Account Receivables Management

What Account Receivables Management?

Accounts receivable is money owed to a firm when it sells its products or services on credit and it does not receive cash immediately.

Account Receivables occupy an important position in the structure of current assets of a firm. They are the outcome of rapid growth of credit sales granted by the firms to their customers. Credit sales are reflected in the value of Sundry Debtors [SD’s in India]. It is also known as Trade Debtors (TD’s), Accounts Receivable (BR’s) on the asset side of balance sheet. Trade credit is most prominent force of modern business.

Objectives of Account Receivables Management

The following are the main objectives of accounts receivables management:

  1. Maximizing the Value of the Firm
  2. Optimum Investment in Sundry Debtors
  3. Control and Cost of Trade Credit
Objectives of Account Receivables Management
Objectives of Account Receivables Management

Maximizing the Value of the Firm

The basic objective of debtors’ management is to maximize the value of the firm by achieving a trade off between liquidity (risk) and return. The main purpose of receivables management is to minimize the risk of bad debts and not maximization of order. Efficient management of receivables expands sales by retaining old customers and attracting new customers.

Optimum Investment in Sundry Debtors

Credit sales expand, but they involve a block of funds, that have an opportunity cost, which can be reduced by optimum investment in receivables. Providing liberal credit increases sales consequently profits will increases, but increasing investment in receivables results in increased costs.

Control and Cost of Trade Credit

When there are zero credit sales, there will not be any trade credit costs. But credit sales increase profits. It is possible only when the firm is able to keep the costs at a minimum.

Costs of Accounts Receivables Management

Management of accounts receivables is not cost-free. The following are the main costs associated with accounts receivables management:

  1. Opportunity Cost
  2. Collection Cost
  3. Bad Debts

Opportunity Cost

Providing goods or services on credit involves a block of a firm’s funds. In other words, the increased level of accounts receivables is an investment in current assets. These blocked funds or investments in receivables need to be financed, by shareholders funds or from short-term borrowings.

They involve some cost. If receivables are financed by shareholder funds, there involves opportunity costs to shareholders. If they are financed by borrowed funds, it involves payments of interest, which is also a cost.

Collection Cost

Collection of receivable is on of the tasks of receivables management. Collection costs are those costs that are increased in collecting the debts from the customers to whom the credit sales have been granted.

The collection cost may include, staff, records, stationery, postage they are related to the maintenance credit department, and exposes details involved in collecting information about a prospective customer, from specialized agencies, for evaluation of prospective customer before going to grant credit.

Bad Debts

Sometimes customers may not be able to honor the dues to the firm because of the inability to pay. Such costs are referred as bad debts, and they have to be written of because they cannot be collected. These cost can be reduced to some extent, if the firm properly evaluates customer before granting credit, but complete avoidance is not possible.

Benefits of Accounts Receivable Management

The importance of accounts receivable management are:

  1. Increased Sales
  2. Market Share Increase
  3. Increase in Profits
Benefits of Accounts Receivable Management
Benefits of Accounts Receivable Management

Increased Sales

Providing goods or services on credit expands sales, by retaining old customers and attraction of prospective customers.

Market Share Increase

when the firm’s able to retain old customer and attract new customer automatically market share will be increased to the extent of new sales.

Increase in Profits

Increased sales, leads to increase in profits, because, it need to produce more products with a given fixed cost and sales of products with a given sales network, in both cost per unit comes down and the profit will be increased.

Techniques for Monitoring Quality of Accounts Receivable

There are three main techniques considered by this paper for monitoring the quality of accounts receivables and they are:

Techniques for Monitoring Quality of Accounts Receivable
Techniques for Monitoring Quality of Accounts Receivable

Average Collection Period

The Average Collection Period (ACP) represents the average number of days’ accrued debt, resulting from sales remains outstanding. Average collection period has two components, according to Graham, Scott (2010); the first components is when time sales is realized to the period the customer initiates payment. The second component deals with the receipt, processing and collection of the payment once initiated by the customer.

On the assumption that the receipt, processing and collection time is constant, then the Average Collection Period project to the firm, the number of days (on average) it takes customers to pay their debts (Graham et al, 2010).

The estimated average collection period may be used by the firm for trend analysis to compare the collection period over time. Secondly, it may be used to compare with the set target by the firm as well as comparing with the industry average. It is mathematically represented as shown below;

ACP = (Average accounts receivable x 365) / Credit sales

Accounts Receivable Aging Schedule

This method is used to monitor accounts receivable by segmenting receivables by their ages, thus the number of days outstanding using an aging schedule. It provides useful information about the state of a firm’s accounts receivable. Table 1 below provides an example of an aging schedule.

Age of accountReceivable amount ($)Percentage of Total Value
0 – 10 days220,00044.0
11 – 30 days166,50032.002
31 – 60 days97,40019.48
61 – 90 days22,5004.50
Beyond 90 days9,0000.017
Total Value500,000100.0
Table 1: Aging schedule for Accounts Receivable

Table 1 depicts that 76.02% of the firm’s accounts receivable are 30 days or less old. If the firm offers 30 days credit sales, then 23.98% of the receivables are past due.

The firm must figure out why much of its outstanding receivables are past due; are customers experiencing temporary financial difficulties? Are customers reluctant in paying due to issues with the product quality? Which customers will eventually pay and which receivables should be considered as bad and doubtful debt and even to be written off as bad debt expense.

Payment Pattern

Payment pattern is the trends customers usually follow in settling their debts. It is expressed as the percentage of total collection of sales made within the month. One approach to determine the payment pattern is to analyze the company’s sales and resulting collections on a monthly basis.

Thus, for each month’s sales, the firm computes the amount collected within the period and that of the subsequent months as well. Every business has a pattern in which its receivables are paid, if changes occur in the payment pattern, the firm should consider reviewing its credit policies.

By tracking these patterns over a period of time, the company can determine the average pattern of its collection using either spreadsheet or regression analysis. For most companies, these patterns tend to be fairly stable over time even as sales volumes fluctuate (Megginson, 2010).

Pricing administration, order processing and invoicing accuracy is of unique importance in management success. There are some basic practices that enhance pricing and invoicing accuracy. They include: Keeping the pricing policies clear and devoid of ambiguity; complex pricing structure complicates receivable management; for example, a large firm selling numerous different products whose prices change sporadically.

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