RECEIVABLES

MANAGEMENT
  Trade credit happens when firms sells its products or services on
credit and does not receive cash immediately
 A firms grants trade credit to protect its sales from the competitors
and to attract the potential customers to buy its product

RECEIVABLES  Trade credit creates accounts receivables or trade debtors also referred
as book debts in India
MANAGMENT  A credit sale has three characteristics
 It involves an element of risk
 It is based in economic value
 It implies futurity
  Large amount is tied up in receivables
 There are chances of bad debts and there will be cost of collection of
debts
 In India after Inventories ,Trade debtors are the major component of
Importance of current assets
 Granting credit and creating debtors amount to blocking of the firm’s
Debtors funds.
Management  The interval between date of sale and the date of payment has to be
financed out of working capital
 This necessitates the firm to get funds from banks or other sources
 Trade debtors represents investment
 As substantial amount are tied up in Trade debtors it requires careful
analysis and proper management.
 • Volume of credit sales
• Collection period
Credit Policy • Discount offered, if paid early

ASPECTS OF •
•
Type of customer
Time taken by customer to pay and default rate
MANAGEMENT Credit analysis • Average collection period(ACP)

OF DEBTORS • Three C’s :Character, Capacity and Condition

• Requirement of additional funds as resources

Control of are blocked
• Administrative costs of record
receivable keeping ,investigation of credit worthiness
• Collection costs, Defaulting costs
  It is an important factor determining both the quantity and quality
of accounts receivables
 The factors which determine the size of the investment a company
makes in accounts receivables are as follows:
Volume of sales
Factors Credit terms
determining Cash discount
Credit Policy  Policies and Practices of the firm for selecting credit customers
 Paying practices and habits of the customers
 The Firm’s policy and practice of collection
 The degree of operating efficiency in the billing and record keeping
 The firm may follow a lenient or stringent credit policy
  Supervising the administration of credit
Factors under  Contribute to top management decision relating to the
best credit policies of the firm
control of  Deciding the criteria for selection of credit applications
finance  Speed up the conversion of receivables into cash by
manager aggressive collection policy
  Increased Sales
 Anticipated Profits
 With relatively liberal policy there will be higher investment in
receivables

Benefits from  However cost will be higher with liberal policies

credit sales  Receivable management should aim at trade-off between profit and
risk
 The cost and benefits to be compared are marginal costs and
benefits
 The firm should consider incremental (additional )benefits and
costs that result from change in credit policy
  Consideration should be given to the company’s investment in
accounts receivable since there is an opportunity cost associated
with holding receivable balances. 
 The major decision regarding accounts receivable is the
Other points to determination of the amount and terms of credit to extend to
customers.
be noted  The credit terms offered have a direct bearing on the associated
costs and revenue to be generated from receivables.
 For example, if credit terms are tight, there will be less of an
investment in accounts receivable and less bad debt losses, but
there will also be lower sales and reduced profits. 
  Additional sales should add to firm’s operating profit.
 There are three types of costs involved:-Production costs and
selling costs, Administration costs and Bad-debt losses
 If Sales expand within the existing capacity, then only variable
costs will increase.

Evaluation of  If capacity is added then incremental costs will include both

variable and fixed costs
change in  Due to loosening of credit policy there will increase in the
credit policy operating profits of the firm and there will be increase in the bad
debts also
 Also there will be opportunity cost involved due to holding of
receivables(due to relaxing credit policy). It is opportunity costs of
fund tied up in receivables which would not have been incurred if
all sales were in cash
  1)Cost of receivables(Opportunity costs of receivables) = Investment in
receivables X Opportunity costs(%)

 2)Investment in receivables = (FC+ VC)/Days in year) X DSO

Formulas  Where, FC = Fixed Cost, VC = Variable Cost and DSO = Days sales
outstanding.(collection period of customers)

