Management of

Current Assets
RECEIVABLES

2
Receivable Management

Objectives The objective of the

firm’s accounts
receivable policy is
to encourage the
sales, increase net
income and gain
additional customers
by extending credit. 3
Responsibilities of Financial Officer

 To evaluate the pertinent cost

and benefits related to credit
extension
 To finance the firm’s investment
in accounts receivable
 Implement the firm’s chosen
credit policy
4

 To enforce collection
Components of Receivable Management

Credit
Management

Collection
Management 5
Cycles of Receivable Management

CREDIT CYCLE

Credit
Standards
Credit system Credit
assessment policies

Credit Credit
approval evaluation
6
Cycles of Receivable Management

COLLECTION CYCLE

Delivery of
Merchandise
Collection Billing policies

Aging of Accounts
receivable Collection
policies
Receivable
7
portfolio
analysis
Credit Management

▪ Credit Standards

- the criteria that

determine which
customers will be
granted credit
and how much
8
Factors to consider in establishing
credit standards

Five C’s of Credit

▪ Character ▪ Collateral
▪ Capacity ▪ Conditions
▪ Capital
9
Credit Management

▪ Credit Terms
-the length of credit
terms if stretched
generally results to
an increase in
product demand
but also an
increase in the cost 10

of financing it.
Costs of a changing credit policy

Cash discounts
Credit and collection
costs
Bad debt losses
Financing costs
11
Aids in analyzing Receivables

Ratio of receivables to net

credit sales
Receivable turnover
Average collection period
Aging of accounts
12
 Situational Example

“ You are a fresh passer

of the October 2019
CPALE. Because of this
achievement, your
confidence boost up and
your eagerness and
passion to start your
profession are boiling
inside you.
13
 Right away, you prepare
“ all the
requirements
necessary
to get
employed. You choose to
apply to AUDITING
Company which is a
famous auditing firm. For
you to pass, you have to
answer some questions
they will give you and it
goes like this: 14
 Situational Example

“ AUDITING Company has

sales of P3 million, of which
is composed of 20% cash
payments. It has a credit
period of 30 days. Upon
looking to its financial
statements, you have
determined that the
company’s trade
receivables is currently
amounting to P1 million at 15

reporting date.
“ Being curious, you
have decided to
analyze the trade
receivables and try
to find out how
much of it (trade
receivables) has
the risk of not being
collected. 16
 You have gathered the following data
relating to its trade receivables during the
Cycles of Receivable
current year: Management
Categories
COLLECTION CYCLE
No. of Balance % collectible
Days Delivery of
Merchandise
0-45 days P250,000 98%
Collection Billing policies

46-90 300,000 97%

days
91-130
Aging of
250,000 95%
Collection policies
days Accounts
receivable
Over 130 200,000 P100,000 definitely
17
days Receivable uncollectible, balance
portfolio analysis
is 90% collectible
Evaluation

AUDITING Company requires you to

answer the following items (assume 360
days per year):

a. What is the receivable turnover?

b. How long is the Days Sales

Outstanding (DSO)? 18
Evaluation

c. Using the aging method, determine

the required allowance for
uncollectible accounts.

d. How much is the net realizable value

of trade receivable?
19
Summary

Trade-offs in CREDIT
POLICIES 20
 Credit Policy Trade-offs
Cycles of Receivable
Benefit ManagementCost

Relaxation of credit a. Increase in sales a. Increase in credit

standards and total
COLLECTION CYCLEprocessing costs
contribution margin b. Increase in
Delivery of
Merchandise
collection costs
c. Higher defaults
Collection
costs
Billing policies
d. Higher capital
cost

Aging of
Extention of credit Accounts
a. Increase in sales a.Collection
Higher capital
policies

period and total

receivable cost
contribution margin b. Higher default 21
Receivable cost
portfolio analysis
 Credit Policy Trade-offs
Cycles of Receivable Management
Benefit Cost
Granting cash a. Increase in sales a. Lesser profit
discount COLLECTION
and total CYCLE
contribution
Delivery of
marginMerchandise
b. Opportunity
Collection income on lower Billing policies

investment in
receivable
Intensified a. Lower defaults
Aging of a. Higher collection
Collection policies
collection effortsreceivable
Accounts costs expenses
b. Lower cost of
capital Receivable 22

portfolio analysis
 Situational Problem

“ The BLT Company expects

to have sales of P10
million, all in credit, this
year under its current
operating policies. Its
variable costs as a
percentage of sales are 80,
and its cost of capital is 16
percent. Currently, BLT’s
credit policy is net 25 (no
discount for early 23

payment).
 However, its days sales outstanding
Cycles of Receivable Management
(DSO) is 30 days, and its bad debts
loss percentage is 2 percent. BLT
spends COLLECTION
P50,000 perCYCLE year to collect
bad debts and Deliveryits
of tax rate is 40
Merchandise
percent.
Collection Billing policies

