of the term credit is 85.71% which is greater than the
minimum required rate of return of 20%, then the proposed relaxing is acceptable.
Shortening credit period with discount offering

Ex. AZX Corporation provides the following data:

Current annual credit sale P15,000,000
Collection period 3months
Terms net/60
Rate of return 10%

AZX Corporation propose to offer a 2/10, net/30 discount. The corporation anticipates 20% of its
customer will take advantage of discount. As a result of the discount policy, the collection period
will decline to two months. Should AZX Corporation offer the new term?

The discount policy is advantageous, as indicated below:

Current accounts receivable balance
(P15,000,000 x 3months) = P3,750,000
12 months
Less: proposed accounts receivable balance after policy change.
(P15,000,000 x 2months)
12months P2,500,000
Reduction in average accounts receivable P1,250,000
Multiply by the rate return x 0.20
Return on decreased accounts receivable P 250,000
Cost of discount (0.20 x P15,000,000 x 0.20) P 60,000
Advantage of discount policy (P250,000 – P60,000) P 190,000
• Credit standard
Credit standards are guidelines followed by the company in giving credit sales to
customers. It refers to the financial strength and credit worthiness a customer must
exhibit in order to quality for credit. If a customers does not qualify for the regular
term credit, he or she can still purchase from the firm under a more restrictive
term.
Ex:
a firms regular term credit might call for payment after 30days, and this term
might be extended to all qualified customer.
Credit standards Five C’s of credit
1. Character . This refers to the moral and ethical quality of the
individual who is responsible for paying loan.
2. Capacity. It is the applicants ability to pay off the credit extended.
3. Capital. It is the level financial resources available to the company
seeking the loan.
4. Condition. These are the general and industry- specific economic
sates
5. Collateral. It consist of asset pledged by the customer
Source of credit information
1. Financial statement. It is not unethical for companies to ask for the
customers financial statement, especially if they are not too familiar
with the customers company.
2. Credit- rating agencies. These credit agencies sell information to
subscribes containing the credit performance of many companies
from different industries.
3. Commercial banks.
4. Trade checking. Trade checking could be done by asking the
prospective customer their list of suppliers.
• Collection policy
o Collection policy refers to the guidelines on handling receivables in terms of
monitoring and collection
o The collection process is expensive
o Changing the collection policy affects the sales, the collection period, and the bad
debts losses.
o Implementing a change in collection policy a carefully designed system should be
established. It must ensure that the benefits of implementing the system are not
overshadowed by cost
Evaluation receivable management

I. Ratio on accounts receivable to net credit sales. This is used

as a determinant to see if the company is too lenient or too strict in
implementing its credit and collection policies.
II. Receivable turnover. This formula tells how fast the accounts
receivable are converted into cash.
III. Average collection period. It refers to the number of days of
sales in the accounts receivable.
Average collection period = average accounts receivable x 360days
net credit sales or
= 360days
accounts receivable turnover
IV. Aging of accounts receivable. The aging of the accounts receivable is one way of
identifying clients who are paying their obligation within the prescribed credit
term. This monitoring technique use a schedule that indicates the percentages of
the total accounts receivable balance that have been outstanding for a specified
period of time. The accounts receivable are ages accordingly and are properly
classified into either “not due “ or “past due”
The classification are:
a. 1 to 30days
b. 31 to 60days
c. 61 to 90days
d. 91 to 120days
e. 121 to 180days
f. 181 to 360days
g. More than one year
h. Bankrupt or under litigation
Aging schedules cannot be constructed from the data presented in the financial
statement.
 illustration 1
Aging schedules of FLT and TGS Corporation

Aging schedules
December 31,2014
FLT CORPORATION TGS CORPORATION
Age of accounts(days) value of amount % of total value value of amount % of total value
0-10 600,000 60% 375,000 37,50%
11-30 400,000 40% 225,000 22.50%
31-45 0 0 125,000 12.50%
46-60 0 0 175,000 17.50%
Over 60 0 0 100,000 10.00%
Total receivable 1,000,000 100% 1,000,000 100%
Illustration 2
Aging the schedule of UMB Company

UMB Company
Aging schedule
December 31,2014
Age of accounts amounts percentage of amount due
0-30 120,000 37.85%
31-60 60,000 18.93
61-90 75,000 23.66
91-120 12,000 3.79
121-180 50,000 15.77
Total receivable 317,000 100%
Desired level of receivable
Receivable = net credit sales x required collection period
360
Ex:
FLI Company would like to maintain a balance of 150,000 in its accounts
receivable account. If the company has a credit sales 3,500,000 a year,
what should be the required collection period of FLI be?

150,000 = 3,500,000 x required collection period

360
Required collection period = P 150,000
P3,500,000
360
=15.43 days