 3)Bad debt losses = Annual credit sales X Percentage default by the

customer
  The important source of financing of receivables are Pledging and
Factoring now- a-days:
 1) Pledging-The firm will use its receivables to secure a short-
term loan .
 A firms receivables can be termed as its most liquid asset and this
serves as prime collateral for a secure loan
Financing of  The lender scrutinizes the quality of receivables ,selects acceptable
Receivables accounts, create lien on the collateral and fixes the percentage of
financing receivables which ranges from 50 to 90%
 The major advantage is the ease and flexibility
 Financing is done regularly
  Factoring-It is relatively a new concept in financing of accounts
receivables.
 Factoring is a financial transaction whereby a business sells its
accounts receivable i.e. invoices to a third party called a factor at a
discount in exchange for immediate money with which to finance
continued business .
Financing of  Factoring differs from a bank loan in three main ways:
Receivables  First, the emphasis is on the value of the receivables (essentially a
financial asset), not the firm’s credit worthiness.
 Secondly, factoring is not a loan - It is the purchase of a financial
asset(the receivable).
 Finally a bank loan involves two parties whereas factoring
involves three
  Through the use of factoring receivables are instantly converted
into cash leading to improved cash flows that can help funding of
future growth.
 It facilitate an efficient follow up of payments from buyers, which
Why use is made possible through relationships developed by factors with
client buyers .
factoring?  Factoring provides credit protection for export sales which enables
to do business with buyers who are unwilling to open letters of
credit .
 Factoring also provides other peripheral services such as advisory
services, credit assessment.
  There are basically two types of factoring arrangements: Domestic
factoring –If you are selling in India.
 The factoring arrangement where all the three –the factor, the seller
Types of & the buyer are in the same country subject to the same laws.
factoring  International factoring - If you are exporting from India. The
arrangements factoring arrangement where the seller & the buyer are in two
different countries involving co-operation between two factoring
companies, one in the seller’s country (export factor) and other in
the buyers country (import factor). 
  Recourse factoring
 In this type of factoring arrangement, the factor provides all types of
facilities except debt protection. In other words, the client is
responsible for any bad debts incurred.
 Invoice discounting-in this type of factoring arrangement only
finance is provided and no other service is offered.
Types of
 Up to 75% to 85% of the invoices receivable is factored.
factoring
 Interest is charged from the date of advance to the date of collection.
arrangements  Factor purchases Receivables on the condition that loss arising on
account of non-recovery will be borne by the client.
 Credit Risk is with the Client.
 Factor does not participate in the credit sanction process.
 In India, factoring is done with Recourse.
  Non-Recourse factoring- It is the most comprehensive type of
factoring arrangement offering all types of services namely:
 Finance
 Sales ledger administration
Types of  Collection
factoring  Debt protection
arrangements  Advisory services
 It gives protection against bad debts to the client.
 In other words, in case the customer fails to pay, the factor will
have “no recourse” to the client and will have to absorb the bad
debts himself.
  Most conventional factoring transactions are structured as
two disbursements.
 The first payment, the advance, can be as high as 85% of the
invoice value, and is made once the invoice is received. The
remaining 15% is held in reserve until the invoice is paid.
Factoring-Why Once the invoice is fully paid, the reserve is rebated, less any
fees.
do factoring  Assume that the invoice is for $100, the factoring fee is $2,
company hold and the advance rate is 85%.

a reserve 1.The invoice arrives and the factoring company advances $85
2.30 days later, the factor receives the $100 payment from the
customer
3.The factor rebates $13. ($100 – $85 advance – $2 fee = $13)
  Now, let’s look at the same transaction, but let’s assume that
the advance rate is 98% and that there is a $4 charge back
for defective items (which can happen).
1.The invoice arrives and the factoring company advances $98
2.30 days later, the factor receives a $96 payment, with a $4
Factoring-Why charge back / credit note
do factoring 3.The transaction can’t be settled because the received
payment is not enough to cover the advance and the fee
company hold 4.The fact that the transaction can’t be settled creates a
a reserve problem for both the client and the finance company. The
client will have to provide funds so that the transaction can
clear. To avoid this problem, factoring companies try to set
up reserves sufficient to cover any potential charge backs
and credit memos.
  The cost associated with factoring are commission, interest.
 Though both factoring and bill discounting provides short term
finance, however in bill discounting the drawer undertakes the
responsibility of collecting the bills and pay the proceeds while in
Factoring and factoring it is the factor that usually undertakes the responsibility of
collecting the bills.
Bill  Bill discounting is always of recourse type while factoring can be
discounting either with or without recourse
 Factoring is an off balance sheet entry in the sense that both amount
of receivables and bank credit are not shown in the balance sheet
which is not the case with the bill discounting which is shown in
the balance sheet.
  The aging schedule of debtors removes one of the limitations of
the average collection period.
 It breaks down the receivables according to the length of time for
which they have been outstanding

Aging  The aging schedule provides information about the collection

experience
schedule of  The aging schedule is used to identify clients that are late in paying
Debtors their invoices. If the bulk of the overdue amount is attributable to a
single client, the business can take necessary steps to ensure that the
customer’s account is collected promptly.
 If there are several customers with overdue amounts that extend
beyond 60 days, it may signal the need to tighten the credit policy
towards the existing and new clients.
  This company has $100,000 in accounts receivable. They
offer a discount if customers pay their bills within 10 days,
which is the discount period. That's why you see the first
line of the aging schedule as 0-10 days. Looking at the
table, you can see that 20% of the firm's customers take
the offered cash discount.

