Receivable Management

Objective of Receivable Management

To encourage sales and gain additional

customers by extending credit.
Factors in Determining Accounts
Receivable Policy
Credit Standards

Credit Terms

Collection Program

Deliquency and default

Cost Associated with Accounts
Receivable
 Credit Analysis, Accounting and collection costs

 Capital Costs

 Deliquency Costs

 Default Costs ( Bad Debts )

 Summary of Trade-offs and Collection Policies
Benefits Costs

1. Relaxation of Credit a.) Increase in sales and a.) increase in credit

Standards total contribution margin b.) increase in collection
costs
c.) higher default costs
d.) higher capital costs
2.) Lengthening of credit a.) increase in sales & a.) higher capital costs
period total contribution margin

3.) Granting cash a.) increase in sales & a.) lesser profit
discount total contribution margin
b.) opportunity income
on lower investment in
receivable
4.) Intensified collection a.) lower default costs a.) higher collection
efforts b.) lower opportunity expense
cost or capital cost. b.) lower sales
 Marginal or Incremental Analysis or
Credit Policies
 It is performed in terms of a systematic comparison of the incremental
returns and the incremental costs resulting from a change in the firm’s
credit policy. All things being equal, the decision concerning the change in
credit policy is made using the following rules.

Incremental Profit
Contribution
Incremental Cost
; Then accept the
change in credit
policy
Incremental Profit
Contribution
Incremental Cost
; Then reject the
change in credit
policy
Incremental Profit
Contribution
Incremental Cost
; Then be indifferent to
the change in credit
policy
Case V. Relaxation of Credit Policy

 ABC Corporation’s product sells for P10 a unit of which P7 represents

variable costs before taxes including credit department cost. Current
annual credit sale are P2.4 million. The firms is considering a more liberal
extension of credit, which will result in a slowing in the average collection
period from one month to two months.

 The relaxation in credit standards is expected to produce a 25% increase in

sales. Assume that the firm’s required rate on investment is 20% before
taxes. Bad debts losses will be 5% incremental sales and collection
expenses will increase by P20,000.

 Required: Should the company liberalize its credit policy?

Solution:
 Incremental contribution margin from
additional units (P60,000 x P3) P180,000
 Less: Bad debts (P600,000 x 5%) P 30,000
Collection Expenses P 20,000
Total P 50,000
Net Incremental Profit P 130,000
Required return on additional investment:
Present level of receivables
(2.4 million / 12 mos.) P 200,000
Level of receivables after change in
credit policy ( 3 million / 6 mos.) P 500,000
Additional Receivables P 300,000
Additional Investment in receivables
(P300,000 x 70%) P210,000
Multiply by Required Return 20%
Required return on additional investment P 42, 000
Conclusion:

In as much as the profit on additional

sales of P130,000, exceeds the required
return on additional investment of P42,000,
the firm would be well-advised to relax its
credit standards
Case VI. Change in Credit Terms
 The Roman Shades Company has 12 % opportunity cost of capital and
currently sells on terms n/20. It has current annual sales of P10 million, 80% of
which are on credit. Current average collection period is 60 days. It is now
considering to offer terms of 2/10, n/30 in order to reduce the collection
period. It expects 60% of its customers to take advantage of the discount
and the collection period to be reduced to 40 days.
 Required: should the company change its terms from n/20 to 2/10, n/30?
Solution: Present Proposed

Opportunity Cost(ROI x
Average Receivables)
Present (12% x 1.333 M) P160,000
Proposed (12 % x 0.888 M) P 106,667
Sales Discount
(P8M x 60% x 2%) P96,000
Total P160,000 P202,667

Conclusion:
The company would be better off by maintaining the present credit terms and policy of not
Granting cash discount because of the lesser costs involved as shown above.