MANAGEMENT

OF
RECEIVABLES
Meaning of Receivables
Management
Receivables are a direct result of credit sales. Credit sales push up firm‘s
sales which ultimately result in pushing up of profits earned by the firm.

 Additional funds are, therefore, required for the operations of the

business which involve extra cost-
Cost of Working Capital
Interest
Bad debts

Therefore a firm should follow a policy which uses cash funds as

economically as possible in extending receivables without adversely
affecting the chances of increasing sales and making more profit.
Definition:
Management of receivables may, therefore, be defined
as the process of making decisions relating to the
investment of funds in this asset which will result in
maximizing the overall return on the investment of
the firm.
Cost of Maintaining Receivables
Administrative Costs

Capital costs

Collection cost

Delinquency cost

Default costs
Administrative Cost:
If a firm liberalizes its credit policy for the good reasons of
either maximizing sales or minimizing erosion of sales, it
incurs two types of costs:
 Credit Investigation and Supervision Cost:
 As a result of lenient credit policy, there is a substantial
increase in the number of debtors. As a result the firm is
required to analysis and supervise a large volume of
accounts at the cost of expenses related with acquiring
credit information either through outside specialist
agencies or from its own staff.
Capital Cost
Maintenance of receivables by a firm leads to blockage of its
financial resources due to the time lag that exists between the
sale of goods to the customers and the payment made by them.

But the firm has to arrange for additional funds to meet its own
obligations, such as payments to the employees, suppliers of
raw materials, etc.

As a consequence, a firm is liable to make arrangements for

meeting such additional obligations from sources other than
sales. Thus, a firm in the course of expanding sales through
receivables makes way for additional capital costs.
Production and Selling Cost: These costs are directly
proportionate to the increase in sales volume. In other words,
production and selling cost increase with the very expansion
in the quantum of sales.

In this respect, a firm confronts two situations; firstly when

the sales expansion takes place within the range of existing
production capacity, in that case only variable costs relating
to the production and sale would increase.

Secondly, when the production capacity is added due to

expansion of sales in excess of existing production capacity.
In such a case incremental production and selling costs
would increase both variable and fixed costs.
Collection Cost
A firm will have to intensify its collection efforts so as
to collect the outstanding bills especially in case of
customers who are financially less sound.

It includes additional expenses of credit department

incurred on the creation and maintenance of staff,
accounting records, stationary, postage and other
related items.
Delinquency Cost
Delinquency cost is cost arising out of failure of
customers to pay on due date.
Default Cost
Default cost emerges as a result of complete failure of a
defaulter (customer) to pay anything to the firm in
return of the goods purchased by him on credit.

When despite of all the efforts, the firm fails to realize

the amount due to its debtors because of his complete
inability to pay for the same. The firm treats such debts
as bad debts, and cannot be recovered in any case.
Key decision areas in
Receivables Management
Credit Policies

Credit Terms

Collection Policies
Credit Policies
 The credit policy of a firm provides the framework to determine whether
or not to extend credit to a customer and how much credit to extend.

 A firm practicing lenient or relatively liberal credit policy its size of

receivables will be comparatively large than the firm with more rigid
credit policy.

 The credit policy decision of a firm has two broad dimensions:

 Credit analysis
 Credit standards

 Credit analysis
 A firm has to establish and use standards in making credit decisions,
develop appropriate sources of credit information and methods of credit
analysis.
Credit Standards
The term ‘credit standards’ represents the basic criteria for the
extension of credit to customers.

Factors should be considered while deciding whether to relax

credit standards are
Investments in Receivables or the Average Collection Period
Level of bad debt losses
Level of sales

The implications of relaxed credit standards are more credit, a large

credit department to service accounts receivable and related
matters, increase in collection costs.

The effect of tightening of credit standards will be exactly the

opposite.
Investments in Receivables or the Average
Collection Period: 
 The investment in accounts receivable involves a capital cost as funds
have to be arranged by the firm to finance them till customers make
payments.

 A change in the credit standards–relaxation or tightening–leads to a

change in the level of accounts receivable either through a change in
(a) sales, or (b) collections.

 In contrast, a tightening of credit standards would signify decrease in

sales and lower average accounts receivable, and an extension of credit
limited to more creditworthy customers who can promptly pay their
bills and, thus, a lower average level of accounts receivable.

 Thus, a change in sales and change in collection period together with a

relaxation in standards would produce a higher carrying costs, while
changes in sales and collection period result in lower costs when credit
standards are tightened.
Bad Debt Expenses:  
Another factor which is expected to be affected by
changes in the credit standards is bad debt (default)
expenses. They can be expected to increase with
relaxation in credit standards and decrease if credit
standards become more restrictive.

Sales Volume  
Changes in credit standards can also change the volume
of sales. As standards are relaxed, sales are expected to
increase; conversely, a tightening is expected to cause a
decline in sales.
Credit Terms
The second decision area in accounts receivable
management is the credit terms. After the credit standards
have been established and the creditworthiness of the
customers has been assessed, the management of a firm
must determine the terms and conditions on which trade
credit will be made available.

The stipulations under which goods are sold on credit are

referred to as credit terms. These relate to the repayment of
the amount under the credit sale. Thus, credit terms
specify the repayment terms of receivables.
Credit period, in terms of the duration of time for
which trade credit is extended–during this period the
overdue amount must be paid by the customer; Cash
discount, if any, which the customer can take
advantage of, that is, the overdue amount will be
reduced by this amount

Cash discount period, which refers to the duration

during which the discount can be availed of. These
terms are usually written in abbreviations, for
instance, ‘2/10 net 30’.
Collection Policies
 The policy, practice and procedure adopted by a business enterprise in
granting credit, deciding as to the amount of credit and the procedure
selected for the collection of the same also greatly influence the level of
receivables of a concern. The more liberal collection policies the more
amount in receivables are required for the purpose of investment.

 Collection policies relates to the steps that should be taken to collect over
dues from the customers. A well-established collection policy should have
clear-cut guidelines as to the sequence of collection efforts. After the
credit period is over and payment remains due, the firm should initiate
measures to collect them.

 The collection policy would be tight if very rigorous procedures are

followed. A tight collection policy has implications which involve benefits
as well costs. The management has to consider a trade-off between them.
Likewise, a lenient collection effort also affects the cost-benefit trade-off