Description
Introduction to Receivables Management
RECEIVABLES MANAGEMENT
• Introduction: Goods sold on credit lead to debtors or receivables. The process -> Inventory of finished goods -> stock transfer to consignment agents /clearing and forwarding agents / wholesalers /stockists > sales -> debtors -> collection -> cash at bank.
Receivables Management
• Daily average credit sales X Collection period in days = Debtors / Receivables. • Purpose: 1. Increase sales / total sales. • 2. Increase profits, as credit sales are at higher margin or lower discount. • 3. Meet competition – more credit than competitor can offer.
Cost of receivables
• 1. Additional capital employed – interest / opportunity costs. • 2. Administration costs – credit appraisal • - monitoring • 3. Collection costs / Commission • 4. Defaulting costs – bad debts, additional collection costs.
Process
• • • • 1. Formulation of credit policy 2. Credit evaluation / appraisal 3. Credit granting decision 4. Monitoring receivables
Credit policy
• Decision regarding:
– 1. How long credit period, – 2. To whom, – 3. How credit will be availed by sub-dealer or shopkeeper: a) credit standards, b) credit period, c) cash discount, d) collection plan. – 4. Possibility of advance payment against cash discount. – 5. “Comparative static analysis” considering other variables constant.
Credit standards
• Stiff: Low level of sales
– Less money locked up – No bad debts – Less spending on collection
• Liberal: increase on sales
– high bad debts – High collection costs, – high litigation costs
Credit standards
• • • • • • Present sales Rs.2 crores Increase expected Rs.24 lakhs Contribution 20% Cost of capital 15% Bad debts 10% of additional sales Average collection period – 45 days.
Credit standards
• 1.Additional profit=delta sales x contribution divided by sales revenue = 2400000x20/100 = 4,80,000. • Additional debtors = delta sales/360 x collection period = 2400000/360x45 = 300000. • Additional investment in receivables = receivables x variable cost/sales revenue = 300000 x 80/100 =2,40,000. Cost of additional investment in debtors = 240000 x 15/100 = 36,000.
Bad debt losses
• Additional new sales x bad debts % = 2400000 x 10/100 = 2,40,000 • Summary: Rs. • Additional profit 480000 • Additional costs of financing 36000 • Loss on account of bad debts 240000 • Net additional benefit 480000 – 276000 =Rs. 2,04,000.
Formula
• Delta P = deltaS (1-V) –k delta I –bn deltaS
– – – – – Delta P = change in profit, Delta S = increase in sales, V = variable costs to sales ratio, k = cost of capital, delta I = increase in investment in debtors = delta S/360 x average collection period (ACP) x V. – bn = bad debts loss on new sales. – 1-V = contribution to sales ratio.
Solution
• Delta P = delta S (1-V) – k delta I – bn delta S. • =2400000 x 0.20 – 0.15 x2400000/360 x 45 x 0.8 – 0.1x2400000 • = 480000 – 36000 –240000 = 204000.
Credit period extension- Problem
• present sales 180 lakhs, • credit – net 30 days ->extension to 45 days proposed. • Contribution to sales ratio – 20%, • cost of funds – 15%, • increase in sales 16 lakhs, • bad debts losses 5%. Whether credit should be extended to 45 days or not?
Credit period extension -solution
• Solution: Additional sales 16 lakhs, contribution 20% - 320000. • Increase in receivables (existing)/ Investments = 18000000/360 x (45-30) • =750000 x80/100 = 600000 • Increase in receivables (new sales) 1600000*45/360 = 200000. • Increase in investment in new sales = • 200000 x80/360 =160000.
Solution – Increase in credit Period
• • • • • • • Total increase in investment in receivables = 600000 + 160000 = 760000 Cost of capital /funds 760000 x 15/100 = 114000. Bad debts loss 1600000 x 5% = 80000 Additional cost 114000 + 80000 = 194000. Net additional benefit = 320000 – 194000 = RS.126000.
Formula – Increase in credit Period
• • • • • • • ? I= Increase in investment AcPn = New arrival credit period. AcPo = Old arrival credit period. V = Ratio of variable cost to sales ? s = increase in sales ? P= ?s(1-V) - K ?I – bn ?s I ? = (AcPn – AcPo) [s/ 360] + v(AcPn) ?s/ 360.
