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Receivables Management.

Receivables Management. Receivables represent amounts owed to the firm as a result of sale of goods or services in the ordinary course of business. These are claims of the firm against its customers and form part of its current assets.

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Receivables Management.

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  1. Receivables Management. • Receivables represent amounts owed to the firm as a result of sale of goods or services in the ordinary course of business. • These are claims of the firm against its customers and form part of its current assets. • Receivables are also known as account receivables, trade receivables, or book debts. • The receivables are carried for the customers. • The period for credit and extent of receivables depends upon the credit policy followed by the firm. • The purpose of maintaining or investing in receivables is to meet competition, and to increase the sales and profits.

  2. Costs of Maintaining Receivables. • The allowing of credit to customers means giving of funds for the customer’s use. • The concern incurs the following costs on maintaining receivables:- • 1. Cost of financing receivables. • 2. Cost of collection. • 3. Bad debts.

  3. Factors influencing the size of Receivables. • Size of credit sales. • Credit policies. • Terms of trade. • Expansion plans. • Relation with profits. • Credit collection efforts. • Habits of customers.

  4. Forecasting the Receivables. • Credit period allowed. • Effect of cost of goods sold. • Forecasting expenses. • Forecasting average collection period and discount. • A.C.P = trade debtors* no of working days/net sales. • Average size of receivables • A. S.R = Estimated annual sales * A.C.P

  5. Meaning and objectives of Receivables Management. • Receivables management is the process of making decisions relating to investment in trade debtors. • If you want to increase sales turnover and profits of the firm, you have to sale goods on credit basis, which includes the risk of bad debts. The objective of receivables management is “to promote sales and profits until that point is reached where the return on investment in further funding of receivables is less than the cost of funds raised to finance that additional credit” .

  6. Factoring and Receivables management. • Receivables constitute a significant portion of current assets of a firm, but for investment in receivables, a firm has to incur certain costs such as costs of financing receivables and cost of collection from receivables as well as risk of bad debts. • It is therefore, very essential to have a proper control and management of receivables. • In fact, maintaining of receivables poses two types of problems, (i) the problem of raising funds to finance the receivables and (ii) the problem of receivable relating to collection, delays and defaults of the receivables.

  7. Factoring. • A factor is a financial institution which offers services relating to management and financing of debts arising out of credit sales. • Factoring is becoming popular all over the world on account of various services offered by the institutions engaged in it. • Factors render services varying from bill discounting facilities offered by commercial banks to total take over of administration of credit sales including maintenance of sales ledger, collection of accounts receivables, credit control, protection from bad debts, provision of finance and rendering of advisory services to their clients, • Thus, factoring is a tool of receivables management employed to release the funds tied up in credit extended to customers and to solve the problems relating to collection, delays and default of the receivables.

  8. The mechanism of Factoring. • It is summed up as below: • (i) An agreement is entered into between the selling firm and the factor firm. The agreement provides the basis and the scope of the understanding reached between the two for rendering factor services. • (ii) The sales documents should contain the instruments to make payments directly to the factor who is assigned the job of collection of receivables. • (iii) When the payment is received by the factor, the account of the selling firm is credited by the factor after deducting its fees, charges, interest etc. as agreed. • (iv) The factor may provide advance finance to the selling firm if the conditions of the agreement so require.

  9. Financial Evaluation of Factoring. • The financial evaluation of factoring is concerned with comparing of costs and benefits associated with factoring. • A firm would prefer to have factoring arrangements if the risk of default or non-payment is high and the cost involved by way of fees and service charges of the factor are less than the benefits associated with the same.

  10. Question. • Monthly credit sales Rs 10,00,000 • Average maturity period 40 days • Factor’s commission 1% • Interest rate charged by factor 15% • Collection dept’s cost(if there is no • factoring) Rs 4500/p.m • Factor’s average remittance period 10 days • The company’s cost of raising funds • ( other than factor) 24%. • Calculate the effective interest rate charged by the factor and advise the company ignoring all other factors including risk of default.

  11. Solution. • No of days for which the funds are advanced by the factor 40-10= 30 days. • Calculation of total costs of financing through factor: Rs. • Factor’s comm(1% of 10,00,000) = 10,000 • Interest charge(10,00,000*15%*30/360) • =12500 • Total comm and interest Rs= 22500 • Less : saving in collection dept’s cost Rs 4500 • Total financing cost net (22500-4500) = Rs 18000

  12. Cont- • Calculation of effective interest rate: • 18000/10,00,000*365/30*100 =21.90% • As the effective rate of interest charged by the factor is 21.9% and the firm can raise funds from other sources at 24% p.a .it is advised that the firm should avail the services of the factor.

  13. Question. • Bharat Ltd, decides to liberalize credit to increase its sales. The liberalized credit policy will bring additional sales of Rs 3,00,000. the variable cost will be 60% of sales and there will be 10% risk for non- payment and 5% collection costs. • Will the company benefit from the new credit policy?

  14. Solution. • Additional sales revenue Rs 3,00,000 • Less : variable cost(60%) 1,80,000 • Incremental revenue Rs 1,20,000 • Less: 10% risk for non-payment • 5% for collection cost • (15% of 3,00,000) 45,000 • Addition revenue from increased(120000-45000) • Sales due to liberal credit policy Rs 75,000 • The company will be benefited with the new credit policy because the increase in revenue is more than the costs of providing additional credit. In fact the profit of the company will increased by Rs 75,000.

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