Aging Age of Account Amount % Total Value of

Receivables
schedule of 0-10 days $20,000 20%
Debtors 11-30 days 40,000 40%
31-60 days 20,000 20%
61-90 days 10,000 10%
Over 90 days 10,000 10%
$100,000 100%
 • Trade Credit
• It refers to the credit extended by the supplier of goods and services
in the normal course of transaction
Financing of • Cash is not paid immediately but at an agreed period of time
Working • There is an informal arrangement between buyer and the seller.
capital and • There is variant of accounts payable i.e bills payable.
Short-term • It represents documentary evidence of credit purchases and a
formal acknowledgement of obligation to pay for credit purchases
financing on a specified date of maturity failing which a legal action will
follow
Financing of  Working capital finance is provided by banks in following ways
Working  i) Cash credits/Overdrafts
capital and  ii) Loans

Short-term  iii) Purchase /discount bills

 iv)Working capital term loans
financing
 • Cash Credit/Overdraft form of arrangement bank specifies a
predetermined borrowing /credit limit
• Within the specified line of credit any number of drawals /drawings
Financing of are possible
Working • Repayments can be paid whenever desired

capital and • The interest is determined on the basis of the running balance
/amount actually utilised by the borrower and not on the basis of
Short-term sanctioned loan

financing • The credit limit extended on the cash credit account is normally a
percentage of the value of the collateralized security.
• Although it is a collateralized form of financing, cash credit is
normally subject to credit approval.
 • A bank would levy charges in the situation when the borrower is
Financing of not using the cash credit account. It’s undeniable from the bank’s
point of view as it is blocking some amount of its ‘float’ for the
Working borrower. These are known as minimum commitment charges.
capital and • A cash credit facility is extended against security. Securities may be
in the form of stock, debtors, etc. as primary security and fixed
Short-term assets and other immovable properties, etc. as collateral security.
financing • The limit allowed is valid for one year, and then the drawing power
will be re-evaluated. 
  MPBF is a method for assessing the working capital requirements
of corporates.
MPBF-  The premise of all the methods of bank finance is just that the
Maximum corporate would put his own contribution let's say x% in the
business/cycle/current assets and the bank would fund (100-x)%.
Permissible This is to ensure commitment from the borrower and to ensure that
Bank finance he isn't over funded by the bank. Overfunding the corporate might
lead to diversion of funds to areas which aren't related to his
business like in real estate/stocks etc.
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PERMISSIBLE
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FINANCE –
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FINANCE –
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FINANCE –
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  Commercial Paper (CP) is an unsecured and discounted promissory note
issued to finance the short-term credit needs of large institutional buyers.
 CPs are currently traded in OTC market settled through clearing
corporations.
 CPs were first introduced in India in the year 1990
 CPs enable a corporate to avail short-term funds from the money market
Commercial within the shortest possible time
 Commercial paper is usually issued by companies with very high credit
Papers ratings
 The CPS can be issued by Companies including NBFCs fulfilling
norms:
 Having net worth of ₹ 100 crore or higher
 Any fund-based facility availed of from bank(s) and/or financial
institutions is classified as a standard asset by all financing
banks/institutions at the time of issue
  CP shall be issued in minimum denomination of ₹ 5 lakh and multiples thereof
 CPs are issued at a discount to face value as may be determined by the issuer.
Investors purchase CPs below par and then receive their face value at maturity.
 Every CP shall have a credit rating
 CPs shall have a minimum credit rating of ‘A3’ as per rating symbol and
Commercial definition prescribed by SEBI
 CPs have minimum maturity pf seven days and maximum maturity of 365 days
Papers  Interest on CP is less than the bank borrowing rate
 A firm does not pay interest on CP rather sells it at a discount rate from face
value.
 The yield calculated on this basis is referred to as interest yield
  Interest shield=FV-SP/SP X 360 /days of maturity
 Sales price will be net of floatation costs associated with the issue
of commercial paper
 Suppose a firm sells 120 day CP (Rs.100 FV ) for Rs.96 net,the
interest yield will be 12.5%
 Interest yield =100-96/96 X 360/12
Commercial  12.5%
Papers  In India the cost of Cp will include the following :
 Discount
 Rating charges
 Stamp duty
 Issuing and paying agent charges