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WCM

WCM. Receivables Management and Factoring. Topics. Nature and Goals of Credit Policy Optimum Credit Policy Credit Policy Variables Credit Evaluation of Individual Accounts Monitoring Receivable. Nature of Credit Policy. Investment in receivable depends on: volume of credit sales

jeanine-sheehan
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WCM

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  1. WCM Receivables Management and Factoring

  2. Topics • Nature and Goals of Credit Policy • Optimum Credit Policy • Credit Policy Variables • Credit Evaluation of Individual Accounts • Monitoring Receivable

  3. Nature of Credit Policy • Investment in receivable depends on: • volume of credit sales • collection period These two depend on the credit policy • Credit policy: three decision variables • credit standards- type of customer • credit terms-duration of credit • collection efforts-actual collection period

  4. Goals of Credit Policy • Marketing tool for sales expansion: - competition - company’s bargaining power - industry practice • Maximisation of sales Vs. incremental profit • production and selling costs (FC increases, if capacity is added)- with loosening of CP, opportunity cost of lost sales comes down, but cost of admin. and bad debt loss increases- Trade off • administration costs (supervision & collection cost rise) • bad-debt losses

  5. Cont… Change in sales Change in cost Change in contribution Loose credit policy: Increases contribution (reduces opportunity loss) Admin cost [credit investigation and supervision cost & collection costs] rise Bad debt loss rises

  6. Costs of credit policy Cost of admin & Bad debt losses Costs & Benefits Opportunity loss Tight Credit policy Loose

  7. Optimum Credit Policy • Estimation of incremental operating profit IOP • Estimation of incremental investment (II)in receivable • Estimation of incremental rate of return (IRR)- IOP/ II • Comparison of incre-mental rate of return with required rate of return (RRR) • Optimum credit policy: IRR = RRR

  8. Incremental cost-benefit analysis Change in cont. (lost cont. due to tightening of CP) = change in sales X PV ratio Change in OP= change in cont- avoidable cost of bad debt and admin. cost associated with a loose policy Investment in debtors = credit sales per day X average collection period Find the incremental rate of return: Change in OP(1-tax rate) / Investment in debtors Sheet-2

  9. Credit Policy Variables • Credit standards- criteria for choosing customer- trade off between incremental return and cost • Credit analysis • collection period • default rate : bad debt loss % • Character- willingness to pay • Capacity-ability to pay • Condition-economy’s impact on ability to pay • collateral

  10. Cont…….. • customer categories • good accounts • bad accounts • marginal accounts (in between good and bad) • Creditworthiness-numerical credit scoring • ad hoc approach (scoring on a scale of factors with due weightage) • simple discriminant approach • multiple discriminant approach

  11. Multiple-discriminant analysis Altman: Z = 0.012 (NWC/TA) + 0.014(RE/TA) + 0.033(EBIT/S) + 0.006 (MV/D) + 0.010(S/TA) Z > 2.675 MV=Book value of equity D=Book value of debt

  12. Credit Policy VariablesCredit-Granting Decision

  13. Credit Policy Variables • Credit terms • credit period • cash discount (compare after tax cost of discount with opportunity of reduced investment in debtors) • Collection policy and procedures • regularity of collections • clarity of collection procedures • responsibility for collection and follow-up • case-by-case approach • cash discount for prompt payment

  14. Credit Evaluation of Customers • Credit information • financial statements • bank references • trade references • Credit investigation and analysis • analysis of credit file • financial analysis • analysis of business and management • Credit limit • Collection efforts

  15. Monitoring Receivable • Collection period • Aging schedule • Collection experience matrix

  16. Collection experience matrix Sales and receivables Rs. In lacs Month July Aug Sept. Oct. Nov Dec. Sales 400 410 370 220 205 350 Receivables July 330 Aug 242 320 Sept 80 245 320 Oct 0 76 210 162 Nov 0 0 72 120 160 Dec 0 0 0 40 130 285

  17. Cont…. Rs. in lacs Month July Aug Sept. Oct. Nov Dec. Sales 400 410 370 220 205 350 Receivables % July 82.5 Aug 60.5 78.0 Sept 20.0 59.8 86.5 Oct 0 18.5 56.8 73.6 Nov 0 0 19.5 54.5 78.0 Dec 0 0 0 18.2 63.0 81.4 Moving down the diagonals tells the collection experience

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