1. Chapter 6 Credit Policy and Collections
Order Order Sale Cash
Placed Received Received
Accounts Collection
< Inventory > < Receivable > < Float >
Accounts Disbursement Time ==>
< Payable > < Float >
Invoice Payment Cash
Received Sent Paid

2. Objectives
Specify advantages of NPV in evaluating credit policy alternatives
Calculate the NPV of alternative credit policies and select the best policy
Identify the 3 major traditional measures of collection patterns, calculate them, and understand their flaws
Calculate and interpret uncollected balance percentages and relate to traditional measures
Describe present corporate credit policy practices
List and explain the major differences encountered when extending credit internationally

3. Evaluate Changes in Credit Policy
Credit term change decision variables
effect on dollar profits
sales effect
receivables effect
return on investment effect
84% can estimate:
default probability
credit limits
opportunity cost of funds invested in receivables
company’s overall cost of capital

4. Incremental Profit vs NPV
Financial statement approach
NPV approach

5. Changing Credit Terms, EQ 6.1
ZN =
[(1+g)SE](1-dN)PN(1-bN) / (1 + iDPN) PV discount pmts
+ [(1+g)SE](1-PN)(1-bN) / (1 + iCPN) PV non-discount pmts
- VCR [(1+g)SE] PV variable cost pmts
- EXPN[(1+g)SE] / (1 + iCPN) PV credit expense pmts

6. Changing Credit Terms, EQ 6.2
ZE =
SE(1-dE)PE(1-bE) / (1 + iDPE) PV discount pmts
+ SE(1-PE)(1-bE) / (1 + iCPE) PV non-discount pmts
- VCR (SE) PV variable cost pmts
- EXPE SE / (1 + iCPE) PV credit expense pmts

7. Changing Credit Terms, EQ 6.3, 6.4
EQ 6.3 Z = ZN - ZE
Decision Rule:
IF Z > 0 then Accept policy change
IF Z < 0 then Reject policy change
EQ 6.4 NPV = Z / i

8. Monitoring Collections
Receivables turnover
least favored technique
Days sales outstanding, DSO
ranked almost as high as aging schedules
Aging schedules
ranked as most favored technique

9. Problem All three traditional measures have a serious flaw
All three are influenced by sales trends
Choice of averaging period impact turnover and DSO
Increasing sales tends to:
improve aging schedules
worsen DSO and turnover

10. Solution
Payment or Balance Fraction Approach

11. Collection Procedures
Typical collection effort
initial contact within 10 days of delinquency
then reminder letter followed by phone call
sales force notified
last resort, reference to collection agency/legal action
Collection agency
Phase 1 - computer generated collection letter, when accounts are 45 to 90 days past due
Phase 2 - commissioned collectors used
Companies tend to be more aggressive the larger the receivables balance
Companies understand the good-will tradeoff when selecting collection methods

12. International Credit Management
Credit policy analysis
lengthening terms increases exchange rate risk
also increases default risk
harder to get D&B reports
harder to get bank credit information
Modifying monitoring and collections
legal remedies for late payment or nonpayment differ by country

13. Summary
This chapter developed the framework for applying the NPV model to credit policy decisions
The NPV approach was applied to changes in credit standards, the credit period, cash discounts
Traditional monitoring tools include aging, DSO and receivables turnover
Improved monitoring measure
uncollected balance percentage
a reliable and unbiased measure of customer payment behavior
Collection procedures were reviewed
The chapter concluded with a look at benchmarking and the impact of foreign sales