Problem
= (45 –30)[ 180/360] + 0.8 * 45*16/360. = 7.5 +1.6 = 9.1 Lakhs • P= 16(0.2) – 0.15 *9.1 – 0.05 *16. = 3.2 – 1.365 –0.8 = Rs. 1.035 Lakh or 103500. Imp Note: 126000 – 103500 = 22500 22500 *100/15 = 150000 • In formula, profit on investment in debtors not eliminated.
Credit rating
• Credit rating by Dun & Bradstreet in USA. No such agency in India. Classification: • High / Good / Fair / Limited
Collection Program
• 1. Aging analysis of debtors • 2. Overdue debtors – dispatch to marketing field staff • 3. Dispatch of letters / email / telephone • 4. Non-payment – notice by company, by advocate • 5. Legal action against defaulting debtors.
Cheque bouncing – action
• 1. 21 days’ notice of return of cheque by bank and demand payment • 2. Criminal case under Negotiable Instruments Act – section 138. • 3. Summary suit for recovery of money • 4. Suit for recovery of interest, costs.
Credit evaluation
• 1. Ratio analysis – compare with standard / industry norms • 2. Obtaining bank’s references • 3. Firm’s own experiences (past dealings) • 4. Numerical credit rating / scoring (Book)
Credit evaluation by ratios
• 1. Current ratio = CA/CL • 2. Quick ratio = (CA-Inventory)/CL • 3. Average payment period = Average balance of Sundry creditors / Average daily credit purchases • 4. Avr. collection period = Avr. balance of Debtors / Avr. daily credit sales • 5. Capital structure ratio / debt equity ratio
Credit evaluation by ratios
• 6. Return on equity = (NP or PAT minus preference share dividend) / Owners’ equity • 7. Fund flow statement • 8. Cash-flow statement • 9. Dividend pay out ratio = Dividend*100/EPS
Monitoring receivables
• 1. Days sales outstanding = accounts receivables / average daily credit sales • 2. Ageing schedule or ageing analysis • 0 – 30 days or upto 1 month/current • 31-60 days or 1 – 2 months • 61–90 days or 2 – 3 months • over 90 days or 3 + months
Collection matrix
• • • • • • Example: Less than 1st month - 10% 2nd month – 40% 3rd month – 30% 4th month – 15% 5th month – 5%
Collection matrix
• 1. Stable / deterioration / improving • 2. Helps in forecasting (historical data can be used) • 3. Helps in cash budgeting
Credit evaluation
• • • • • • 1. No risk of default 2. Negligible risk of default 3. Little risk of default 4. Some risk of default 5. Significant risk of default, or Very good / Good / Fair / Average / Not satisfactory.
Decision tree approach
• Sales – Rs.80000, Cost of sales – Rs.60000, Financial benefit – Rs.20000, Probability – 0.90 and 0.10. Cost benefit analysis will be: • P(sales-cost) – (1-p) cost • = 0.90 (80000-60000) – (1-0.90) 60000 • = 0.90 x20000 – 0.10 x 60000 = • = 18000 - 6000 = 12000 /- positive. • Credit should be given.
Decision tree approach
• Example: • A businessman is considering offering credit to a customer. The probability that customer would pay is 0.5, and default is 0.5. Revenue from sale will be Rs.2500 and cost of sales Rs.1700. • Expected profit from offering credit is : • 0.5 (2500-1700) – 0.5 (1700) = minus Rs.450. Hence, company cannot offer credit.
Repeat order situation
• Probability of payment 0.90, default 0.10 for first order. Probability for repeat order 0.95, and default 0.05. Sales value Rs.1,00,000, cost of sales Rs.70,000 and profit Rs.30,000. • Solution: I order 0.9 x 30000 – 0.1x70000 = 27000-7000 =20000. • II order [0.95x30000 – 0.05x70000] x 0.9 =[28500 –3500]x0.9 = 25000x0.9 = 22,500. • Total for both orders 20000 + 22500 = 42500. • 0.90 – because supply against repeat order is dependent on payment against first order.
Why debtors do not pay?
• 1. Rejection awaiting replacement or issue of credit note. • 2. Shortage or deficit of cash or funds. • 3. Poor trade practices / business ethics. • 4. Confusion about status of credit, length / duration, method of remittance, etc. • 5. Debtor resorting to overtrading. • 6. Customers of debtor not paying in time. • 7. Poor sales.
Remedy
• 1. Credit notes for rejection, return, discounts, expenses reimbursements should be speeded up. • 2. Cash Management Service (CMS) be availed from bank. • 3. Invoicing to avoid bank holidays / Sundays / Saturdays or expiry of credit. • 4. Dispatch of documents promptly.
doc_852698775.ppt
Introduction to Receivables Management
RECEIVABLES MANAGEMENT
• Introduction: Goods sold on credit lead to debtors or receivables. The process -> Inventory of finished goods -> stock transfer to consignment agents /clearing and forwarding agents / wholesalers /stockists > sales -> debtors -> collection -> cash at bank.
