1. Accounts Receivable Management
A / R

2. JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.
CONTACT:
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.

3. JOIN KHALID AZIZ CRASH CLASSES FOR COMPLETION OF IMPORTANT TOPICS
ICMAP STAGE 1 & 2
FINANCIAL AND COST ACCOUNTING
JOIN NOW

4. The Cash Flow Timeline Order Order Sale Payment Sent Cash
Placed Received Received
Accounts Collection
< Inventory > < Receivable > < Float >
Time ==>
Accounts Disbursement
< Payable > < Float >
Invoice Received Payment Sent Cash Disbursed

5. Learning Objectives Define credit policy and indicate its components.
Describe the typical credit-granting sequence.
Apply net present value analysis to credit extension decisions.
Define credit scoring and explain limitations.
List the elements in a credit rating report.
Describe how receivables management can benefit from EDI.

6. Trade Credit and Shareholder Value
Trade credit arises when goods sold under delayed payment terms
Traced to Romans due to obstacles faced in transferring money through various trading areas
Credit terms are taken for granted today
Value can be added by managing three areas:
aggregate investment in receivables
credit terms
credit standards
Over-investing in receivables can be costly
...but, if credit terms are not competitive, then lost sales can be costly

7. Conclusion Minimize bad debts and outstanding receivables
Maintain financial flexibility
Optimize mix of company assets
Convert receivables to cash in a timely manner
Analyze customer risk
Respond to customer needs

8. A/R Management and Shareholder Value
Marketing Strategy
Market Share Obj.
Aggregate Inv. in A/R
Credit Terms
Credit Standards
Total Dollar Investment
Length of Time to Pay
Acceptance of Marg Cust.
Max Shareholder Value

9. Trade vs. Bank Credit Length of terms Security Amounts involved
Resource transferred (goods vs. money)
Extent of analysis

10. Why Extend Credit? Financial Motive Operating Motive
Contracting Motive
Pricing Motive
All reasons are related to market imperfections

11. Financial Motive Potential of getting a higher price
Sellers raise capital at lower rates than customers and have cost advantages vis-a-vis banks due to:
similarity of customers
the information gathered in the selling process
lower probability of default (the goods purchased are an essential element of the buyer’s business)
seller can more easily resell product if payment is not made.

12. Operating Motive Respond to variable and uncertain demand
Change credit terms rather than:
install extra capacity,
building or depleting inventories,
or forcing customers to wait.

13. JOIN KHALID AZIZ CRASH CLASSES FOR COMPLETION OF IMPORTANT TOPICS
ICMAP STAGE 1 & 2
FINANCIAL AND COST ACCOUNTING
JOIN NOW

14. Contracting Cost Motive
Buyer gets to inspect goods prior to payment
Seller has less theft with separation of collection and product delivery

15. Pricing Motive
Change price by changing credit terms

16. Trends Affecting Trade Credit
Zero net working capital objective
Improved internal and external credit-related information
Electronic commerce

17. The Credit Decision Process
Marketing contact
Credit investigation
Customer contact for information
Finalize written documents, e.g.. security agreements
Establish customer credit file
Financial analysis
Time

18. Basic Credit Granting Model
S - EXP(S)
NPV = VCR(S)
1 + iCP
Where:
NPV = net present value of the credit sale
VCR = variable cost ratio
S = dollar amount of credit sale
EXP = credit administration and collection expense ratio
i = daily interest rate
CP = collection period for sale

19. Managing the Credit Policy
Should we extend credit?
Credit policy components
Credit-granting decision

20. Should We Extend Credit?
Follow industry practice
Extent and form of credit offer
in-house credit card
sell receivables to a factor
captive finance company?

21. Components of Credit Policy
Development of credit standards
profile of minimally acceptable credit worthy customer
Credit terms
credit period
cash discount
Credit limit
maximum dollar level of credit balances
Collection procedures
how long to wait past due date to initiate collection efforts
methods of contact
whether and at what point to refer account to collection agency

22. Credit-Granting Decision
Development of credit standards
Gathering necessary information
Credit analysis: applying credit standards
Risk analysis

23. Grant-Granting Sequence
Order and credit
request received No
Yes
New/increased
credit limit
Material
change in customer status
Redo credit
investigation
Yes No
Check new A/R
total vs credit lmt
Size of proposed
credit limit
Record
disposition
Large
Medium
Small No
Extend Credit
Indepth
credit invest.
Moderate
credit invest.
Minimal
credit invest.
Yes
Set up,post
A/R, ship

24. Credit Standards Based on five C's of Credit
Character
Capital
Capacity
Collateral
Conditions
Determine risk classification system
Link customer evaluations to credit standards

25. Gathering Information
credit reporting agencies, e.g.. Dun & Bradstreet
credit interchange bureaus, NACM
bank letters
references from other suppliers
financial statements
field data gathered by sales reps

26. Credit Analysis: Applying the Standards
Nonfinancial
concerned with willingness to pay, character
Financial
ability to pay, financial ratios etc.. (other C’s of credit)
Credit scoring models
Example: Y = (INCOME) (PAYHIST) (EMPLOYMT)

27. Emergence of Expert Systems
Example of decision rule: “If gross income is equal to or grater than $20,000 and the applicant has not been delinquent and gross income per household member is equal to or greater than $12,000 and debt/equity ratio is equal to or greater than 30% but less than 50% and personal property is equal to or greater than $50,000, then grant credit.”

28. Factors Affecting Credit Terms
Competition
Operating cycle
Type of good (raw materials vs finished goods, perishables, etc.)
Seasonality of demand
Consumer acceptance
Cost and pricing
Customer type
Product profit margin

29. Cash Discounts The lower the VC, the higher the feasible discount
Based on company’s cost of funds
Consider timing effect when changing discounts
Should be based on product’s price elasticity
Higher the bad debt experience, higher the optimal discount

30. Practice of Taking Cash Discounts
51% of firms always took cash discount
40% sometimes
9% take discount and pay late
Study found that 4 or 5 companies would be more profitable if cash discount was eliminated

31. A/R Management in Practice
Discounts appear to be changed to match competitors, not inflation or interest rates
The higher a firm’s contribution margin, the more likely the firm should be to offer discounts.
A price cut is thought to have more impact than instituting a cash discount
The more receivables a firm has, does not necessarily relate to use of penalty fees
The greater amount of receivables does not relate to a more active credit evaluation.

32. Receivables, Collections, and EDI
If credit approval is delayed...
buyers using EDI purchase orders and JIT manufacturing can encounter serious problems.
sellers can now ship within hours of receiving orders...thus seller must be able to handle electronically transmitted orders.
Seller may also issues electronic invoices and be paid electronically using an EDI-capable bank so that remittance data can be automatically read by seller’s A/R system
Trend is for use of data transmission to automate the cash application process

33. Summary Investment in A/R represents a significant investment.
Key aspects outlined
credit policy
credit standards
credit granting sequence
credit limits
credit terms
Management of A/R is influenced by what competitors are doing not by shareholder wealth considerations.
Proper use of NPV techniques can ensure that credit decisions enhance shareholder value.

34. JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.
CONTACT:
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.