Description
It takes examples of HUL and ITC as cases to explain the concepts.It covers collection and credit policies,credit terms,credit credit period,discounts,risk,collection policy,credit check
Accounts Receivable Management
Hindustan Unilever Ltd. vs. Indian Tobacco Corporation Ltd.
Vs.
Accounts Receivable Management: HUL vs. ITC Ltd.
Contents
S. no. Topics Page no.
1.
Comparative Financial Ratio Analysis of HUL and ITC
3
Accounts receivable management 2. ? Collection and credit policies ? Analyzing the credit applicant
5 5 14
3.
Account Receivable Management- ITC
17
4.
Account Receivable Management- HUL
19
5.
Accounts Receivable Management - HUL vs. ITC
23
Page 2
Accounts Receivable Management: HUL vs. ITC Ltd.
COMPARATIVE FINANCIAL RATIO ANALYSIS OF HUL & ITC (2008-09)
For the purpose of financial analysis it would be best to compare the ratios of the two companies and draw conclusions on the liquidity, debt conditions, operating efficiency and profitability.
Ratios 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Current ratio Acid test ratio Debt to equity Debt to total assets ratio Long term debt to total capitalization Interest coverage ratio Inventory turnover ratio Inventory turnover in days Debtors turnover ratio Debtor turnover in days Creditors turnover ratio Creditors turnover in days Operating cycle Cash cycle Total asset turnover ratio Gross profit margin Net profit margin Return on assets Return on equity Return on investment (Du Pont) Return on Equity (Du Pont) HUL 0.87 0.52 0.203 0.050 0.060 566.5 6.90 65 days 36.39 12 days 3.49 104 days 78 days -26 days 2.368 14.8% 12.1% 28.8% 116.74% 28.8% 116.7% ITC 2.09 1.141 0.013 0.009 0.001 121.8 2.35 155 days 20.32 18 days 3.31 110 days 173 days 63 days 0.810 29.6% 19.9% 16.6% 23.94% 16.6% 23.9%
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Accounts Receivable Management: HUL vs. ITC Ltd.
1. ITC has a current ratio of around 2.09 hence it is supposed have a better short term financial position comparatively. It may be because of ITC diversifying into the new areas over the past few years. 2. ITC’s acid quick ratio shows that it has better ability to satisfy its current liabilities. This shows that ITC Ltd. has been stocking fewer inventories as compared to HUL Ltd. 3. ITC having a lower debt to equity ratio is in a more favorable position in comparison to HUL. As ITC has lower financial leverage in relies lesser on borrowings from creditors. In case of HUL, 20% of the company's finance is provided by the creditors, whereas, in the case of ITC 1.3% of the company's finance is provided by the creditors. 4. ITC having a lower debt to total asset ratio in comparison to HUL is in a more favorable position. ITC performs its operations with comparatively lower financial risk. It indicates that ITC Ltd. has more assets than debts as compared to HUL Ltd. 5. ITC having a lower long term debt to total capitalization ratio is operating at a comparatively lower risk level. 6. Interest coverage ratio of HUL is much higher than ITC which means it has very low debt. ITC is more dependent on debt for services as compared to ITC. 7. Inventory turnover ratio and in days measures short term sales potential. Higher ratio indicates problem with sales forecasts. Lower ratio than the industry norms indicate loss of sales due to firm’s inability to fulfill demand. HUL turns over more number of receivables in a year. HUL is more successful in collecting back its receivables. 8. Higher debtor’s turnover ratio shows that HUL turns over more number of receivables in a year. Debtor turnover in days shows that HUL is more successful in collecting back its receivables. It shows better quality of debtors and that that debts are being collected very quickly. 9. Creditor turnover in ratio and in days shows that both ITC and HUL are managing their working capital really well. 10. HUL has a lower operating cycle and a negative cash cycle so it is more profitable than ITC. 11. High Total asset turnover ratio of HUL indicates that the firm is efficiently utilizing its total assets to generate sales. 12. When we compare the gross profit ratio of the two companies we find that ITC margins are significantly above that of HUL indicating it’s relatively more effective at producing and selling products than the latter. 13. On comparing the net profit margins of the two companies we find that net profit margins of ITC are larger than HUL. This indicates that ITC is having a higher relative level of Sales Profitability than HUL. 14. HUL has a higher ROA and ROE than ITC. A higher ROA means more efficient utilization of assets while higher ROE shows HUL has allocated capital in a more effective manner. Page 4
Accounts Receivable Management: HUL vs. ITC Ltd.
ACCOUNTS RECEIVABLE MANAGEMENT
? ? Accounts Receivable is the amount of money owed to a firm by customers who have bought goods and services on credit. It is a current asset and is also called receivables. Factors influencing accounts receivables 1. economic conditions 2. product pricing 3. product quality 4. firms credit policies The first 3 factors are beyond the control of the financial manager. The manager can vary the levels of receivables in keeping with the trade off between profitability and risk. ? Credit and collection policy variables include 1. Quality of the trade accounts accepted 2. Length of the credit period 3. The cash discount for early payment 4. Collection program of the firm ? Together the above mentioned factors determine 1. Average collection period 2. Ratio of bad debts to credit sales
CREDIT STANDARDS
? ? ? It is the minimum quality of credit worthiness of a credit applicant that is acceptable to the firm. Credit influences the demand for a firm’s product. Lowering of credit standard should be done as long as the profitability of sales generated exceeds the added costs of the receivables.
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Accounts Receivable Management: HUL vs. ITC Ltd.
? Added costs include 1. Enlarged credit departments 2. Checking additional accounts 3. Servicing the added volume of receivables 4. Increased probability of bad debt losses 5. Opportunity cost ? Additional receivables results from 1. Increased sales 2. A longer average collection period ? Disadvantages of relaxing credit standards 1. If the new customers are attracted by the relaxed credit standards, collecting from new less creditworthy customers is likely to be slower. 2. Existing customers will be less careful in paying their bills on time. ? An example of the Trade off
CREDIT STANDARDS CHANGE (profitability vs. required return)
Let us take a hypothetical example to assess the profitability of a more liberal extension of credit. This information reduces our evaluation to a tradeoff between the added expected profitability on the additional sales and the opportunity cost of the increased investment in receivables. The increased investment arises solely from new, slower paying customers. An optimal policy would involve extending credit more liberally until the marginal profitability on the additional sales equals the required return on the additional investment in receivables necessary to generate those sales. However, as we do this, we also increase the risk of the firm, which manifest it in additional bad debt losses. Here, as profitability on additional sales far exceeds the required return on additional investments, the firm would be well advised to relax its credit standards.
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Accounts Receivable Management: HUL vs. ITC Ltd.