Mr. Puno ng Tiwala, credit manager,

is considering four alternative
proposals
Aging of
Accounts
BLT’s
for changingCollection policies credit
receivable
policy.
24
Receivable
1 2 3 portfolio
4 analysis
1. Relaxation
Relaxation of Credit Standards
Cycles of Receivable Management
Policy 1: Lengthen the credit
period COLLECTION
by going from
CYCLEnet 25 to
net 30. Collection expenditures
Delivery of
Merchandise
will remain constant. Under this
proposal, sales are expected to
Collection Billing policies

increase by P1 million annually.

Aging of
Collection policies
Accounts
receivable

26
Receivable
portfolio analysis
Cycles
Theof bad
Receivable
debts Management
loss percentage
on the new sales is expected to
rise toCOLLECTION
4 percent CYCLE(the loss
percentage on old assets should
Delivery of
Merchandise

not change. In addition, the DSO

Collection Billing policies
is expected to increase from 30
to 45 days on all sales.
Aging of
Collection policies
Accounts
receivable

27
Receivable
portfolio analysis
 REQUIRED (Assume 360 days):
Cycles of Receivable Management
• The change in bad debt loses;
COLLECTION CYCLE
• Find the expected change in
Delivery of
net income, taking into
Merchandise

consideration anticipated
Collection Billing policies

changes in carrying cost for

accounts receivable;
Aging of
Collection policies
• Should a change in credit
Accounts
receivable

policy be made? Receivable

28

portfolio analysis
2. Change of Credit Terms
Lengthening and shortening of
credit period
 Policy 2: Shorten the credit
Cycles of Receivable
period by goingManagement
from net 25 to
net 20. Again, collection
COLLECTION
expenses CYCLE constant.
will remain
The anticipated effects of this
Delivery of
Merchandise

change are a decrease in sales

Collection Billing policies
of P1 million per year, a decline
in the DSO from 30 to 22 days,
and a decline in the bad debt loss
Aging of
Accounts
Collection policies

percentage to 1 percent on all

receivable

sales. Receivable
30

portfolio analysis
 REQUIRED (Assume 360 days):
Cycles of Receivable Management
• The change bad debt loses;
COLLECTION CYCLE
• Find the expected change in
Delivery of
net income, taking into
Merchandise

consideration anticipated
Collection Billing policies
changes in carrying cost for
accounts receivable;
Aging of

• Should a change in credit

Collection policies
Accounts
receivable

policy be made? 31
Receivable
portfolio analysis
3. Change of Credit Terms
Granting cash discounts
Cycles of Receivable Management
Policy 3: Again, collection
expenses will remain
COLLECTION CYCLE constant.
The company will provide 2/10,
Delivery of
Merchandise
net 25 credit term. It is estimated
that 80% of the credit sales paid
Collection Billing policies

within the discount period.

Aging of
Collection policies
Accounts
receivable

33
Receivable
portfolio analysis
Cycles of Receivable Management

The anticipated effects

COLLECTION CYCLE
of this
change are an increase in sales
Delivery of
of P1 million per year, a decline
Merchandise

in the DSO from 30 to 20 days.

Collection Billing policies

Aging of
Collection policies
Accounts
receivable

34
Receivable
portfolio analysis
 REQUIRED (Assume 360 days):
Cycles of Receivable Management
• The discounts likely to be taken
COLLECTION CYCLE
• Find the expected change in
Delivery of
net income, taking into
Merchandise

consideration anticipated
Collection Billing policies

changes in carrying cost for

accounts receivable;
Aging of
Collection policies
Accounts
• Should a change in credit
receivable

policy be made? Receivable

35

portfolio analysis
4. Intensified Collection
Efforts
 Policy 4: The company spends
Cycles of Receivable
P50,000 per Management
annum on its
collection department. The
company COLLECTION
believesCYCLE
that if it were
to double its collection personnel,
Delivery of
Merchandise

it could bring down the average

collection period to 20 days and
Collection Billing policies

bad debts losses to 0.5 percent.

