Presentation on theme: "Working Capital, Credit and Accounts Receivable Management"— Presentation transcript:
1 Working Capital, Credit and Accounts Receivable Management
2 Cash Flow Cycle of a Business Purchase ofMaterialsPayment forSale ofProductCollect A/RDays’ InventoryCash Conversion CycleDays’ ReceivablesDays’ PayablesDay 1Day 30Day 45Day 75
3 Working Capital Cash Flow Cycle: Cash Conversion Cycle Formulas for three time periods are necessary to calculate the cash conversion cycle.
4 Credit Policy and Collections Order Order Sale CashPlaced Received ReceivedAccounts Collection< Inventory > < Receivable > < Float >Time ==>Accounts Disbursement< Payable > < Float >Invoice Payment CashReceived Sent Paid
5 Objectives of Credit Management Creating, preserving, and collecting A/R.Establishing and communicating credit policies.Evaluation of customers and setting credit lines.Ensuring prompt and accurate billing.Maintaining up-to-date records of accounts receivables.Initiating collection procedures on overdue accounts.
6 Reasons to Offer Credit CompetitionMarket SharePromotionCredit Availability to CustomersCustomer ConvenienceProfit
7 Credit and A/R Management: Fit Into the Financial Organization A credit manager or a captive finance company is the administrator of credit policies.Credit policies and collections will impact cash flows so credit and cash managers must work together.Reasons for credit and cash manager interaction include the accuracy of cash flow forecast, banking network management, and accounts receivable updating.
8 Cost Associated With a Credit Policy Credit Department CostsCredit Evaluation CostsA/R Carrying CostDiscounted PaymentsSelling and Production CostCollection ExpensesBad Debts
9 Analysis of Credit Extension NPV = Sales – Collection Expense Variable1+(Cost of Cap. X Coll. Days) CostsIf NPV > 0 then Extend Credit
10 Forms of Credit Extension Installment CreditRevolving CreditLetters of CreditOpen Account
11 Common Terms of Sales Cash Before Delivery (CBD) Cash on Delivery (COD)Cash TermsNet TermsDiscount TermsMonthly BillingBill of Lading or Documentary CollectionSeasonal DatingConsignment
12 The Five C’s of Credit Character Capacity Capital Collateral Conditions
13 Cost of Trade CreditFrom a seller’s viewpoint, the cost of the discount must be weighted against the benefit of receiving early payment.From buyer’s viewpoint, the cost of trade credit is an opportunity cost.A buyer should take the discount if its cost of borrowing is less than the cost of foregoing the discount.Alternatively, a buyer should forego the discount if investment rates are higher than the cost of foregoing the discount.
14 Cost of Trade Credit Cost of Trade Credit = Early Payment Discount x(1 – Early Payment Discount) (Net Payment Period -Discount Payment Period)
15 Annualized Cost of Trade Credit Example Assuming terms of 2/10, net 45, the cost of not taking the discount can be determined as follows:If the company can borrow at less than 21.28%, it should do so and use the borrowed funds to pay early and take the discount.
16 Account Receivable Monitoring and Control Monitoring and control is the responsibility of the credit manager.Receivables turnoverleast favored techniqueMonitoring conducted on individual accounts through aging schedules.Monitoring conducted at the aggregate level using days’ sales outstanding (DSO).
17 DSO Can give an indication of overall collection efficiency. Changes in sales volume, payment patterns, or strong seasonality in sales can distort DSO.
18 Days’ Sales Outstanding (DSO) Assume that a company has outstanding receivables of Rs350,000 at the end of the first quarter and credit sales of Rs425,000 for the quarter. Using a 90-day averaging period, the DSO for this company can be computed as follows:If the company’s credit terms are net 60, the average past due is computed as follows:
19 Aging ScheduleIs a list of the percentage and/or amounts of outstanding A/R classified as current or past due.Used primarily to identify past due accounts.Can be prepared at the aggregate level or customer-by-customer.Subject to distortions due to sales variations.
20 Aging ScheduleSeparates A/R into current and past due receivables in 30-day increments (on a customer or aggregate basis) and can determine the percent past dueAge of AccountsA/R% of A/R0 – 30 days31 – 60 days61 – 90 days91 + daysTotalRs1,750,000Rs375,000Rs250,000Rs125,000Rs2,500,00070%15%10%5%100%
21 A/R Balance PatternGives the percent of credit sales in a time period that remains outstanding at the end of each time period.Based on aging schedules.It is not directly affected by sales variations.A useful tool in cash flow forecasting because it can be used to project A/R levels and collections.
22 Remaining A/R from Month Sales at End of March A/R Balance PatternMonth SalesSalesRemaining A/R from Month Sales at End of MarchFebruaryJanuaryMarchAprilRs250,000Rs300,000Rs400,000Rs500,00020%55%95%Remaining A/Ras a % of Month SalesRs50,000Rs165,000Rs380,000The total outstanding A/R balance at the end of March is:Rs595,000 = (Rs50,000 + Rs165,000 + Rs380,000)The estimate of cash inflows for April = 5% of April sales + 40% of March sales + 35% of February sales + 20% of January sales:Estimated April inflows = (0.05 x Rs500,000) + (0.40 x Rs400,000)+ (0.35 x Rs300,000) + (0.20 x Rs250,000) = Rs340,000
23 A/R Financing Unsecured Bank Borrowing Secured Bank Borrowing Captive Finance CompanyThird Party Financing InstitutionsCredit CardFactoringPrivate Label Financing
24 Evaluate Changes in Credit Policy Credit term change decision variableseffect on dollar profitssales effectreceivables effectreturn on investment effectdefault probabilitycredit limitsopportunity cost of funds invested in receivablescompany’s overall cost of capital
25 Cash ApplicationCash application is the process of matching and applying a customer’s payment against accounts receivable.Done via an Open Item or a Balance Forward system.
26 Open Item System Used in commercial transactions. Each invoice is recorded separately in an account receivable file.Payments are matched to the particular invoice in the file.
27 Balance Forward System Used in retail applications.Credit limits are established for each individual.As purchases are made, A/R increase.Payments are applied against the aggregate A/R outstanding.
28 Collection Procedures Typical collection effortinitial contact within 10 days of delinquencythen reminder letter followed by phone callsales force notifiedlast resort, reference to collection agency/legal actionCollection agencyPhase 1 - computer generated collection letter, when accounts are 45 to 90 days past duePhase 2 - commissioned collectors used
29 Collection Procedures Companies tend to be more aggressive the larger the receivables balanceCompanies understand the good-will tradeoff when selecting collection methods
30 International Credit Management Credit policy analysislengthening terms increases exchange rate riskalso increases default riskharder to get D&B reportsharder to get bank credit informationModifying monitoring and collectionslegal remedies for late payment or nonpayment differ by country
31 ATTENTION COMMERCE STUDENTS ACCOUNTING(FINANCIAL & COST) OF ICMAP STAGE 1,2,3,4 CA..MODULE B,C,D PIPFA (FOUNDATION,INTERMEDIATE,FINAL) ACCA-F1,F2,F3 BBA,MBA B.COM(FRESH),M.COM MA-ECONOMICS..O/A LEVELS KHALID AZIZ… kARACHI JOIN GROUP