CREDIT TERMS
? ? Credit terms specify the length of time over which credit is extended to a customer and the discount, if any, given for early payment. E.g. “2/10, net 30” implies that 2 % discount is given if the bill is paid within 10 days of the invoice date. If discount is not taken, the full payment is due by 30th day from the invoice date. Credit terms include:
?
1. Credit period 2. Cash discount period and cash discount 3. Seasonal datings
CREDIT PERIOD
? ? Credit period is the total length of time over which credit is extended to a customer to pay a bill. Credit period change (profitability vs. required return): Let us say the firm in our example changes its terms from “net 30” to “net 60” thus increasing its credit period from 30 days to 60 days. More liberal credit period results in increase in sales. The total additional receivables are composed of two parts. 1. Receivables associated with increase in sales: Additional sales (Rs) 3,60,000 Receivable turnover ratio 6 Additional receivables (Rs) = 3,60,000/6 = 60,000 Investment (Rs) = 0.8 x 60,000 = 48,000 2. Slowing in collections associated with sales to original customers Original sales (Rs) Original turnover Original Receivables (before the credit period change) (Rs) New turnover New receivables (Rs) Investment in additional receivables (Rs) 24,00,000 12 24,00,000/12 = 2,00,000 6 24,00,000/6 = 4,00,000 = 4,00,000 – 2,00,000 = 2,00,000
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Accounts Receivable Management: HUL vs. ITC Ltd.
Hence there is Rs. 2, 00,000 in additional receivables associated with the sales to original customers. The incremental receivables would have been collected in cash had it not been for the change in credit period. Therefore, the firm must increase its investment in receivable by 2, 00,000. Profitability of additional sales (Rs) = 2x 36,000 = 72,000 Total investment in additional receivables (Rs) =48,000 + 2,00,000 = 2,48,000 Required return on investment (Rs) =0.2 x 2,48,00 = 49,600 The profitability on the additional sales exceeds the required return on the investment in additional receivables. Hence the change in credit period from 30 to 60 days is worthwhile. The profitability on the additional sales more than offsets the opportunity cost associated with the added investment in receivables. The bulk of this added investment comes from existing customers slowing their payments.
CASH DISCOUNT PERIOD AND CASH DISCOUNT
? ? ? ? Cash discount period the period of time during which cash discount can be taken for early payment. Cash discount is a percent reduction in sales or purchase price allowed for early payment of invoices. Varying the cash discount involves an attempt to speed up the payment of receivables. Cash discount change (cost vs. savings)
Assume that the sales term of a firm is “net 45”, without discount. By initiating terms of “2/10, net 45”, the average collection period can be reduced to one month, as 60% of the customers take advantage of 2% discount. Annual credit sales (Rs) Old receivable turnover Receivables before cash discount (Rs) New receivable turnover Receivable associated with cash discounts (Rs) Reduction of investment in accounts receivable (Rs) Cash discount Percentage taking discount Cost of cash discount change (Rs) Opportunity savings on reduction of receivables (Rs) 30,00,000 6 30,00,000/6 = 5,00,000 12 30,00,000/12= 2,50,000 5,00,000-2,50,000= 2,50,000 2% 60% 0.02 x 0.60 x 30,00,000 = 36,000 0.20 x 2,50,000 = 50,000
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Accounts Receivable Management: HUL vs. ITC Ltd.
Since opportunity savings arising from the speedup in collection is greater than the cost of the discount, the firm should adopt a 2% discount. If speed up in collections had not resulted in sufficient opportunity savings to offset the cost of the cash discount, the discount policy would not be changed. It is possible that discount other than 2 % may result in an even greater difference between the opportunity saving and the cost of the discount.
SEASONAL DATING
? ? ? ? ? Credit terms that encourage the buyer of seasonal products to take delivery before the peak sales period and to defer payment until after the peak sales period. During periods of slack sales, firms will sometimes sell to customers without requiring payment for some time to come. It may stimulate demand from customers who cannot pay until later in the season. It can also used to avoid inventory carrying costs Profitability of additional sales should be compared with the require return on additional investment in receivables to determine whether datings are appropriate terms by which to stimulate demand.
DEFAULT RISK
? ? ? ? Optimum credit standard policy is not necessarily the one that minimizes bad debt losses. Firm is not only concerned with Optimal policy provides the greatest incremental benefit. Credit policy changes (profitability vs. required return) The present credit policy along with two, increasingly more liberal, new ones are expected to produce the following results Present policy 24,00,000 Policy A 30,00,000 6,00,000 Policy B 3,300,000 3,00,000
Credit sales Incremental sales Default loses a. original sales b. incremental sales Average collection period a. original sales b. incremental sales
2% 10% 1 month 2 months 3 months Page 9 18%
Accounts Receivable Management: HUL vs. ITC Ltd.
Policy A Profitability of additional sales = 0.20 x 6,00,000 =1,20,000 Additional bad debt losses =0.10 x 6,00,000 =60,000 Additional receivables = 6,00,000/6 =1,00,000 Investment in additional =0.80 x 1,00,000 receivables =80,000 Required return on additional =0.20 x 80,000 investment =16,000 Additional bad debt losses + =76,000 additional required return Incremental profitability =1,20,000 -76,000 =44,000
Policy B = 0.20 x 3,00,000 =60,000 = 0.18 x 3,00,000 =54,000 =3,00,000/4 =75,000 =0.80 x 75,000 =60,000 =0.20 x60,000 =12,000 =66,000 =60,000-66,000 =(6,000)
The marginal benefit is positive in moving from the present policy to policy A but negative in going from policy A to policy B. The optimal profit is one that provides greatest incremental benefit.
COLLECTION POLICY AND PROCEDURE:
The firm determines its overall collection policy by the combination of collection procedures it undertakes. These procedures include such things as letters, faxes, phone calls, personal visits and legal action. One of the principal policy variables is the amount of money spent on collection procedures. Within a range, the greater the relative amount expended the lower proportion of bad-debt losses, and the shorter the average collection period, all other things being same. The relationships are not linear. Initial collection expenditure is likely to cause little reduction in bad-debts. Additional expenditure begin to have significant effect upto a point – then they tend to have little effect in the further reducing these losses. This relationship between collection expenditure and bad debts are shown in the figure.
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Accounts Receivable Management: HUL vs. ITC Ltd.
BAD-DEBT LOSSES
Saturation point
COLLECTION EXPENDITURE Because the receivable is only as good as the likelihood that it will be paid, a firm cannot afford to wait too long before initiating collection procedure. On the other hand, if it initiates the procedure too soon, it may anger reasonably good customers who, for some reason, fail to make payment by the due date.
C OMMONLY
PRACTICED PROCEDURE OF RECEIVABLE COLLECTION :
Telephone call asking why payment is not made
Letter is sent followed by additional letter with more serious note
Phone call or letter from cos. attorney may be neccessary
Collection personal visit customer about overdue account
If all else fails, account can be turned over to a collection agency who charge nearly half amount of recievables
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Accounts Receivable Management: HUL vs. ITC Ltd.