The added cost if P150,000,
Aging of
Collection policies
Accounts
bringing total expenditure to
receivable

P200,000 annually. Receivable

37

portfolio analysis
 REQUIRED (Assume 360 days):
Cycles of Receivable Management
• The change in bad debt loses;
COLLECTION CYCLE
• Find the expected change in
Delivery of
net income, taking into
Merchandise

consideration anticipated
Collection Billing policies

changes in carrying cost for

accounts receivable;
Aging of
Collection policies
• Should a change in credit
Accounts
receivable

policy be made? Receivable

38

portfolio analysis
Summary

Trade-offs in CREDIT
POLICIES 39
Credit Mgt. Credit Policy E F F E C T S T O
Cycles of Receivable Management
Variables Collection Receivable
Balance
COLLECTION Faster
Discount rate High CYCLE Decrease
Discount rate Low Delivery of Slower Increase
Merchandise

Discount Short (strict) Faster Decrease

Collection Billing policies
time
Discount Long (Lax) Slower Increase
time
Aging of
Collection policies
Credit period Short (strict)
Accounts
receivable
Faster Decrease
Credit period Long (Lax) Slower Increase
40
Receivable
portfolio analysis
 Credit Mgt.of Receivable
Cycles Credit E FFECTS TO
Management
Variables Policy Receivable Collection
Turnover Period
COLLECTION CYCLE
Discount rate High Higher Shorter
Delivery of
Discount rate Low Merchandise Lower Longer

Discount time Collection

Short (strict) Higher
Billing policiesShorter

Discount time Long (Lax) Lower Longer

Credit period Short (strict)

Aging of Higher Shorter
Collection policies
Accounts
Credit period Long (Lax)
receivable Lower Longer
41
Receivable
portfolio analysis
Marginal or
Incremental Analysis
of Credit Policy 42
What is the rule?

1. Incremental
profit Incremental ; Then accept
the change in
contribution Cost credit policy

2. Incremental
profit Incremental
; Then reject
the change in
contribution Cost credit policy

3. Incremental
profit Incremental ; Then be
indifferent to
contribution Cost the change in 43

credit policy
 Situational Problems

“ You are the only trusted

consultant of your firm, which
is MAS Consultancy, that’s
why they send you to perform
consultancy service to a well
known construction company,
the AFAR Company. The
AFAR Company needs your
help to make opinions and
suggest to whether should
they stick to their old credit
policy or institute their
proposed policy for a change. 44
 Currently, AFAR Company has
Cycles of Receivable Management
annual credit sales of P2,500,000. Its
average collection period is 45 days,
and badCOLLECTION
debts are 3 CYCLE
percent of sales.
Delivery of
Merchandise
The credit and collection manager is
considering
Collection instituting Billingapolicies stricter
collection policy, whereby bad debts
would be reduced to 1.5 percent of
Aging of
total Accounts
sales, and the average collection
Collection policies
receivable
period would fall to 30 days.
45
Receivable
portfolio analysis
Cycles of Receivable Management
However, sales would also fall by
an estimated P300,000 annually.
COLLECTION CYCLE
Variable costs are 75 percent of
Delivery of
sales and the cost of carrying
Merchandise

receivables is 10 percent assume

Collection Billing policies

the tax-rate of 40 percent and

360 days per year.
Aging of
Collection policies
Accounts
receivable

46
Receivable
portfolio analysis
 Now, guided by the foregoing
Cycles of Receivable
statements, Management
answer the following
questions:
COLLECTION CYCLE
• How muchDelivery isof the incremental
profit? Merchandise

• How much is the incremental

Collection Billing policies
cost?
• Decide whether should the
company stick to their old credit
policy
Aging of or institute their proposed
Collection policies
Accounts
policy.
receivable (based on your answers
above) 47
Receivable
portfolio analysis
Summary

Trade-offs in Collection
Policies 48
Collection
Cycles of Receivable Management
Policy/ Collection Receivable Collection
System Turnover Period
COLLECTION CYCLE
Delivery of
Merchandise