Receivables Management
• Daily average credit sales X Collection period in days = Debtors / Receivables. • Purpose: 1. Increase sales / total sales. • 2. Increase profits, as credit sales are at higher margin or lower discount. • 3. Meet competition – more credit than competitor can offer.
Cost of receivables
• 1. Additional capital employed – interest / opportunity costs. • 2. Administration costs – credit appraisal • - monitoring • 3. Collection costs / Commission • 4. Defaulting costs – bad debts, additional collection costs.
Process
• • • • 1. Formulation of credit policy 2. Credit evaluation / appraisal 3. Credit granting decision 4. Monitoring receivables
Credit policy
• Decision regarding:
– 1. How long credit period, – 2. To whom, – 3. How credit will be availed by sub-dealer or shopkeeper: a) credit standards, b) credit period, c) cash discount, d) collection plan. – 4. Possibility of advance payment against cash discount. – 5. “Comparative static analysis” considering other variables constant.
Credit standards
• Stiff: Low level of sales
– Less money locked up – No bad debts – Less spending on collection
• Liberal: increase on sales
– high bad debts – High collection costs, – high litigation costs
Credit standards
• • • • • • Present sales Rs.2 crores Increase expected Rs.24 lakhs Contribution 20% Cost of capital 15% Bad debts 10% of additional sales Average collection period – 45 days.
Credit standards
• 1.Additional profit=delta sales x contribution divided by sales revenue = 2400000x20/100 = 4,80,000. • Additional debtors = delta sales/360 x collection period = 2400000/360x45 = 300000. • Additional investment in receivables = receivables x variable cost/sales revenue = 300000 x 80/100 =2,40,000. Cost of additional investment in debtors = 240000 x 15/100 = 36,000.
Bad debt losses
• Additional new sales x bad debts % = 2400000 x 10/100 = 2,40,000 • Summary: Rs. • Additional profit 480000 • Additional costs of financing 36000 • Loss on account of bad debts 240000 • Net additional benefit 480000 – 276000 =Rs. 2,04,000.
Formula
• Delta P = deltaS (1-V) –k delta I –bn deltaS
– – – – – Delta P = change in profit, Delta S = increase in sales, V = variable costs to sales ratio, k = cost of capital, delta I = increase in investment in debtors = delta S/360 x average collection period (ACP) x V. – bn = bad debts loss on new sales. – 1-V = contribution to sales ratio.
Solution
• Delta P = delta S (1-V) – k delta I – bn delta S. • =2400000 x 0.20 – 0.15 x2400000/360 x 45 x 0.8 – 0.1x2400000 • = 480000 – 36000 –240000 = 204000.
Credit period extension- Problem
• present sales 180 lakhs, • credit – net 30 days ->extension to 45 days proposed. • Contribution to sales ratio – 20%, • cost of funds – 15%, • increase in sales 16 lakhs, • bad debts losses 5%. Whether credit should be extended to 45 days or not?
Credit period extension -solution
• Solution: Additional sales 16 lakhs, contribution 20% - 320000. • Increase in receivables (existing)/ Investments = 18000000/360 x (45-30) • =750000 x80/100 = 600000 • Increase in receivables (new sales) 1600000*45/360 = 200000. • Increase in investment in new sales = • 200000 x80/360 =160000.
Solution – Increase in credit Period
• • • • • • • Total increase in investment in receivables = 600000 + 160000 = 760000 Cost of capital /funds 760000 x 15/100 = 114000. Bad debts loss 1600000 x 5% = 80000 Additional cost 114000 + 80000 = 194000. Net additional benefit = 320000 – 194000 = RS.126000.
Formula – Increase in credit Period
• • • • • • • ? I= Increase in investment AcPn = New arrival credit period. AcPo = Old arrival credit period. V = Ratio of variable cost to sales ? s = increase in sales ? P= ?s(1-V) - K ?I – bn ?s I ? = (AcPn – AcPo) [s/ 360] + v(AcPn) ?s/ 360.