CREDIT AND COLLECTION POLICY
The credit and collection policy of a firm involves several decisions: 1. The quality of accounts accepted 2. The length of the credit period 3. The size of the cash discount allowed 4. Any special terms, such as seasonal datings 5. The level of collection expenditure. In each case, the decision should involve a comparison of possible gains from a change in policy with the cost of the change. Optimal credit and collection policies would be those that in the marginal gain equaling the marginal cost. To maximize profits arising from credit and collection policies, the firm should vary those that resulted in these policies jointly until it achieves an optimal solution. That solution determines the best combination of credit standards, credit period, cash discount policy, special terms, and level of collection expenditure. For most policy variables, profit increase at a decreasing rate up to a point and then decrease as the policy is varied from no effort to an extreme efforts. Following figures shows the relation this relationship with the quality of accounts rejected.
QUALITY OF ACCOUNTS REJECTED When there was no credit standards (i.e. when all the credit applicants were accepted), sales are maximized, but they are offset by large bad debt losses as well as by opportunity cost of carrying very large receivables portion. As the credit standards are initiated and the applicants rejected the revenue from the sales declines, but so do the average collection period and the bad debts. Because the last two decline initially at a faster rate than sales, profit increases. As the credit standards are increasingly tightened, sales revenue declines at an increasing rate.
SALES
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Accounts Receivable Management: HUL vs. ITC Ltd.
AVG. COLLECTION PERIOD
QUALITY OF ACCOUNTS REJECTED BAD DEBT LOSSES QUALITY OF ACCOUNTS REJECTED At the same time, the average collection period and bad debt losses decrease at a decreasing rate. Fewer and fewer bad credit risks are eliminated. PROFITS
X
QUALITY OF ACCOUNTS REJECTED Because of the combination of these influences, total profits of the firm increase at a diminishing rate with stricter standards up to a point, after which the decline. The optimal policy with respect Page 13
Accounts Receivable Management: HUL vs. ITC Ltd.
to credit standards is represented by X in the figure. In turn, this policy determines the level of accounts receivable held by the firm.
ANALYZING THE CREDIT APPLICANT
Having established the terms of sale to be offered, the firm must evaluate individual credit applicants and consider the possibilities of a bad debt or slow payment. The credit evaluation involves three related steps: 1. Obtaining information on the applicant. 2. Analyzing this information to determine the applicant’s creditworthiness.
3. Making credit decisions.
SOURCES OF INFORMATION:
It is to be noticed that sometimes the cost of these information may outweigh the potential profitability of the account. The firm extending credit may have to be satisfied with limited amount information on which to base a decision. In addition to cost, the firm should also consider the time it takes to investigate a credit applicant. Thus the amount of information collected need to be considered in relation to the time and expense required. Depending on these considerations, the credit analyst may use one or more of the following sources of information. ? FINANCIAL STATEMENTS: At the time of the prospective sale, the seller may request the financial statement which one of the desirable sources of information for credit analysis. Frequently there is a correlation between a company’s refusal to provide statements and a weak financial position. Audited statements are preferred.
CREDIT RATING AND REPORTS:
?
?
Credit rating is a published ranking, based on detailed financial analysis by a credit bureau, of one's financial history, specifically as it relates to one's ability to meet debt obligations. The highest rating is usually AAA, and the lowest is D. Credit reports is a report containing detailed information on a person's credit history, including identifying information, credit accounts and loans, bankruptcies and late payments, and recent inquiries. It can be obtained by prospective lenders with the borrower's permission, to determine his or her creditworthiness BANK CHECKING: Another source of credit information for credit analyst checking on the particular firm is the firm’s bank. Most banks have credit departments that will provide information on their commercial customers as a service to those customers seeking to acquire trade credits (credit granted from one business to another). By calling or writing Page 14
Accounts Receivable Management: HUL vs. ITC Ltd.
to a bank in which the credit applicant has an account, the analyst can obtain information, such as average cash balance carried, loan accommodations, experience and sometimes more extensive financial information. TRADE CHECKING: Credit information is frequently exchanged among companies selling to the same customers. Through various credit organizations, credit people in a particular area become a closely knit group. A company can ask others suppliers about their own experience with an account. THE COMPANY’S OWN EXPERIENCE: A study of the promptness of past payments, including any seasonal patterns, is very useful. Frequently, the credit department will make written assessments of the quality of the management of a company to whom credit may be extended. The assessments are very important, for they pertain to the original “three Cs” of credit analysis: ? Character - creditor’s willingness to honour obligation ? Capacity – creditor’s ability to generate cash to meet obligations ? Capital – creditor’s net worth and the relationship net worth to debt.
?
?
CREDIT ANALYSIS
Having collected credit information, the firm must make a credit analysis of the applicant. In practice the collection of information and its analysis is closely related. If, on the basis of initial credit information, a large account appears to be relatively risky, the credit analyst will obtain further information. In addition to analyzing financial statements, the credit analyst will consider the characters of the company and its management, the financial strength of the firm, and various other matters. Then the analyst attempts to determine the ability of the applicant to service credit and the probability of an applicant are not paying on time and of a bad-debt loss. On the basis of this information, together with the information about the profit margin on the product or service being sold a decision is reached on whether or not to extend credit. (SIP next page) CREDIT-SCORING SYSTEM: A system used to decide whether to grant credit by assigning numerical score to various characteristics related to credit worthiness. Numerical ratings systems are also being used by some companies extending trade credit. With the overall growth of trade credit, a number of companies are finding it worthwhile to identify clearly unacceptable and acceptable applicants.
CREDIT DECISION AND LINE OF CREDIT
Once the credit analyst has marshaled the necessary evidence and analyzed it, a decision must be reached about the disposition of the account. In an initial sale, the first decision to be made is whether or not to ship the good and extend credit. If repeat sales are likely, the company will
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Accounts Receivable Management: HUL vs. ITC Ltd.
probably want to establish procedure so that it does not have to fully evaluate the extension of the credit each time an order is received. One line of streamlining the procedure is to establish a line of credit for an account. A line of credit is a maximum limit on the amount the firm will permit to be owed at any one time. Purchaser can buy on credit up to that limit. In essence, it represents the maximum risk exposure that the firm will allow itself to undergo for an account. The entire credit/collection function can be outsourced i.e., subcontracted to an outside firm. As with the outsourcing of any business function, its often comes down to a question of core competence. Where such internal competence does not exist or is inefficient, the decision – even for large companies – may be to buy the service on the outside. For small and medium sized companies, credit and collections may simply prove to be too costly to do on one’s own.
SEQUENTIAL INVESTIGATION PROCESS:
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Accounts Receivable Management: HUL vs. ITC Ltd.
