Credit Control ( AR Management)

1. Credit Control ( AR Management) Dr Clive Vlieland-Boddy

2. Working capital management requires managing current assets (cash balances, accounts receivable and inventory) and current liabilities (accounts payable and short-term debt) when faced with political, foreign exchange, tax and liquidity constraints. The overall goal is to reduce funds tied up in working capital while simultaneously providing sufficient funding and liquidity for the conduct of global business. Working capital management should enhance return on assets and return on equity and should also improve efficiency ratios and other performance measures. Working Capital Management 2

3. ACCOUNTS RECEIVABLE MANAGEMENT The level of accounts receivable is dependant on two factors: The volume of credit sales The average collection period Economic conditions cannot be controlled, but a business can control its collection policies with an effect on both sales and average collection period. CREDIT POLICIES There are four elements of a credit policy: Credit Period Cash Discounts Credit Standards Collection Policy 3

4. Accounts Receivable Management:The Five Cs of Credit • Character: The applicant’s record of meeting past obligations. • Capacity: The applicant’s ability to repay the requested credit. • Capital: The applicant’s debt relative to equity. • Collateral: The amount of assets the applicant has available for use in securing the credit. • Conditions: Current general and industry-specific economic conditions.

5. The 4 Elements of credit policy Credit Period – How long to pay? Shorter period reduces DSO and average A/R, but it may discourage sales. Cash Discounts – Lowers price. Attracts new customers and reduces DSO. Credit Standards – Tighter standards tend to reduce sales, but reduce bad debt expense. Fewer bad debts reduce DSO. Collection Policy – How tough? Tougher policy will reduce DSO but may damage customer relationships.

6. ACCOUNTS RECEIVABLE MANAGEMENT Credit Terms A business may wish to increase its rate of discount for three reasons: To increase sales by attracting new customers; To encourage existing customers to pay more quickly; To reduce bad debts. A business can increase its rate of discount to the point where the marginal cost of discount equals the marginal profit generated. 6

7. ACCOUNTS RECEIVABLE MANAGEMENT Collection Policy Is the action a firm takes to recover its overdue accounts. A weak collection policy will save on collection costs but probably result in bad debts. On the other had a severe collection policy may reduce bad debts but may result in high collection costs, lost sales and loss of customer goodwill. Most businesses would prefer to tread a middle path. A company may increase its collection expenditure to a point in which the costs of such effort equal the revenues earned as a result. 7

8. AR Management Quality of Trade Account Length of Credit Period Average Collection Period Bad-debt Losses Firm Collection Policy Possible Cash Discount

9. CASH AND LIQUID ASSET MANAGEMENT Cash Businesses must hold sufficient cash to meet its debts, but excessive cash balances are unproductive, as they could be invested in other assets to generate income. A business will hold cash for - transaction motive - precautionary motive - speculative motive 9

10. Other Liquid assets Deposits, securities that are easily converted to cash in short time Can earn income in meantime until needed Control Cash via Cash Budget Synchronising cash Cash sales/purchases Credit sales/purchases Wages, other expenses CASH AND LIQUID ASSET MANAGEMENT 10

11. The Risk of tight credit policy? Yes, a tighter credit policy may discourage sales. Some customers may choose to go elsewhere if they are pressured to pay their bills sooner.

12. Credit Standards A larger credit department Additional clerical work Servicing additional accounts Bad-debt losses Opportunity costs (Loss of the use of the money) • Costs arising from relaxing credit standards

13. Collection Policy and Procedures The firm should increase collection expenditures until the marginal reduction in bad-debt losses equals the marginal outlay to collect. Collection Procedures Letters Phone calls Personal visits Legal action Saturation Point Bad-Debt Losses Collection Expenditures

14. Analyzing the Credit Applicant Obtaining information on the credit applicant Analyzing this information to determine the applicant’s creditworthiness Making the credit decision

15. Sources of Information Financial statements Credit ratings and reports Bank checking Trade checking Company’s own experience May be use a simple matrix The company must weigh the amount of information needed versus the time and expense required.

16. Credit Analysis the financial statements of the firm (ratio analysis) the character of the company the character of management the financial strength of the firm other individual issues specific to the firm A credit analyst is likely to utilize information regarding:

17. Other Credit Decision Issues Line of Credit A limit to the amount of credit extended to an account. Purchaser can buy on credit up to that limit. Streamlines the procedure for shipping goods. • Credit-scoring System • A system using a simple matrix, to decide whether to grant credit by assigning numerical scores to various characteristics related to creditworthiness.

18. Trade Credit ( AP Management) Dr Clive Vlieland-Boddy

19. What is trade credit? Trade credit is credit furnished by a firm’s suppliers. Trade credit is often the largest source of short-term credit, especially for small firms. Spontaneous, easy to get, but cost can be high.

20. Bye for now! Please ensure you Prepare for next session I’m ready forsome leisure time.