## Management of Receivables
### Meaning and Objective
Management of receivables refers to planning and controlling the debt owed to the firm from customers on account of credit sales. Also called trade credit management.
Basic Objective: Optimize the return on investment in receivables.
The fundamental trade-off:
| Situation | Problem |
|---|---|
| Large receivables | Higher bad debt risk + higher collection costs |
| Low/tight receivables | Restricts sales growth and competitiveness |
→ Proper policy is essential to strike the right balance.
---
## Three Aspects of Debtors Management
### 1. Credit Policy
Involves decisions on:
- Credit standards — Who qualifies for credit?
- Credit terms — For how long? At what discount?
- Collection efforts — How aggressively to pursue overdue accounts?
A firm's Cash Discount Policy specifies three elements:
1. Cash Discount Period
2. Cash Discount Rate
3. Net Credit Period
### 2. Credit Analysis
The finance manager assesses how risky it is to extend credit to a particular customer.
- Involves due diligence on creditworthiness
- Uses financial statements, credit reports, and trade references
### 3. Control of Receivables
- Lay down and execute collection policies
- Follow up with debtors regularly
Four Costs of Maintaining Receivables:
| Cost | Description |
|---|---|
| Cost of funds blocked | Opportunity cost of capital tied up |
| Administrative costs | Record-keeping, billing, management |
| Collection costs | Costs of chasing overdue payments |
| Defaulting costs | Bad debts written off |
---
## Factors Determining Credit Policy
| Factor | Consideration |
|---|---|
| Impact on sales | Does tighter/looser credit affect revenue? |
| Credit terms | Period and conditions offered |
| Cash discount | Rate and period of early-payment discount |
| Customer selection | Criteria for approving applications |
| Customer payment habits | Historical behavior of customer segments |
| Collection policies | Aggressiveness of debt recovery |
| Billing/record-keeping | Efficiency of invoicing and documentation |
> Lenient policy → Higher sales but higher bad debt risk
> Stringent policy → Lower risk but potential loss of customers
---
## Factors Under the Finance Manager's Control
1. Supervising credit administration
2. Contributing to top management's credit policy decisions
3. Deciding criteria for credit application selection
4. Speeding up conversion of receivables into cash via aggressive collection policy
---
## Financing Receivables
When goods/services are sold on credit, money is locked in receivables. To free up funds and manage cash flow, businesses use receivable financing methods (e.g., factoring, discounting bills) to convert receivables into immediate cash.