ACCOUNT RECEIVABLE MANAGEMENT- ITC
The credit policy adopted by ITC recovers their debtor amount by 18 days in 2009 and 22 days in 2008. The year end debtor balance against net sales is 803.58 Cr. in 2009 and 879.42 Cr. in 2008 which is expressed in terms of ratio as 1:20.32 in 2009 and 1:16.66 in 2008.
Recievable Turnover Ratio
50 R a t i o 40 30 20 10 0 2008 2009 YEAR Industry Average 16.66 20.32 Recievable Turnover Ratio 44.6
The above information indicates that credit policy is effectively being implemented. It helps in generating cash by reducing 4 days, so the company is benefited by 4 days w.r.t. the interest cost and this will help the company to invest this capital in working process.
Recievable Turnover in Days
25 20 D 15 A Y 10 S 5 0 2008 2009 YEAR Industry Average 22 18 14.54
Recievable Turnover in Days
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Accounts Receivable Management: HUL vs. ITC Ltd.
But when compared to the industrial average for receivable turnover ratio and receivable turnover in days, it found that both, the turnover ratio and turnover in days, for the company is much below. Hence the company has great scope to improve their credit policy. The percentage default of debtor is denominated by bad debts in the company. The bad debt incurred by company in 2009 was 8.67 Cr. and in 2008 was 7.32 Cr. Also when taking out percentage bad debt to total debt we found that it was 1.07% in 2009 and 0.8% in 2008. This shows increasing trend for bad debts which is not a good sign for the company. Moreover the Provision for Bad Debt made by the company for 2009 was 48.06 Cr and for 2008 was 42.41 Cr. Hence it can be said that the increase in bad debts of the company has made them increase the provision for bad debts in 2009.
Bad Debt
9 8.5 8 7.5 7 6.5 2008 2009 Bad Debt
% Bad Debt - Total Debt
1.2 1 0.8 0.6 0.4 0.2 0 2008 2009 % Bad Debt - Total Debt 0.8 1.07
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Accounts Receivable Management: HUL vs. ITC Ltd.
ACCOUNT RECEIVABLE MANAGEMENT- HUL
We can see an increasing trend in account receivable in case of HUL, the company is also incurring higher bad debt over the last 3 financial years, although increased account receivable is reflected upon the increased sales.
The various factor which influence the account receivable management of HUL revolve around The variable factors associated with the Credit Policy are:• 1. Credit Standards • 2. Credit Period • 3. Cash Discount • 4. Collection Program.
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Accounts Receivable Management: HUL vs. ITC Ltd.
Account Receivable Turnover
Account Receivable Turnover 36.57253 27.48452 29.540495 44.6
2006-07
2007-08
2008-09
Industry Average
The receivable turnover ratio provides insight into quality of HUL receivables; the median industry turnover is 44.6, which tell us that HUL receivables are considerably faster in turning over than the typical for the industry. 1. This might be an indication of efficient collection policy and less number of past due accounts on the books. 2. HUL has monitored collection activities.
Account Receivable Days
Account Receivable Days 13.28 12.37 12.44
8.18
2006-07
2007-08
2008-09
Industry Average
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Accounts Receivable Management: HUL vs. ITC Ltd.
Account Receivable Days tells us the average number of days for which receivables are outstanding before been collected. The average collection period of FMCG industry is 8.18 days, HUL is showing an improvement in terms of its collection effort, the collection effort of a company is decided by the collection policy which is a part of the overall credit policy of the company. The objective of collection policy is to achieve timely collection of receivables, thereby releasing the funds locked up in the receivables for a longer period than they should have been under the credit terms and to minimize the debt losses. • HUL Focus on cash generation continued and delivers a strong operating cash flow during the period 2008-09. This was driven by good business performance, underlying efficiencies and cost savings across the supply chain and a continued efficient collection system.
% increase in sale % increase in Account Receivable
49.44941
20.56858 13.33815 5.577025
2007
2008
Credit Policy has a significant impact on the sales, we can see that the sales have increased from 13.3% in 2007 to 49.45 % in 2008 due to which there is corresponding increase in the account receivable of the company, we can derive following inference from it: 1. New customers have been attracted by the relaxed credit standard of HUL. 2. There might be an increase in the less creditworthy customers. These customers have slower collection rate then the existing customer, so HUL should take conscientious efforts to reduce the possibility of increased bad debts.
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Accounts Receivable Management: HUL vs. ITC Ltd.
Portfolio of Good & Bad Debt
% of Good Debt % of Bad Debt
10.5479 89.4521 2006-07
11.4383 88.5617 2007-08
10.348381 89.651619 2008-09
We can see that in the Account receivable portfolio of HUL, good debts have higher proportion then the bad debts and the company has maintained consistence in the following area. We can derive following inference from it:1. Although there has been an increase in account receivable from past 3 years, HUL has been able to maintain the bad debts which mean that they have good credit standard and good collection policy. 2. Higher good debts have stimulated the demand for the company’s product, which has been reflected in the increase sales. Hence it has been an investment debt which has created value. 3. HUL should work upon reducing the current bad debt, though there proportion has been consistence in following years any kind of increase may lead to stringent credit policy which can eventually affect the sale.
OpportunityCost
Account Receivable 46493.06 27784.66 3911.17 5192.71 2006-07 2007-08 6328.69 6301.83 2008-09 6921.48 Short term loan Bad Debt 56056.02 44037.1
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Accounts Receivable Management: HUL vs. ITC Ltd.
All these variables underlying a HUL’s credit policy influences sales, the amount locked up in the form of receivables mean while company also takes short term loans to meet its current obligation hence there is an opportunity cost attached to the increased account receivable and some of the receivables turning sour and eventually becoming bad debts. In financial year 2008-09 although the sales and account receivables of the company has increased, we can also see the increase in short term loans of the company which is not a positive trend. As these calculations may provide calculations may provide an "early warning" sign of potential problems in receivables management and rising bad debt risks. Trends show that HUL has no trouble in collecting its receivables, but it should keep a check on it short term loans. HUL is moving towards realising the ambition of a chequeless organisation since 2008-09, they have implemented both e-collection (from sales) and e-payments (for purchases). These have increased speed and service substantially while simplifying processes
ACCOUNTS RECEIVABLE MANAGEMENT: HUL VS. ITC
A/C Receivables Turnover ratio
44.6 36.57253
20.32
HUL
ITC
Industrial Average
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Accounts Receivable Management: HUL vs. ITC Ltd.
A/C Receivable Days
18
12.44
8.18
HUL
ITC
Industrial Average
Based on our analysis we can conclude that HUL has a better account receivable turnover ratio than ITC but is lower than the industrial average. There is more scope for both the companies to improve their Account receivable by modifying their credit policies.
