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CREDIT MANAGEMENT

CREDIT MANAGEMENT. Time. Cash collection. Accounts receivable. The Cash Flows of Granting Credit. Credit sale is made. Customer mails check. Firm deposits check. Bank credits firm’s account. COSTS & BENEFITS OF CREDIT MANAGEMENT. OPPORTUNITY COST COLLECTION COST BAD DEBTS

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CREDIT MANAGEMENT

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  1. CREDIT MANAGEMENT

  2. Time Cash collection Accounts receivable The Cash Flows of Granting Credit Credit sale is made Customer mails check Firm deposits check Bank credits firm’s account

  3. COSTS & BENEFITS OF CREDIT MANAGEMENT • OPPORTUNITY COST • COLLECTION COST • BAD DEBTS • INCREASED SALES • INCREASE IN MARKET SHARE • INCREASE IN PROFITS

  4. TERMS OF PAYMENT • Cash Mode • Bill of Exchange • Letter of Credit • Consignment

  5. CREDIT POLICY VARIABLES • The important dimensions of a firm’s credit policy are: • Credit standards • Credit period • Cash discount • Collection effort

  6. CREDIT STANDARDS • LiberalStiff • Sales Higher Lower • Bad debt loss Higher Lower • Investment Larger Smaller • in receivables • Collection costs Higher Lower

  7. IMPACT ON RESIDUAL INCOME OF RELAXATION P = [S(1 – V) - Sbn] (1 – t ) – k  I where P = change in Profit S = increase in sales V = ratio if variable costs to sales bn = bad debt loss ratio on new sales t = corporate tax rate I = increase in receivables investment

  8. Q.PSD Ltd. is considering relaxing its credit standards. S = Rs.15 million, bn = 0.10, V = 0.80, ACP = 40 days, k = 0.10, t = 0.4 P = [15,000,000 (1 – 0.80) – 15,000,000 x 0.10] (1 – 0.4) 15,000,000 – 0.10 x x 40 x 0.80 360 = Rs.766,667

  9. CREDIT PERIOD • LongerShorter • Sales Higher Lower • Investment in Larger Smaller • receivables • Bad debts Higher Lower

  10. IMPACT ON RESIDUAL INCOME OF LONGER CREDIT PERIOD P = [S(1 – V) - Sbn] (1 – t ) – k  I

  11. INCREASE IN RECEIVABLES INVESTMENT S0 S I = (ACPn – ACP0) + V (ACPn) 360 360 where: I = increase in receivables investment ACPn = new average collection period (after lengthening the credit period) ACP0 = old average collection period V = ratio of variable cost to sales S = increase in sales

  12. Q. X Limited is considering extending its credit period from 30 to 60 days. S = Rs.50 million, S = Rs.5 million, V = 0.85, bn = 0.08, k = 0.10, t = 0.40 P = [5,000,000 x 0.15 – 5,000,000 x 0.08] (0.6) – 0.10 (60 – 30) x + 0.85 x 60 x = [750,000 – 400,000] (0.6) – 0.10 [4,166,667 + 708,333] = – 277,500 5,000,000 360 50,000,000 360

  13. LIBERALISING THE CASH DISCOUNT POLICY P = [S(1 – V) - DIS] (1 – t ) + k  I

  14. DECREASING THE RIGOUR OF COLLECTION PROGRAMME RI = [S(1 – V) - BD] (1 – t ) – k  I

  15. Cash Discounts • Often part of the terms of sale • There is a tradeoff between the size of the discount and the increased speed and rate of collection of receivables. • An example would be “3/10, net 30” • The customer can take a 3% discount if s/he pays within 10 days. • In any event, s/he must pay within 30 days.

  16. $970 0 10 30 $1,000 0 10 30 The Interest Rate Implicit in 3/10, net 30 A firm offering credit terms of 3/10, net 30 is essentially offering their customers a 20-day loan. To see this, consider a firm that makes a $1,000 sale on day 0. Some customers will pay on day 10 and take the discount. Other customers will pay on day 30 and forgo the discount.

  17. Calculation of Cost of Cash Discount Rate of discount x No. of days in a year 1- Rate of discount (Credit period-Discount period)

  18. Credit terms Cost of trade credit(%) 2/10 Net 30 36.72 2/10 Net 45 20.99 1/10 Net 60 18.18 2/15 Net 30 48.98

  19. Total costs Carrying Costs Opportunity costs 28.3 Optimal Credit Policy Costs in dollars Level of credit extended C* At the optimal amount of credit, the incremental cash flows from increased sales are exactly equal to the carrying costs from the increase in accounts receivable.

  20. TRADITIONAL CREDIT ANALYSIS Five Cs of Credit Character : The willingness of the customer to honour his obligations Capacity : The operating cash flows of the customer Capital : The financial reserves of the customer Collateral : The security offered by the customer Conditions : The general economic conditions that affect the customer Case History : Checking customers past transaction to extend credit to the customer :

  21. MONITORING OF ACCOUNTS RECEIVABLES • RECEIVABLES TURNOVER • AVERAGE COLLECTION PERIOD (ACP) • AGEING SCHEDULE • COLLECTION MATRIX

  22. RECEIVABLES TURNOVER • How quickly RECEIVABLES are CONVERTED in to CASH Receivables Turnover Rate = Total Net Sales Avg. Debtors* (*including Bills Receivables)

  23. AVERAGE COLLECTION PERIOD (ACP) • Time (no. of Days) • the Credit Sales • are converted • In to Cash ACP= 365/ Receivables Turnover

  24. AGEING SCHEDULE • Statement showing • AGE WISE GROUPING OF DEBTORS OR • Breaking up of Debtors • according to the LENGTH OF TIME • for which they have been OUTSTANDING

  25. COLLECTION MATRIX • Shows • the collection pattern (in months) • for the CREDIT SALES • made in a month

  26. The factor pays an agreed-upon percentage of the accounts receivable to the firm. The factor bears the risk of nonpaying customers. Customers send payment to the factor. Goods Factoring • The sale of a firm’s accounts receivable to a financial institution (known as a factor) • The firm and the factor agree on the basic credit terms for each customer. Factor Customer Firm

  27. TYPES OF FACTORING

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