Republic of the Philippines

West Visayas State University

Lambunao Campus
SCHOOL OF GRADUATE STUDIES
Lambunao Iloilo
Course No: ADS 503
Course Title: Fiscal Administration
Reporter: Aries Bell Buscar-Borcillo

ACCOUNTS RECEIVABLE MANAGEMENT

Accounts receivable consists of money owed to a firm for goods and services sold on credit. This type of
credit basically takes two forms:

1. Trade or commercial credit. Credit which the firm extends to other firms.
2. Consumer or retail credit. Credit which the firm extends to its final customers.

OBJECTIVES OF ACCOUNTS RECEIVABLE MANAGEMENT

The goal of accounts receivable management is to ensure that the firm’s investment in accounts
receivable is appropriate and contributes to shareholder wealth maximization. It is therefore the
responsibility of the finance officer to evaluate the pertinent costs and benefits related to credit
extension, to finance the firm’s investment in accounts receivable, implement the firm’s credit policy
and enforce collection.

CREDIT POLICY

Credit Policy is a set of guidelines for extending credit to customers. The success and failure of the
business depends primarily on the demand for its products- as a rule, the higher its sales, the larger its
profits and the higher the value of its stocks.

Credit Policy generally covers the following variables:

1. CREDIT STANDARDS. This refers to the minimum financial strength of acceptable credit
customer and the amounts available to different customer. Credit policy can have significant
influence upon sales. If credit policy is relaxed, while sales may increase, the quality of accounts
receivable may suffer. Setting credit standards implicitly requires a measurement of credit
quality, which is defined in terms of the probability of a customer’s default. The probability
estimate for a given customer is for the most part a subjective judgment.

To measure the credit quality and customer’s credit worthiness, the following areas are generally
evaluated:

a. Character. This refers to the probability that the customers will pay their debts or obligations.
b. Capacity. This refers to the judgment of customers’ abilities to pay. It is determined in part by
the customers’ past records and business methods.
c. Capital. It is measured by general financial condition of a firm as indicated by an analysis of its
financial statements. Special emphasis is given to the risk ratios-the debts/assets ratio, the
current ratio and the time-interest-earned ratio.
d. Collateral. It is represented by assets that customers may offer as security in order to obtain
credit.
e. Conditions. This refers to both general economic trends and to special developments in certain
geographic regions or sectors of the economy that might affect customers’ abilities to meet
their obligations.

2. CREDIT TERMS. Credit terms involve both the length of the credit period and the discount given.
 Credit period is the length of time buyers are given to pay for their purchases. Discounts are
price reductions for early payment.
3. COLLECTION POLICY. This refers to the procedures the firm follows to collect past-due accounts.
4. DELINQUENCY AND DEFAULT. Whatever credit policies a business firm may adopt, there will be
some customers who will delay and others who will default entirely, thereby increasing the total
accounts receivable cost. The Optimal credit policy that should be adopted is the one that
provides the greatest marginal benefits.

COST ASSOCIATED WITH INVESTMENT IN ACCOUNTS RECEIVABLE

1. Credit analysis, accounting and collection cost. If the firm is extending credit in anticipation of
attracting more business, it incurs the cost of hiring a credit manager plus assistants and
bookkeepers within the finance department; of acquiring credit information sources and of
generally maintaining and operating a credit and collection department.
2. Capital Cost. Once the firm extends credits, it must raise funds in order to finance it. The
interest to be paid if the funds barrowed or the opportunity cost of equity capital will constitute
the cost of funds that will be tied up in the receivables.
3. Delinquency cost. These costs are incurred when the customer is late in paying. This delay adds
collection cost above those associated with a normal collection. It also creates an opportunity
cost for any additional time the funds are tied up after the normal collection period.
4. Default Costs (Bad Debts). The firm incurs default costs when the customer fails to pay at all. In
addition to the collection costs, capital costs and delinquency costs incurred up to this point, the
firm loses the cost of goods sold not paid for. It has to write off the entire sales once it decides
the delinquent account has defaulted and no longer collectible.

ANALYZING PROPOSED CHANGES IN CREDIT POLICY

If a business enterprise eases its credit policy either by way of lengthening the credit period,
relaxing credit standards and collection policy, or offering cash discounts, then sales should increase.
Cost will also rise because of increase in production costs. Likewise, additional investment in accounts
receivable will increase carrying costs and bad debt and/ or discount expenses may also rise.

MARGINAL OR INCREMENTAL ANALYSIS OF CREDIT POLICIES

Marginal analysis is performed in terms of systematic comparison of the incremental returns

and the incremental costs resulting from a change in the firm’s credit policy. Whenever the incremental
or profit from a proposed change in the management of accounts receivable exceeds the required
return or incremental costs of the additional investment, the change should be implemented. All things
must be equal; the decision concerning the change in credit policy is made using the following rules”
If:
1. Incremental profit contribution > Incremental Cost; then accept the change in credit policy
2. Incremental profit contribution < Incremental cost; then reject the change in credit policy
3. Incremental profit contribution = incremental Cost; then be indifferent to the change