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doc_246699658.docx
It takes examples of HUL and ITC as cases to explain the concepts.It covers collection and credit policies,credit terms,credit credit period,discounts,risk,collection policy,credit check
Accounts Receivable Management
Hindustan Unilever Ltd. vs. Indian Tobacco Corporation Ltd.
Vs.
Accounts Receivable Management: HUL vs. ITC Ltd.
Contents
S. no. Topics Page no.
1.
Comparative Financial Ratio Analysis of HUL and ITC
3
Accounts receivable management 2. ? Collection and credit policies ? Analyzing the credit applicant
5 5 14
3.
Account Receivable Management- ITC
17
4.
Account Receivable Management- HUL
19
5.
Accounts Receivable Management - HUL vs. ITC
23
Page 2
Accounts Receivable Management: HUL vs. ITC Ltd.
COMPARATIVE FINANCIAL RATIO ANALYSIS OF HUL & ITC (2008-09)
For the purpose of financial analysis it would be best to compare the ratios of the two companies and draw conclusions on the liquidity, debt conditions, operating efficiency and profitability.
Ratios 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Current ratio Acid test ratio Debt to equity Debt to total assets ratio Long term debt to total capitalization Interest coverage ratio Inventory turnover ratio Inventory turnover in days Debtors turnover ratio Debtor turnover in days Creditors turnover ratio Creditors turnover in days Operating cycle Cash cycle Total asset turnover ratio Gross profit margin Net profit margin Return on assets Return on equity Return on investment (Du Pont) Return on Equity (Du Pont) HUL 0.87 0.52 0.203 0.050 0.060 566.5 6.90 65 days 36.39 12 days 3.49 104 days 78 days -26 days 2.368 14.8% 12.1% 28.8% 116.74% 28.8% 116.7% ITC 2.09 1.141 0.013 0.009 0.001 121.8 2.35 155 days 20.32 18 days 3.31 110 days 173 days 63 days 0.810 29.6% 19.9% 16.6% 23.94% 16.6% 23.9%
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Accounts Receivable Management: HUL vs. ITC Ltd.
1. ITC has a current ratio of around 2.09 hence it is supposed have a better short term financial position comparatively. It may be because of ITC diversifying into the new areas over the past few years. 2. ITC’s acid quick ratio shows that it has better ability to satisfy its current liabilities. This shows that ITC Ltd. has been stocking fewer inventories as compared to HUL Ltd. 3. ITC having a lower debt to equity ratio is in a more favorable position in comparison to HUL. As ITC has lower financial leverage in relies lesser on borrowings from creditors. In case of HUL, 20% of the company's finance is provided by the creditors, whereas, in the case of ITC 1.3% of the company's finance is provided by the creditors. 4. ITC having a lower debt to total asset ratio in comparison to HUL is in a more favorable position. ITC performs its operations with comparatively lower financial risk. It indicates that ITC Ltd. has more assets than debts as compared to HUL Ltd. 5. ITC having a lower long term debt to total capitalization ratio is operating at a comparatively lower risk level. 6. Interest coverage ratio of HUL is much higher than ITC which means it has very low debt. ITC is more dependent on debt for services as compared to ITC. 7. Inventory turnover ratio and in days measures short term sales potential. Higher ratio indicates problem with sales forecasts. Lower ratio than the industry norms indicate loss of sales due to firm’s inability to fulfill demand. HUL turns over more number of receivables in a year. HUL is more successful in collecting back its receivables. 8. Higher debtor’s turnover ratio shows that HUL turns over more number of receivables in a year. Debtor turnover in days shows that HUL is more successful in collecting back its receivables. It shows better quality of debtors and that that debts are being collected very quickly. 9. Creditor turnover in ratio and in days shows that both ITC and HUL are managing their working capital really well. 10. HUL has a lower operating cycle and a negative cash cycle so it is more profitable than ITC. 11. High Total asset turnover ratio of HUL indicates that the firm is efficiently utilizing its total assets to generate sales. 12. When we compare the gross profit ratio of the two companies we find that ITC margins are significantly above that of HUL indicating it’s relatively more effective at producing and selling products than the latter. 13. On comparing the net profit margins of the two companies we find that net profit margins of ITC are larger than HUL. This indicates that ITC is having a higher relative level of Sales Profitability than HUL. 14. HUL has a higher ROA and ROE than ITC. A higher ROA means more efficient utilization of assets while higher ROE shows HUL has allocated capital in a more effective manner. Page 4
Accounts Receivable Management: HUL vs. ITC Ltd.
ACCOUNTS RECEIVABLE MANAGEMENT
? ? Accounts Receivable is the amount of money owed to a firm by customers who have bought goods and services on credit. It is a current asset and is also called receivables. Factors influencing accounts receivables 1. economic conditions 2. product pricing 3. product quality 4. firms credit policies The first 3 factors are beyond the control of the financial manager. The manager can vary the levels of receivables in keeping with the trade off between profitability and risk. ? Credit and collection policy variables include 1. Quality of the trade accounts accepted 2. Length of the credit period 3. The cash discount for early payment 4. Collection program of the firm ? Together the above mentioned factors determine 1. Average collection period 2. Ratio of bad debts to credit sales
CREDIT STANDARDS
? ? ? It is the minimum quality of credit worthiness of a credit applicant that is acceptable to the firm. Credit influences the demand for a firm’s product. Lowering of credit standard should be done as long as the profitability of sales generated exceeds the added costs of the receivables.
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Accounts Receivable Management: HUL vs. ITC Ltd.
? Added costs include 1. Enlarged credit departments 2. Checking additional accounts 3. Servicing the added volume of receivables 4. Increased probability of bad debt losses 5. Opportunity cost ? Additional receivables results from 1. Increased sales 2. A longer average collection period ? Disadvantages of relaxing credit standards 1. If the new customers are attracted by the relaxed credit standards, collecting from new less creditworthy customers is likely to be slower. 2. Existing customers will be less careful in paying their bills on time. ? An example of the Trade off
CREDIT STANDARDS CHANGE (profitability vs. required return)
Let us take a hypothetical example to assess the profitability of a more liberal extension of credit. This information reduces our evaluation to a tradeoff between the added expected profitability on the additional sales and the opportunity cost of the increased investment in receivables. The increased investment arises solely from new, slower paying customers. An optimal policy would involve extending credit more liberally until the marginal profitability on the additional sales equals the required return on the additional investment in receivables necessary to generate those sales. However, as we do this, we also increase the risk of the firm, which manifest it in additional bad debt losses. Here, as profitability on additional sales far exceeds the required return on additional investments, the firm would be well advised to relax its credit standards.
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Accounts Receivable Management: HUL vs. ITC Ltd.
