Table of Contents:
- What is Receivables Management
- Meaning of Receivables Management
- Meaning of Receivables
- Definition of Receivables Management
- Objectives of Receivables Management
- Aspects of Receivables Management
What is Receivables Management
Receivables management refers to the planning and controlling of ‘debt’ owed to the firm from customers on account of credit sales. This practice is commonly referred to as trade credit management.
The basic objective of the receivables management (debtors) is to optimise the return on investment on these assets.
Large amounts are tied up in receivables, there are chances of bad debts and there will be a cost of collection of debts. On the contrary, low investment in receivables can potentially restrict sales, as competitors may offer more favourable terms. Therefore, the management of receivables is an important matter that requires the establishment and execution of appropriate policies.
Meaning of Receivables Management
Receivables management refers to the strategic decision making process concerning investments in trade debtors. Certain investment in receivables is required to increase a firm’s sales and profits. But at the same time investment in this asset also involves cost considerations. Furthermore, there is always a risk of bad debts too.
The term receivables management may be defined as a collection of steps and procedures required to properly weigh the costs and benefits attached to the credit policies. The receivables management consists of matching the cost of increasing sales (particularly credit sales) with the benefits arising out of increased sales to maximize the return on investment of the firm.
Meaning of Receivables
Accounts receivables are simply extensions of credit to the firm’s customers, allowing them a reasonable period in which to pay for the goods. Most firms treat account receivables as a marketing tool to promote sales and profits. The receivables (including the debtors & the bills) constitute a significant portion of the working capital and are an important element of it. The receivables emerge whenever goods are sold on credit & payments are deferred by customers. Receivable is a type of loan extended by a seller to the buyer to facilitate the purchase process. In comparison to conventional loans, trade credit in the form of receivables does not generate profits for the firm. Instead, it functions as an incentive or facility provided to the buyer-customer of the firm.
Definition of Receivables Management
According to Robert N. Anthony, “Accounts receivables are amounts owed to the business enterprise, usually by its customers. Sometimes it is broken down into trade accounts receivables; the former refers to amounts owed by customers, and the latter refers to amounts owed by employees and others”.
According to Hampton, “Receivables are asset accounts representing the amount owned to the firm as a result of the sale of goods or services in the ordinary course of business”.
Thus, receivables are forms of investment in any enterprise manufacturing and selling goods on a credit basis large sums of funds are tied up in trade debtors. Hence, a great deal of careful analysis and proper management is exercised for effective and efficient management of receivables to ensure a positive contribution towards an increase in turnover and profits.
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Objectives of Receivables Management
The objectives of receivables management are to improve sales, eliminate bad debts, reduce transaction costs incidental to the maintenance of accounts and collection of sale proceeds and, finally, enhance the profits of the firm. Credit sales help the organization to make extra profit. It is a known fact, firms charge a higher price, when sold on credit, compared to the normal price.
1) Utilizing Accounts Receivable as a Marketing Strategy for Business Enhancement
If the firm wants to expand its business, it has to, necessarily, sell on credit. After a certain level, additional sales do not create additional production costs due to fixed costs. So, the additional contribution, goes towards profit, improving the profitability of the firm.
2) Optimum Level of Investment in Receivables
To support sales, the firm must make investments in receivables. Investing in receivables involves costs as funds are tied up in debtors. Further, there is also a risk concerning bad debts. On the other hand, receivables bring returns. If so, to what level investment is to be made in receivables? Investment in receivables is to be made till the incremental costs are less than the total return. Investment in receivables is to be made till the incremental costs are less than the total return.
In other words, the objective of receivables management is to promote sales and profits until that point is reached where the return on investment in further funding receivables is less than the cost of funds raised to finance that extra credit (i.e., cost of capital).
Receivables Management Purpose
The primary purpose of credit management is not only to maximize sales or to minimize the risk of bad debts. Instead, it aims to effectively balance these aspects by expanding sales while keeping the associated risk within acceptable limits.
To attain the maximum value of the firm, it should manage its trade credit to:
(i) Maintain investment in debtors at an optimum level, by extending liberal credit, sales and profits increase but increased investment in debtors also results in increased cost and therefore, makes a trade-off between costs and benefits.
(ii) obtain the optimum volumes of sales for which efficient and effective credit management helps the firm retain old customers and attract new customers.
(iii) Control the cost of credit and keep it at a minimum, which is associated with trade credit in the form of administrative expenses, bad debt losses and the opportunity cost of funds tied up in receivables.
Aspects of Receivables Management
There are three aspects of the receivables management:
1. Credit Policy
The credit policy is to be determined. The Credit policy includes the determination of credit standards, Credit terms, and collection efforts. It involves a trade-off between the profits on additional sales that arise due to credit being extended on the one hand and the expenses associated with managing outstanding debts and potential losses on the other. This seeks to determine the appropriate credit period, cash discount, and other pertinent considerations. The credit period is generally expressed in terms of net days.
For example, if the company credit terms are “net 50”. It is expected that customers will repay credit obligations by 50 days. Furthermore, the cash discount policy of the firm specifies the following points:
(a) The rate of cash discount.
(b) The cash discount period; and
(c) The net credit period.
For example, the credit terms can be expressed as “3/15 net 60”. This means that a 3% discount will be granted if the customer pays within 15 days; if he does not avail of the offer he must make payment within 60 days.
2. Credit Analysis
This requires the finance manager to determine how risky it is to advance credit to a particular party.
3. Control of Receivable
This requires the finance manager to follow up with debtors and decide on a suitable credit collection policy. It involves both the laying down of credit policies and the execution of such policies.
There is always the cost of maintaining receivables which comprises of following costs:
(i) The company needs extra funds because resources are tied up in receivables, resulting in costs in the form of interest (for loan funds) or opportunity cost (for invested funds).
(ii) Administrative costs which include record keeping, investigation of creditworthiness etc.
(iii) Collection costs.
(iv) Defaulting costs.
