## Collection Practices and Credit-Evaluation Tools
### Objective of Collection
The goal of receivable collection is to reduce, monitor and control receivables while preserving customer goodwill. The guiding principle is to minimise the time lag between sale and collection, which prevents a buildup of receivables and cuts bad-debt risk. Delays usually come from billing/collection inefficiency or from the customers themselves.
### Major Collection Practices
- Timely issue of invoices — faster billing → faster payment cycles.
- Open account / open-end credit — continuous credit flexibility for trusted customers.
- Clear credit terms / time limits — defined payment terms keep receivables manageable.
- Periodic statements & follow-ups — regular reminders track and prompt payment.
- Payment incentives & penalties — early-payment discounts and late fees.
- Record-keeping & continuous audit — accurate tracking gives financial control.
- Export factoring — third-party factors handle credit management, loss protection and collection for exporters.
- Business Process Outsourcing (BPO) — outsource collection to specialist agencies for efficiency and cost savings.
### Financial Tools / Techniques
| Tool | Purpose |
|---|---|
| Credit Analysis | Evaluate customer creditworthiness to minimise bad debts and set terms |
| Credit Rating | Score debtors on financial status, reputation and payment history (e.g. Dun & Bradstreet) |
| Credit Limit Setting | Fix a limit after assessing creditworthiness; raise it with a good payment record |
| Decision-Tree Analysis | Use probability to weigh the risk vs. benefit of granting credit |
| Receivables Control | Monitoring and follow-up to enforce credit policy |
| Collection Policy | Ensure timely collection, minimise bad debts, cut average collection period |
Sources for credit evaluation: trade references, bank references, credit-bureau reports, past experience, published financial statements, and salesman's reports.
### Decision-Tree Analysis for Granting Credit
When deciding whether to grant credit, model it as a decision tree. If credit is granted, the customer either pays (probability `p₹) giving a profit, or does not pay (probability ₹1−p₹) giving a loss. Compute the expected net benefit; grant credit only if it is positive.
```
Credit Evaluation
/ \
Grant Do not Grant
/ \
Pays Does not Pay
p = 0.9 1−p = 0.1
profit loss
```
### Key Questions a Collection Policy Must Answer
- When should collection effort start?
- What is the procedure for follow-ups and reminders?
- Should representatives visit defaulting customers?
- How are doubtful accounts handled — legal action or an escalation matrix?
The policy must strike a balance between efficient collection and good customer relations — chase too hard and you lose the customer.