Components of Receivables Management

Credit Policy, Discounts, and Analysis

Effective receivables management relies on several key components that work together to optimize cash flow and minimize risk. These components include a well-defined credit policy, strategic use of cash discounts, and regular analysis of outstanding debtors.

1. Credit Policy

A company's credit policy outlines the terms and conditions under which credit is extended to customers. It serves as a roadmap for managing receivables and minimizing potential losses.

Key Elements of a Credit Policy:

• Credit Period: The length of time customers are allowed to make payments after a purchase (e.g., 30 days, 60 days, 90 days). A longer credit period can attract more customers but increases the risk of late payments.
• Credit Standards: The criteria used to assess a customer's creditworthiness before granting credit. This might include:
  • Credit history checks
  • Financial statement analysis
  • References from other suppliers
  • Setting minimum credit scores or financial ratios
• Collection Policy: The procedures and actions taken to recover overdue payments. This might include:
  • Reminder notices
  • Phone calls
  • Late payment fees or penalties
  • Negotiated payment plans
  • Legal action (as a last resort)

Balancing Act: Liberal vs. Strict Credit Policies

Companies must carefully weigh the trade-offs between a liberal and strict credit policy:

• Liberal Credit Policy:
  • Pros: Increased sales, attracting more customers.
  • Cons: Higher risk of bad debts, longer average collection period, increased administrative costs.
• Strict Credit Policy:
  • Pros: Reduced bad debts, faster collections, lower administrative costs.
  • Cons: Discouraged potential customers, potentially lower sales volume.

2. Cash Discount

A cash discount is an incentive offered to customers for paying their invoices early. It encourages faster collections and improves cash flow.

Example:

"2/10, net 30" means:

• A 2% discount is offered if payment is made within 10 days.
• Otherwise, the full invoice amount is due within 30 days.

Benefits of Offering Cash Discounts:

• Encourages Early Payments: Reduces the average collection period.
• Lowers Credit Risk & Bad Debts: Fewer overdue accounts decrease the risk of non-payment.
• Improves Cash Flow: Provides faster access to cash, reducing dependence on external financing.

3. Debtors Outstanding & Ageing Analysis

Debtors Outstanding:

• Definition: The total amount of unpaid invoices from customers at a given point in time (also known as accounts receivable).
• Importance: Managing outstanding debtors efficiently is crucial for maintaining liquidity and financial stability.
• Key Actions:
  • Monitor overdue accounts closely to prevent defaults.
  • Strive for a high receivables turnover ratio, indicating efficient collections.

Ageing Analysis:

• Definition: Categorizing outstanding receivables based on the number of days they have been outstanding (past due).

• Example Ageing Schedule:

  Age Bracket	Amount Outstanding	Percentage of Total Receivables
  0 - 30 days	$50,000	40%
  31 - 60 days	$30,000	25%
  61 - 90 days	$20,000	20%
  91+ days	$10,000	15%

• Purpose of Ageing Analysis:

  • Identifies Overdue Accounts: Highlights accounts needing immediate attention and follow-up.
  • Evaluates Credit Policy Effectiveness: Helps determine if the current credit policy is working effectively or needs adjustments.
  • Assists in Bad Debt Provisioning: Provides information needed to estimate and set aside funds for potential bad debts.

Conclusion: The Receivables Management Trifecta

Efficient receivables management helps a business:

• Optimize cash flow
• Minimize credit risk
• Maintain healthy customer relationships

By establishing a clear credit policy, strategically offering cash discounts, and regularly analyzing outstanding debtors through ageing analysis, companies can ensure that credit sales contribute to profitability rather than financial losses.