16. Management Of Accounts Receivable And Payable

Question 1

What are the two major issues to consider in granting customers credit?

Answer 1

1. Should credit be granted to all customers? Even if this is normal trade practice for the industry, business might consider leading a change in restricting credit. Or, where credit is not the norm, offering credit may stimulate sales.
2. What is the true cost to the business of customer credit? This will be influenced by the risk of bad debts and the cost of financing accounts receivable.

Question 2

What are two reports that may be used to help monitor accounts receivable?

Answer 2

1. Aged receivables listing
2. Credit utilisation report - showing how much of each customer’s credit limit is being utilized.

Question 3

State 6 ways a business may assess creditworthiness.

Answer 3

1. Bank reference
2. Trade reference
3. Credit rating/reference agencies
4. Latest available financials.
5. Information from financial media including press, journals and the internet.
6. A visit to get a feel for if the business should be given credit.

Question 4

What are 7 methods a business may use to help ensure customers pay on a timely basis?

Answer 4

1. Monthly statements
2. Chasing letters - directed to senior personnel.
3. Chasing phone calls
4. Personal approach eg partner has a word with the client’s CEO.
5. Legal action
6. External debt collection agency

Question 5

What are some methods that organisations with foreign accounts receivable can be paid with?

Answer 5

1. Bill of exchange
2. Forfaiting - bank discounts a series of bills of exchange without recourse to the exporter if the customer does not pay.
3. Letter of credit - payment guarantee backed by one or more banks.
4. Open account trading- trusting customer without additional collateral
5. Cash against documents - document of title to goods not is not released till payment is made.
6. Export credit houses - organisations that give credit to the overseas customer and guarantee payment to the supplier.
7. Export merchant - intermediary that buys discounted goods from exporter and sells to the final customer and pays the exporter (in 7 days).
8. Export credit insurance - protects against risks that could lead to default.
9. Export factoring - factors but the trade receivables from exporter and charge commission.
10. Counter trade - goods or services exchanged for goods or services.

Question 6

What is invoice discounting? State 3 advantages and two disadvantages.

Answer 6

Invoice discounting - selling selected invoices to a 3rd party for a discounted cash sum, while retaining full control over the receivables ledger.

Advantages:
1. Improved cash flow.
2. Flexibility - amount of financing rises and falls with the level of activity.
3. Confidentiality - customers are unaware that the business is borrowing against sales invoices.

Disadvantages:
1. An expensive form of financing compared to an overdraft or bank loan.
2. As the finance company takes a legal charge over the receivables ledger, the business has fewer assets available to secure other forms of borrowing.

Question 7

What is a debt factor? What are 4 advantages and disadvantages of debt factoring?

Answer 7

A debt factor is a business that offers a range of services in the area of sales administration and the collection of amounts due from customers.

Debt factors may offer services such as accounting and collection, credit control and finance against sales.

Advantages:
1. Administrative savings allowing business to concentrate on generating sales.
2. Provides a flexible source of finance.
3. Obtain benefits from the factor’s economies of scale.
4. Obtain benefits from the factor’s expertise.

Disadvantages:
1. Charges can be high
2. Loss of customer contact and factor’s vigor may damage relationships/customer goodwill.
3. Difficult of rebuilding own sales ledger function at a later date.

Question 8

What are some of the associated costs of using trade credit as a form of financing?

Answer 8

1. The business may lose any discounts for prompt payment.
2. Supplier may charge interest on late payments or increase selling prices to compensate for the finance provided.
3. Loss of goodwill with the supplier leading to lower priority future orders and possible late deliveries.
4. Supplier may eventually demand cash in advance.

Question 9

What are 4 advantages of using trade credit as a source of finance?

Answer 9

1. Convenient and informal
2. Can be used if unable to obtain credit from financial institutions.
3. If settlement discounts are taken, it can result in a cheap source of financing - as a period of time is still allowed before payment.
4. Can be used on a short-term. Asks to overcome unexpected cash flow crises.