CREDIT TERMS
? ? Credit terms specify the length of time over which credit is extended to a customer and the discount, if any, given for early payment. E.g. “2/10, net 30” implies that 2 % discount is given if the bill is paid within 10 days of the invoice date. If discount is not taken, the full payment is due by 30th day from the invoice date. Credit terms include:
?
1. Credit period 2. Cash discount period and cash discount 3. Seasonal datings
CREDIT PERIOD
? ? Credit period is the total length of time over which credit is extended to a customer to pay a bill. Credit period change (profitability vs. required return): Let us say the firm in our example changes its terms from “net 30” to “net 60” thus increasing its credit period from 30 days to 60 days. More liberal credit period results in increase in sales. The total additional receivables are composed of two parts. 1. Receivables associated with increase in sales: Additional sales (Rs) 3,60,000 Receivable turnover ratio 6 Additional receivables (Rs) = 3,60,000/6 = 60,000 Investment (Rs) = 0.8 x 60,000 = 48,000 2. Slowing in collections associated with sales to original customers Original sales (Rs) Original turnover Original Receivables (before the credit period change) (Rs) New turnover New receivables (Rs) Investment in additional receivables (Rs) 24,00,000 12 24,00,000/12 = 2,00,000 6 24,00,000/6 = 4,00,000 = 4,00,000 – 2,00,000 = 2,00,000
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Accounts Receivable Management: HUL vs. ITC Ltd.
Hence there is Rs. 2, 00,000 in additional receivables associated with the sales to original customers. The incremental receivables would have been collected in cash had it not been for the change in credit period. Therefore, the firm must increase its investment in receivable by 2, 00,000. Profitability of additional sales (Rs) = 2x 36,000 = 72,000 Total investment in additional receivables (Rs) =48,000 + 2,00,000 = 2,48,000 Required return on investment (Rs) =0.2 x 2,48,00 = 49,600 The profitability on the additional sales exceeds the required return on the investment in additional receivables. Hence the change in credit period from 30 to 60 days is worthwhile. The profitability on the additional sales more than offsets the opportunity cost associated with the added investment in receivables. The bulk of this added investment comes from existing customers slowing their payments.
CASH DISCOUNT PERIOD AND CASH DISCOUNT
? ? ? ? Cash discount period the period of time during which cash discount can be taken for early payment. Cash discount is a percent reduction in sales or purchase price allowed for early payment of invoices. Varying the cash discount involves an attempt to speed up the payment of receivables. Cash discount change (cost vs. savings)
Assume that the sales term of a firm is “net 45”, without discount. By initiating terms of “2/10, net 45”, the average collection period can be reduced to one month, as 60% of the customers take advantage of 2% discount. Annual credit sales (Rs) Old receivable turnover Receivables before cash discount (Rs) New receivable turnover Receivable associated with cash discounts (Rs) Reduction of investment in accounts receivable (Rs) Cash discount Percentage taking discount Cost of cash discount change (Rs) Opportunity savings on reduction of receivables (Rs) 30,00,000 6 30,00,000/6 = 5,00,000 12 30,00,000/12= 2,50,000 5,00,000-2,50,000= 2,50,000 2% 60% 0.02 x 0.60 x 30,00,000 = 36,000 0.20 x 2,50,000 = 50,000
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Accounts Receivable Management: HUL vs. ITC Ltd.
Since opportunity savings arising from the speedup in collection is greater than the cost of the discount, the firm should adopt a 2% discount. If speed up in collections had not resulted in sufficient opportunity savings to offset the cost of the cash discount, the discount policy would not be changed. It is possible that discount other than 2 % may result in an even greater difference between the opportunity saving and the cost of the discount.
SEASONAL DATING
? ? ? ? ? Credit terms that encourage the buyer of seasonal products to take delivery before the peak sales period and to defer payment until after the peak sales period. During periods of slack sales, firms will sometimes sell to customers without requiring payment for some time to come. It may stimulate demand from customers who cannot pay until later in the season. It can also used to avoid inventory carrying costs Profitability of additional sales should be compared with the require return on additional investment in receivables to determine whether datings are appropriate terms by which to stimulate demand.
DEFAULT RISK
? ? ? ? Optimum credit standard policy is not necessarily the one that minimizes bad debt losses. Firm is not only concerned with Optimal policy provides the greatest incremental benefit. Credit policy changes (profitability vs. required return) The present credit policy along with two, increasingly more liberal, new ones are expected to produce the following results Present policy 24,00,000 Policy A 30,00,000 6,00,000 Policy B 3,300,000 3,00,000
Credit sales Incremental sales Default loses a. original sales b. incremental sales Average collection period a. original sales b. incremental sales
2% 10% 1 month 2 months 3 months Page 9 18%
Accounts Receivable Management: HUL vs. ITC Ltd.
Policy A Profitability of additional sales = 0.20 x 6,00,000 =1,20,000 Additional bad debt losses =0.10 x 6,00,000 =60,000 Additional receivables = 6,00,000/6 =1,00,000 Investment in additional =0.80 x 1,00,000 receivables =80,000 Required return on additional =0.20 x 80,000 investment =16,000 Additional bad debt losses + =76,000 additional required return Incremental profitability =1,20,000 -76,000 =44,000
Policy B = 0.20 x 3,00,000 =60,000 = 0.18 x 3,00,000 =54,000 =3,00,000/4 =75,000 =0.80 x 75,000 =60,000 =0.20 x60,000 =12,000 =66,000 =60,000-66,000 =(6,000)
The marginal benefit is positive in moving from the present policy to policy A but negative in going from policy A to policy B. The optimal profit is one that provides greatest incremental benefit.
COLLECTION POLICY AND PROCEDURE:
The firm determines its overall collection policy by the combination of collection procedures it undertakes. These procedures include such things as letters, faxes, phone calls, personal visits and legal action. One of the principal policy variables is the amount of money spent on collection procedures. Within a range, the greater the relative amount expended the lower proportion of bad-debt losses, and the shorter the average collection period, all other things being same. The relationships are not linear. Initial collection expenditure is likely to cause little reduction in bad-debts. Additional expenditure begin to have significant effect upto a point – then they tend to have little effect in the further reducing these losses. This relationship between collection expenditure and bad debts are shown in the figure.
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Accounts Receivable Management: HUL vs. ITC Ltd.
BAD-DEBT LOSSES
Saturation point
COLLECTION EXPENDITURE Because the receivable is only as good as the likelihood that it will be paid, a firm cannot afford to wait too long before initiating collection procedure. On the other hand, if it initiates the procedure too soon, it may anger reasonably good customers who, for some reason, fail to make payment by the due date.
C OMMONLY
PRACTICED PROCEDURE OF RECEIVABLE COLLECTION :
Telephone call asking why payment is not made
Letter is sent followed by additional letter with more serious note
Phone call or letter from cos. attorney may be neccessary
Collection personal visit customer about overdue account
If all else fails, account can be turned over to a collection agency who charge nearly half amount of recievables
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Accounts Receivable Management: HUL vs. ITC Ltd.
