RECEIVABLES MANAGEMENT

ANUSHA (11MBMA61) ARCHANA (11MBMA44) SRI HARSHA (11MBMA ) SANDEEP (11MBMA ) VINAY (11MBMA ) KARTAVYA (11MBMA ) AJEET (11MBMA ) MEGHAMALA (11MBMA02)

RECEIVABLES: Debt owed to the firm by customers arising from sale of goods or services in the ordinary course of business.
Receivables management is also called trade credit management Investments in receivables involve both benefits and costs. BENEFITS: Increased sales Anticipated profits COSTS: Collection cost Capital cost Delinquency cost Default cost

ASPECTS OF RECEIVABLES MANAGEMENT The following are the different aspects of receivables management: Credit policy variables Credit evaluation Credit granting decision Control of receivables Management of trade credit in India

CREDIT POLICY VARIABLES Important dimensions of a firms credit policy: Credit standards Credit period Cash discount

Collection effort

CREDIT STANDARDS:

The basic criteria for the extension of credit to customers

liberal credit standards stiff credit standards

The effect of relaxing the credit standards on profit may be estimated by the formula:

P = S(1-V) kI bnS
Where P = change in profit S = increase in sales V = ratio of variable costs to sales k = cost of capital I = increase in receivables investment bn = bad debt loss ratio on new sales I = (S/360) *ACP*(V) Change in profit (P) = (increase in gross profit)- (opportunity cost)- (increase in bad debts)

EXAMPLE: The current sales of a firm are Rs.100 lakhs. The firm classifies its customers into 4 categories, 1 through 4. Credit rating diminishes as one goes from category 1 to 4. The firm extends unlimited credit to customers in categories 1 and 2, limited credit to those in category 3, and no credit to those in category 4. As a result, the firm is foregoing sales to the extent of Rs.10 lakhs to customers in category 3 and Rs.10 lakhs to those in category 4. The firm is considering the adoption of a more liberal credit policy under which customers in category 3 would be extended unlimited credit and those in category 4 would be extended limited credit. Such relaxation would increase the sales by Rs.15 lakhs on which bad debt losses would be 10%. The contribution margin ratio, (1-V), for the firm is 15%, the average collection period is 40 days, and the cost of funds is 10%. Should the firm adopt the new policy? SOLUTION: S = Rs.15,00,000 (1-V) = 0.15 k = 0.10 ACP = 40 days bn = 0.10

I = (S/360) *ACP*V = (15,00,000/360)*40*0.85 I = 141666.667 P = (15,00,000*0.15) (0.10*141666.667) (O.10*15,00,000) P = Rs. 60,833

Since the impact of change in credit standards on the profit is positive, the proposed change is desirable.
PROBLEM: Present sales of Soumya Enterprises are Rs.50 lakhs. The firm classifies its customers into 3 credit categories: A,B, and C. The firm extends unlimited credit to customers in category A, limited credit to those in B, and no credit to those in C. As a result of this credit policy, the firm is foregoing sales to the extent of Rs.5 lakhs to customers in category B and Rs.10 lakhs to those in C. The firm is considering the adoption of a more liberal credit policy under which customers in category C would be provided limited credit. Such relaxation would increase the sales by Rs.10 lakhs on which bad debt losses would be 8%. The contribution margin ratio for the firm is 15%, the average collection period is 60 days, and the cost of funds is 21%. What will be the effect of relaxing the credit policy on the profit of the firm? ANS: P = Rs.40250