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# Accounts Receivable

Management
Sushmita Nigam
Nikunj Pasari
Dharmik Patel
Yash Patel
Sanket Patil

(I025)
(I026)
(I027)
(I028)
(I029)

Introduction
Receivables
Types of Costs:

Benefits
Increased sales & anticipated profits
Attracts new customers along with
holding the current ones
Protects current sales against
emerging competition
Sales expansion oriented

## Credit Policy Variables

Important dimensions of a firms
credit policy are:

Credit Standards
Problem:
A firm is currently selling a product @Rs 10 per unit. The most recent annual sales ere
30,000 units. The variable cost per unit is Rs 6 and the average cost per unit, given
a sales of 30,000 units is Rs8.The total fixed cost is Rs60,000.The average
collection period is 30days.The firm is contemplating a relaxation of credit
standards that is expected to result a 15% increase in units sales ;the average
collection period would increase to 45 days with no change in bad debt. It is
expected that increased sales will result in additional net working capital to the
extent of 30,000. The required return on investment is 15%.Should the firm relax
the credit standards?

## Solution: Proposed Plan

1. Sales revenue (34,500*
units Rs10)

Rs 3,45,000

2. Less : Costs
a) Variable (34,500* Rs 6) 2,07,000
b) Fixed
3. Profit from sales

60,000

2,67,000
78,000

Current Plan
1. Sales
revenue(30,000*unit
s Rs10)
2. Less :Costs
a) Variable
(30,000*Rs6)
b) Fixed

3,00,000

1,80,000
60,000

2,40,000

60,000

plan

18,000

## Cost of Marginal Investment in Receivables

Proposed Plan= No of days in the year/Avg
collection period= 360 /45=8
Present Plan = 360/30 =12

## Total cost of sales:

Present Plan= No. of units*cost per unit = 30,000*8 = Rs 2,40,000
Proposed Plan = (30,000*8) +(4,500*6) = Rs 2,67,000
Avg investment in accounts receivables
Present Plan = Rs 2,40,000/12 = Rs 20,000
Proposed plan = Rs 2,67,000/8 = Rs 33,375
Marginal Investments = 33,375 20,000 = Rs 13,375
Given 15% required ROI, the cost is = Rs 13,375*15/100 = Rs
2,006.35
Cost of Working Capital = Rs 10,000 * 0.15 = Rs 1,500
Since additional profits on increased sales is more than the cost of
incremental investments and working capital the firm should
relax its credit standards.
The overall increase in profits= 18,000 -2,006.25 1,500) = Rs
14,493.75

Credit Period
Refers to the length of time customers are allowed to pay for their
purchases.
Effects of increase in credit period are:

Item

Direction of
Change
(I=Increase,
D=Decrease)
I

Effect on
Profits
(positive or
Negative)
Negative

Average
collection
period
Sales Volume
I
Positive
A reduction
in the credit periodIis likely to have Negative
an opposite effect.
Expenses

Example:
Suppose, a firm is contemplating an increase in the credit period from 30 to 60
days. The average collection period which is at present 45 days is expected to
increase to 75 days. It is also likely that the bad debt expenses will increase from
the current level of 1 per cent to 3 per cent of sales. Total credit sales are
expected to increase from the level of 30,000 units to 34,500 units. The present
average cost per unit is Rs 8, the variable cost and sales per unit is Rs 6 and Rs 10
per unit respectively. Assume the firm expects a rate of return of 15 per cent.
Should the firm extend the credit period?
Solution:
(i) Profit on additional sales: = (Rs 4 4,500) = Rs 18,000
(ii) Cost of additional investments in receivables: = Average
investments with the proposed credit period less average
investments in receivables with the present credit period

## Rs 8 30,000 Rs 6 4,500 Rs 55,625

Cost of sales

Turnover of receivables
360 75
Rs 8 30,000 Rs 30,000
Present plan
360 45
Proposed plan

## Additional investment in accs receivable=55625-30000=Rs 25625

Cost of additional investment at 15% =0.15 x Rs. 25625=Rs. 3843.75
(iii) Additional bad debt expenses: This is the difference between the bad debt
expenses with the proposed and present credit periods.
Bad debt with proposed credit period = 0.03 Rs 3,45,000 = Rs 10,350
Bad debt with present credit period = 0.01 Rs 3,00,000 = Rs 3,000
Additional bad debt expense = (Rs 10,350 - Rs 3,000) = Rs 7,350
Thus, the incremental cost associated with the extension of the credit period is Rs
11,193.75 (Rs 3,843.75 + Rs 7,350). As against this, the benefits are Rs 18,000.
There is, therefore, a net gain of Rs 6,806.25, that is,
(Rs 18,000 Rs 11,193.75). The firm would be well-advised to extend the credit
period from 30 to 60 days.