Problem
= (45 –30)[ 180/360] + 0.8 * 45*16/360. = 7.5 +1.6 = 9.1 Lakhs • P= 16(0.2) – 0.15 *9.1 – 0.05 *16. = 3.2 – 1.365 –0.8 = Rs. 1.035 Lakh or 103500. Imp Note: 126000 – 103500 = 22500 22500 *100/15 = 150000 • In formula, profit on investment in debtors not eliminated.
Credit rating
• Credit rating by Dun & Bradstreet in USA. No such agency in India. Classification: • High / Good / Fair / Limited
Collection Program
• 1. Aging analysis of debtors • 2. Overdue debtors – dispatch to marketing field staff • 3. Dispatch of letters / email / telephone • 4. Non-payment – notice by company, by advocate • 5. Legal action against defaulting debtors.
Cheque bouncing – action
• 1. 21 days’ notice of return of cheque by bank and demand payment • 2. Criminal case under Negotiable Instruments Act – section 138. • 3. Summary suit for recovery of money • 4. Suit for recovery of interest, costs.
Credit evaluation
• 1. Ratio analysis – compare with standard / industry norms • 2. Obtaining bank’s references • 3. Firm’s own experiences (past dealings) • 4. Numerical credit rating / scoring (Book)
Credit evaluation by ratios
• 1. Current ratio = CA/CL • 2. Quick ratio = (CA-Inventory)/CL • 3. Average payment period = Average balance of Sundry creditors / Average daily credit purchases • 4. Avr. collection period = Avr. balance of Debtors / Avr. daily credit sales • 5. Capital structure ratio / debt equity ratio
Credit evaluation by ratios
• 6. Return on equity = (NP or PAT minus preference share dividend) / Owners’ equity • 7. Fund flow statement • 8. Cash-flow statement • 9. Dividend pay out ratio = Dividend*100/EPS
Monitoring receivables
• 1. Days sales outstanding = accounts receivables / average daily credit sales • 2. Ageing schedule or ageing analysis • 0 – 30 days or upto 1 month/current • 31-60 days or 1 – 2 months • 61–90 days or 2 – 3 months • over 90 days or 3 + months
Collection matrix
• • • • • • Example: Less than 1st month - 10% 2nd month – 40% 3rd month – 30% 4th month – 15% 5th month – 5%
Collection matrix
• 1. Stable / deterioration / improving • 2. Helps in forecasting (historical data can be used) • 3. Helps in cash budgeting
Credit evaluation
• • • • • • 1. No risk of default 2. Negligible risk of default 3. Little risk of default 4. Some risk of default 5. Significant risk of default, or Very good / Good / Fair / Average / Not satisfactory.
Decision tree approach
• Sales – Rs.80000, Cost of sales – Rs.60000, Financial benefit – Rs.20000, Probability – 0.90 and 0.10. Cost benefit analysis will be: • P(sales-cost) – (1-p) cost • = 0.90 (80000-60000) – (1-0.90) 60000 • = 0.90 x20000 – 0.10 x 60000 = • = 18000 - 6000 = 12000 /- positive. • Credit should be given.
Decision tree approach
• Example: • A businessman is considering offering credit to a customer. The probability that customer would pay is 0.5, and default is 0.5. Revenue from sale will be Rs.2500 and cost of sales Rs.1700. • Expected profit from offering credit is : • 0.5 (2500-1700) – 0.5 (1700) = minus Rs.450. Hence, company cannot offer credit.
Repeat order situation
• Probability of payment 0.90, default 0.10 for first order. Probability for repeat order 0.95, and default 0.05. Sales value Rs.1,00,000, cost of sales Rs.70,000 and profit Rs.30,000. • Solution: I order 0.9 x 30000 – 0.1x70000 = 27000-7000 =20000. • II order [0.95x30000 – 0.05x70000] x 0.9 =[28500 –3500]x0.9 = 25000x0.9 = 22,500. • Total for both orders 20000 + 22500 = 42500. • 0.90 – because supply against repeat order is dependent on payment against first order.
Why debtors do not pay?
• 1. Rejection awaiting replacement or issue of credit note. • 2. Shortage or deficit of cash or funds. • 3. Poor trade practices / business ethics. • 4. Confusion about status of credit, length / duration, method of remittance, etc. • 5. Debtor resorting to overtrading. • 6. Customers of debtor not paying in time. • 7. Poor sales.
Remedy
• 1. Credit notes for rejection, return, discounts, expenses reimbursements should be speeded up. • 2. Cash Management Service (CMS) be availed from bank. • 3. Invoicing to avoid bank holidays / Sundays / Saturdays or expiry of credit. • 4. Dispatch of documents promptly.
doc_852698775.ppt