Efficient Faster
Collection
Higher Shorter Billing policies

Aging of
Collection policies
Inefficient Slower
Accounts
receivable Lower Longer
49
Receivable
portfolio analysis
 Situational Problems
Cycles
TAXof Receivable
Company Management
is studying a
proposed collection system that
COLLECTION
will decrease CYCLE
collection period
from 45 days to 30 days. To do
Delivery of
Merchandise

this, administrative costs in

Collection Billing policies
relation to collection activities are
expected to increase by 1% of
the net sales, which is projected
Aging of
Accounts
Collection policies

to remain at P30 million.

receivable

50
Receivable
portfolio analysis
 Theof Receivable
Cycles effective rate of return
Management
prevailing in the market with the
same type of investment
COLLECTION CYCLE risk is
12%. Variable rate is 80%.
Delivery of
Merchandise

Collection Billing policies

Should TAX Company institute

the change in the collection
Aging of
policy? (Use 360 days)
Accounts
receivable
Collection policies

51
Receivable
portfolio analysis
Summary

Management of
Current Assets 52
 Situational Problems
“
Since you’ve been hired as
an internal consultant in
FAR Company, nothing
thrills you yet, that’s why
you’re thinking to quit your
job and apply another.

53
 Situational Problems

“ Your senior manager, Mr.

Rodelio Roque, noticed
that problem of yours and
gave you a work you
haven’t encountered before.
Mr. Roque said that the
decision lies in your hands.
If you succeed, you will get
promoted but if not, you are
free to go.
54

1
FAR Company is currently facing sort
of difficult situations requiring
possible solutions. The first is that the
company cannot think of a better way
to balance the carrying cost and
ordering cost of inventories, hence,
money tied up in inventories.

Another, when they sold these

inventories, they don’t have a proper
credit and collection policy,
55
that’s why many opportunities are
being lost. Lastly, when instead
of receivables, the customers
paid cash, the company hold
excess funds in anticipation of a
cash outlay which should have
been invested for a return to
maximize income from idle funds.

56
FAR Company sells a number of
products to many restaurant in
the area. One product is a
special knife. Knives are sold in a
package of 12 at P500 per
package. It has been determined
that the demand for the
replacement of knives is at a
constant rate of 2,000 packages
per month.
57
The packages cost P100 each
from the manufacturer and
require a three-day lead time
from date of order to date of
delivery. The ordering cost is P50
per order, and the carrying cost is
10 percent per year. The
company doesn’t know how to
use the economic order quantity
formula.
58
At the end of the year, the
company actually sold 22,000
packages. 70 percent of which is
made on account and the rest is
paid in cash. The FAR Company
presently gives terms of net 30
days. Its average collection period
is 45 days. To stimulate demand,
the company may give terms of net
60 days. 59
If this policy implemented, sales
are expected to increase by 15%.
After the change, average
collection period is expected to be
at 75 days, with no difference in
payment habits between old and
new customers.

60
Variable costs are P.70 for every
P1.00 of sales, and the company’s
required rate of return on
investment in receivables is 20
percent. The company expects to
spend an incremental collection
cost of P200,000 to undertake this
change in credit policy.

61
Customer’s defaults in payments
are expected to reach 3 percent on
total credit sales as compared from
minimal 1.5 percent based on the
present credit terms. Ignore tax
consequence.

62
Considering only the cash paid on
current sales, it is not enough to be
used for the cash outlay amounting
to P4,000,000 the company will
incur throughout the next period.

63
Mr. Roque told you that they have
two plans: first, to meet the
balance of cash requirements by
periodically selling marketable
securities from its portfolio.

64
The company’s marketable
securities are invested to earn 15
percent, and the cost per
transaction of converting securities
to cash is P30;

Or second, to finance the cash

outlay entirely by marketable
securities, and invest the excess in
cash from sales in another
marketable securities. 65
In order to buy and sell, however,
the company must pay an annual
transaction fee of P100,000. The
company have no idea what
securities should they purchase
and what yield is favorable for
them.

66
REQUIREMENTS (Assume 360 days):

• Determine the EOQ, the number of

orders needed per year, reorder
point and cost of ordering and
carrying cost of knives for the year.

• Determine the incremental profit

contribution and incremental cost
and decide whether should the
company extend its credit period or
not. 67
REQUIREMENTS
• Using the Baumol model, determine
the OTS for transfers from
marketable securities to cash and
determine the average cash
balance.

• What minimum required yield would

the securities have to return for the
firm to hold them for three months
(what is the break-even yield for
three month holding period)? 68
THAT’S ALL
FOLKS,
THANK YOU!
69