## Effect of Relaxation of Credit Period to Two Months

Particulars
Incremental Sales revenue (4,500 x Rs 10)

Amount (Rs)
45,000

## Less: incremental variable costs (4,500 x Rs 6)

Incremental contribution
Less: incremental cost of additional investment in debtors
Less: increase in bad debts
Incremental profit

27,000
18,000
3,843.75
7,350.00
6,806.25

## Cash discount is the amount that will be reduced from the

overdue amount
Cash discount period refers to the duration during
whichthediscount can be availed. Usually written in
abbreviations, for instance, 2/10 net 30.
Example:
A firm is currently selling a product @ Rs 10 per unit. The
most recent annual sales (all credit) were 30,000 units. The
variable cost per unit is Rs .6 and the average cost per unit,
given a sales volume of 30,000 units, is Rs 8. The total fixed
cost is Rs 60,000. The average collection period may be
assumed to be 30 days.
The firm is contemplating a relaxation of credit standards
that is expected to result in a 15 per cent increase in units
salesThe increase in collection expenses may be assumed to
be negligible. The firm is contemplating to allow 2 per cent
discount for payment within 10 days after a credit purchase.
It is expected that if discounts are offered, sales will
increase by 15 per cent and the average collection period

## Profit on sales: The profit on sale = sale of

additional units multiplied by the difference
between the sales price and the variable cost
per unit = 4,500 (Rs 10 Rs 6) = 4,500 Rs 4
= Rs 18,000
Saving on average collection period: This
saving is what would have been earned on the
reduced investments in accounts receivable as
a result of the cash discount.
Cost of sales

## Average investment in accounts receivable

Receivable s turnover
30,000 Rs 8 Rs 20,000
(a) Present plan (without discount)
12(i.e.360 /30)
30,000 Rs 8 4,500 Rs 6 Rs 2,67,000 Rs 11,125
(b) Proposed plan (with discount)
24 i.e.360/15
24

## Thus, if cash discount is allowed, the average

investments in receivables will decline by Rs 8,875 (i.e.
Rs 20,000 Rs 11,125).
Given a 15 per cent rate of return, the firm could earn Rs
1,331.25 on Rs 8,875. Thus, the saving resulting from a
drop in the average collection period is Rs 1,331.25.
The total benefits associated with the cash discount:
Profit on additional Sale + Saving in cost =
18000+1331.25
= Rs.
19,331.25

## Cash discount: The cost involved in the cash discount

on credit sales, that is, 2 per cent of credit sales = 0.02
Rs 2,07,000 (i.e. 0.60 Rs 3,45,000) = Rs 4,140

## Thus, against a cost of Rs 4,140, the benefit from

initiating cash discount is Rs 19,331.25; that is, there is a
net gain of Rs 15,191.25 (Rs 19,331.25 Rs 4,140). The

Collection Policies
Has 2 aspect- (i) Degree of collection period
(ii) type of collection period
Analysing the credit application
5 Cs of credit analysis:
Character
Capacity
Capital
Collateral
Condition

Example:
XYZ Corporation is considering relaxing its present credit policy and is in the process
of evaluating two alternative policies. Currently, the firm has annual credit sales of Rs
50 lakh and accounts receivable turnover ratio of 4 times a year. The current level of
loss due to bad debts is Rs 1,50,000. The firm is required to give a return of 25 per cent
on the investment in new accounts receivable. The companys variable costs are 70 per
cent of the selling price. Given the following information, which is a better option?

Particulars

## Annual credit sales

Accounts receivable turnover ratio

## Present policy Policy option I Policy option II

Rs 50,00,000

Rs 60,00,000

Rs 67,50,000

2.4

1,50,000

3,00,000

4,50,000

Solution:
Relative Suitability of Policy Options
Particulars
Sales revenue
Less :Variable cost (70%)
Contribution margin (manufacturing)

Present policy

Policy option I

Policy option II

Rs 50,00,000

Rs 60,00,000

Rs 67,50,000

35,00,000

42,00,000

47,25,000

15,00,000

18,00,000

20,25,000

1,50,000

3,00,000

4,50,000

2,18,750

3,50,000

4,92,187.50

11,31,250

11,50,000

10,82,812.50

## Less: Other relevant costs:

Investment cost (see working
notes)
Contribution margin (final)

Recommendation The firm is advised to adopt policy option I (extend credit terms to 4
months).

Working Notes
Strictly speaking, investment in accounts receivable should be determined with
reference to total cost of goods sold on credit. However, fixed costs are not given.
It is assumed that there are no fixed costs and investment in debtors/receivables is
determined with reference to variable costs only.
Present policy: (Rs 35,00,000 / 4) = Rs 8,75,000 0.25 = Rs 2,18,750
Policy option I: (Rs 42,00,000 / 3) = Rs 14,00,000 0.25 = Rs 3,50,000
Policy option II: (Rs 47,25,000 / 2.4) = Rs 19,68,750 0.25 = Rs 4,92,187.5

Credit Analysis
Credit Analysis- Obtaining credit information &
evaluation of credit applicants.
1. Sources of Information:
Internal

External

Financial Statements
Bank References
Credit Bureau Reports

## 2. Analysis of Credit Information

Quantitative
Based on factual information
Ratio analysis of liquidity, profitability & debt capacity of
applicant

Qualitative
References from suppliers, Banks, Bureau Reports
Helps in decision making of credit extension

Thank You