CREDIT AND COLLECTION POLICY
The credit and collection policy of a firm involves several decisions: 1. The quality of accounts accepted 2. The length of the credit period 3. The size of the cash discount allowed 4. Any special terms, such as seasonal datings 5. The level of collection expenditure. In each case, the decision should involve a comparison of possible gains from a change in policy with the cost of the change. Optimal credit and collection policies would be those that in the marginal gain equaling the marginal cost. To maximize profits arising from credit and collection policies, the firm should vary those that resulted in these policies jointly until it achieves an optimal solution. That solution determines the best combination of credit standards, credit period, cash discount policy, special terms, and level of collection expenditure. For most policy variables, profit increase at a decreasing rate up to a point and then decrease as the policy is varied from no effort to an extreme efforts. Following figures shows the relation this relationship with the quality of accounts rejected.
QUALITY OF ACCOUNTS REJECTED When there was no credit standards (i.e. when all the credit applicants were accepted), sales are maximized, but they are offset by large bad debt losses as well as by opportunity cost of carrying very large receivables portion. As the credit standards are initiated and the applicants rejected the revenue from the sales declines, but so do the average collection period and the bad debts. Because the last two decline initially at a faster rate than sales, profit increases. As the credit standards are increasingly tightened, sales revenue declines at an increasing rate.
SALES
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Accounts Receivable Management: HUL vs. ITC Ltd.
AVG. COLLECTION PERIOD
QUALITY OF ACCOUNTS REJECTED BAD DEBT LOSSES QUALITY OF ACCOUNTS REJECTED At the same time, the average collection period and bad debt losses decrease at a decreasing rate. Fewer and fewer bad credit risks are eliminated. PROFITS
X
QUALITY OF ACCOUNTS REJECTED Because of the combination of these influences, total profits of the firm increase at a diminishing rate with stricter standards up to a point, after which the decline. The optimal policy with respect Page 13
Accounts Receivable Management: HUL vs. ITC Ltd.
to credit standards is represented by X in the figure. In turn, this policy determines the level of accounts receivable held by the firm.
ANALYZING THE CREDIT APPLICANT
Having established the terms of sale to be offered, the firm must evaluate individual credit applicants and consider the possibilities of a bad debt or slow payment. The credit evaluation involves three related steps: 1. Obtaining information on the applicant. 2. Analyzing this information to determine the applicant’s creditworthiness.
3. Making credit decisions.
SOURCES OF INFORMATION:
It is to be noticed that sometimes the cost of these information may outweigh the potential profitability of the account. The firm extending credit may have to be satisfied with limited amount information on which to base a decision. In addition to cost, the firm should also consider the time it takes to investigate a credit applicant. Thus the amount of information collected need to be considered in relation to the time and expense required. Depending on these considerations, the credit analyst may use one or more of the following sources of information. ? FINANCIAL STATEMENTS: At the time of the prospective sale, the seller may request the financial statement which one of the desirable sources of information for credit analysis. Frequently there is a correlation between a company’s refusal to provide statements and a weak financial position. Audited statements are preferred.
CREDIT RATING AND REPORTS:
?
?
Credit rating is a published ranking, based on detailed financial analysis by a credit bureau, of one's financial history, specifically as it relates to one's ability to meet debt obligations. The highest rating is usually AAA, and the lowest is D. Credit reports is a report containing detailed information on a person's credit history, including identifying information, credit accounts and loans, bankruptcies and late payments, and recent inquiries. It can be obtained by prospective lenders with the borrower's permission, to determine his or her creditworthiness BANK CHECKING: Another source of credit information for credit analyst checking on the particular firm is the firm’s bank. Most banks have credit departments that will provide information on their commercial customers as a service to those customers seeking to acquire trade credits (credit granted from one business to another). By calling or writing Page 14
Accounts Receivable Management: HUL vs. ITC Ltd.
to a bank in which the credit applicant has an account, the analyst can obtain information, such as average cash balance carried, loan accommodations, experience and sometimes more extensive financial information. TRADE CHECKING: Credit information is frequently exchanged among companies selling to the same customers. Through various credit organizations, credit people in a particular area become a closely knit group. A company can ask others suppliers about their own experience with an account. THE COMPANY’S OWN EXPERIENCE: A study of the promptness of past payments, including any seasonal patterns, is very useful. Frequently, the credit department will make written assessments of the quality of the management of a company to whom credit may be extended. The assessments are very important, for they pertain to the original “three Cs” of credit analysis: ? Character - creditor’s willingness to honour obligation ? Capacity – creditor’s ability to generate cash to meet obligations ? Capital – creditor’s net worth and the relationship net worth to debt.
?
?
CREDIT ANALYSIS
Having collected credit information, the firm must make a credit analysis of the applicant. In practice the collection of information and its analysis is closely related. If, on the basis of initial credit information, a large account appears to be relatively risky, the credit analyst will obtain further information. In addition to analyzing financial statements, the credit analyst will consider the characters of the company and its management, the financial strength of the firm, and various other matters. Then the analyst attempts to determine the ability of the applicant to service credit and the probability of an applicant are not paying on time and of a bad-debt loss. On the basis of this information, together with the information about the profit margin on the product or service being sold a decision is reached on whether or not to extend credit. (SIP next page) CREDIT-SCORING SYSTEM: A system used to decide whether to grant credit by assigning numerical score to various characteristics related to credit worthiness. Numerical ratings systems are also being used by some companies extending trade credit. With the overall growth of trade credit, a number of companies are finding it worthwhile to identify clearly unacceptable and acceptable applicants.
CREDIT DECISION AND LINE OF CREDIT
Once the credit analyst has marshaled the necessary evidence and analyzed it, a decision must be reached about the disposition of the account. In an initial sale, the first decision to be made is whether or not to ship the good and extend credit. If repeat sales are likely, the company will
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Accounts Receivable Management: HUL vs. ITC Ltd.
probably want to establish procedure so that it does not have to fully evaluate the extension of the credit each time an order is received. One line of streamlining the procedure is to establish a line of credit for an account. A line of credit is a maximum limit on the amount the firm will permit to be owed at any one time. Purchaser can buy on credit up to that limit. In essence, it represents the maximum risk exposure that the firm will allow itself to undergo for an account. The entire credit/collection function can be outsourced i.e., subcontracted to an outside firm. As with the outsourcing of any business function, its often comes down to a question of core competence. Where such internal competence does not exist or is inefficient, the decision – even for large companies – may be to buy the service on the outside. For small and medium sized companies, credit and collections may simply prove to be too costly to do on one’s own.
SEQUENTIAL INVESTIGATION PROCESS:
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Accounts Receivable Management: HUL vs. ITC Ltd.
ACCOUNT RECEIVABLE MANAGEMENT- ITC
The credit policy adopted by ITC recovers their debtor amount by 18 days in 2009 and 22 days in 2008. The year end debtor balance against net sales is 803.58 Cr. in 2009 and 879.42 Cr. in 2008 which is expressed in terms of ratio as 1:20.32 in 2009 and 1:16.66 in 2008.
Recievable Turnover Ratio
50 R a t i o 40 30 20 10 0 2008 2009 YEAR Industry Average 16.66 20.32 Recievable Turnover Ratio 44.6
The above information indicates that credit policy is effectively being implemented. It helps in generating cash by reducing 4 days, so the company is benefited by 4 days w.r.t. the interest cost and this will help the company to invest this capital in working process.
Recievable Turnover in Days
25 20 D 15 A Y 10 S 5 0 2008 2009 YEAR Industry Average 22 18 14.54
Recievable Turnover in Days
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Accounts Receivable Management: HUL vs. ITC Ltd.
But when compared to the industrial average for receivable turnover ratio and receivable turnover in days, it found that both, the turnover ratio and turnover in days, for the company is much below. Hence the company has great scope to improve their credit policy. The percentage default of debtor is denominated by bad debts in the company. The bad debt incurred by company in 2009 was 8.67 Cr. and in 2008 was 7.32 Cr. Also when taking out percentage bad debt to total debt we found that it was 1.07% in 2009 and 0.8% in 2008. This shows increasing trend for bad debts which is not a good sign for the company. Moreover the Provision for Bad Debt made by the company for 2009 was 48.06 Cr and for 2008 was 42.41 Cr. Hence it can be said that the increase in bad debts of the company has made them increase the provision for bad debts in 2009.
Bad Debt
9 8.5 8 7.5 7 6.5 2008 2009 Bad Debt
% Bad Debt - Total Debt
1.2 1 0.8 0.6 0.4 0.2 0 2008 2009 % Bad Debt - Total Debt 0.8 1.07
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Accounts Receivable Management: HUL vs. ITC Ltd.
ACCOUNT RECEIVABLE MANAGEMENT- HUL
We can see an increasing trend in account receivable in case of HUL, the company is also incurring higher bad debt over the last 3 financial years, although increased account receivable is reflected upon the increased sales.
The various factor which influence the account receivable management of HUL revolve around The variable factors associated with the Credit Policy are:• 1. Credit Standards • 2. Credit Period • 3. Cash Discount • 4. Collection Program.
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Accounts Receivable Management: HUL vs. ITC Ltd.
Account Receivable Turnover
Account Receivable Turnover 36.57253 27.48452 29.540495 44.6
2006-07
2007-08
2008-09
Industry Average
The receivable turnover ratio provides insight into quality of HUL receivables; the median industry turnover is 44.6, which tell us that HUL receivables are considerably faster in turning over than the typical for the industry. 1. This might be an indication of efficient collection policy and less number of past due accounts on the books. 2. HUL has monitored collection activities.
Account Receivable Days
Account Receivable Days 13.28 12.37 12.44
8.18
2006-07
2007-08
2008-09
Industry Average
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Accounts Receivable Management: HUL vs. ITC Ltd.
Account Receivable Days tells us the average number of days for which receivables are outstanding before been collected. The average collection period of FMCG industry is 8.18 days, HUL is showing an improvement in terms of its collection effort, the collection effort of a company is decided by the collection policy which is a part of the overall credit policy of the company. The objective of collection policy is to achieve timely collection of receivables, thereby releasing the funds locked up in the receivables for a longer period than they should have been under the credit terms and to minimize the debt losses. • HUL Focus on cash generation continued and delivers a strong operating cash flow during the period 2008-09. This was driven by good business performance, underlying efficiencies and cost savings across the supply chain and a continued efficient collection system.
% increase in sale % increase in Account Receivable
49.44941
20.56858 13.33815 5.577025
2007
2008
Credit Policy has a significant impact on the sales, we can see that the sales have increased from 13.3% in 2007 to 49.45 % in 2008 due to which there is corresponding increase in the account receivable of the company, we can derive following inference from it: 1. New customers have been attracted by the relaxed credit standard of HUL. 2. There might be an increase in the less creditworthy customers. These customers have slower collection rate then the existing customer, so HUL should take conscientious efforts to reduce the possibility of increased bad debts.
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Accounts Receivable Management: HUL vs. ITC Ltd.
Portfolio of Good & Bad Debt
% of Good Debt % of Bad Debt
10.5479 89.4521 2006-07
11.4383 88.5617 2007-08
10.348381 89.651619 2008-09
We can see that in the Account receivable portfolio of HUL, good debts have higher proportion then the bad debts and the company has maintained consistence in the following area. We can derive following inference from it:1. Although there has been an increase in account receivable from past 3 years, HUL has been able to maintain the bad debts which mean that they have good credit standard and good collection policy. 2. Higher good debts have stimulated the demand for the company’s product, which has been reflected in the increase sales. Hence it has been an investment debt which has created value. 3. HUL should work upon reducing the current bad debt, though there proportion has been consistence in following years any kind of increase may lead to stringent credit policy which can eventually affect the sale.
OpportunityCost
Account Receivable 46493.06 27784.66 3911.17 5192.71 2006-07 2007-08 6328.69 6301.83 2008-09 6921.48 Short term loan Bad Debt 56056.02 44037.1
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Accounts Receivable Management: HUL vs. ITC Ltd.
All these variables underlying a HUL’s credit policy influences sales, the amount locked up in the form of receivables mean while company also takes short term loans to meet its current obligation hence there is an opportunity cost attached to the increased account receivable and some of the receivables turning sour and eventually becoming bad debts. In financial year 2008-09 although the sales and account receivables of the company has increased, we can also see the increase in short term loans of the company which is not a positive trend. As these calculations may provide calculations may provide an "early warning" sign of potential problems in receivables management and rising bad debt risks. Trends show that HUL has no trouble in collecting its receivables, but it should keep a check on it short term loans. HUL is moving towards realising the ambition of a chequeless organisation since 2008-09, they have implemented both e-collection (from sales) and e-payments (for purchases). These have increased speed and service substantially while simplifying processes
ACCOUNTS RECEIVABLE MANAGEMENT: HUL VS. ITC
A/C Receivables Turnover ratio
44.6 36.57253
20.32
HUL
ITC
Industrial Average
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Accounts Receivable Management: HUL vs. ITC Ltd.
A/C Receivable Days
18
12.44
8.18
HUL
ITC
Industrial Average
Based on our analysis we can conclude that HUL has a better account receivable turnover ratio than ITC but is lower than the industrial average. There is more scope for both the companies to improve their Account receivable by modifying their credit policies.
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