5: Monitoring and controlling customer accounts

Question 1

Credit control monitoring techniques:

Which one is the main monitoring process?

What other techniques are there?

Answer 1

The main monitoring process is the trade receivables analysis

There are also a number of other guiding principles and sources of information used in an effectively managed credit control function.

1) Trading history
2) Average periods of credit
3) 80/20 rule
4) Materiality

Question 2

Credit control monitoring techniques:

What kind of information does trade receivables analysis provide?

Answer 2

Provides critical information about the accounts of individual customers.

Question 3

Credit control monitoring techniques: Trading history

What questions the credit controller will ask about a customer?

What will this information tell the credit controller?

How can this information be backed up?

Answer 3

a) Has the customer kept within the agreed credit limit?
b) Has the customer settled sales invoices on time?

This will tell the credit controller how reliable the customer is and whether the customer may need chasing up.

This can also, in case of any doubt, be backed up by the taking of status reports from credit reference agencies.

Question 4

Credit control monitoring techniques: Average periods of credit

Answer 4

This is calculated as the account receivables collection period, the average number of days it takes the trade receivables of an organisation to pay invoices.

Trade receivables/Sales revenue x 365 = average length of credit taken

Question 5

Credit control monitoring techniques: 80/20 rule

Answer 5

States that 80% of the total value of the receivables is represented by only 20% of customers. It therefore follows that the organisation would do well to concentrate its credit control efforts on that 20% of customers.

Question 6

Credit control monitoring techniques: Materiality

Answer 6

it follows that the remaining 80% of customers (and 20% of the sales ledger balances outstanding) are not as material to the credit control process as the top 20% of customers.

Question 7

What is a trade receivables analysis?

What it shows?

Answer 7

A trade receivables analysis is a summary of amounts owed by customers, analysed into time period columns showing how long the amounts have been outstanding.

It shows the organisation the customers that are slow in setting invoices and the customers that may become irrecoverable debts.

Question 8

Trade receivables analysis and liquidity: what pinpoints this analysis and why is it important?

Answer 8

A trade receivables analysis is an essential report which pinpoints the cause of potential liquidity problems and is critical in the process of liquidity management.

Funds not received from trade receivables will need to be financed from elsewhere and will increase the costs of the organisation.

Question 9

What is the format of a trade receivables analysis?

Answer 9

A trade receivables analysis can either be drawn up manually, or it can be printed out as a report from a computer accounting package.

Question 10

Which document will state when should the trade receivables analysis be produced?

When is it normally done?

Answer 10

The credit control policy of the organisation will normally state when the trade receivables analysis should be produced.

This is normally after the end of each month after the statements have been sent out.

Question 11

What action the organisation will take after the trade receivables analysis?

Answer 11

From the analysis the organisation decides which customers it is going to chase up, and how. It may send a letter or an email, or it may telephone the customer.

Question 12

What information is included in the trade receivables analysis?

Answer 12

1) Account name and account number
2) Credit limit and balance columns
3) Invoice “age” columns

Question 13

What will the credit controller look for in a trade receivables analysis despite of individual accounts?

Answer 13

When analysing the report, the credit controller will look not only at individual accounts, but also at a number of relationships and trends by comparing this report with the previous month’s analysis.

Question 14

How is it done the trade receivables analysis?

What happens next?

Answer 14

Analysis of individual accounts is likely to start with a look at the far right-hand column. This process will then continue as each column from right to left is scrutinised for “out of order” amounts.

Whatever the situation, action will need to be taken, in line with the Credit Control Policy.

Question 15

Security and systems: how should data be taken care of?

Answer 15

1) It is important that all data used within credit control (as with all finance functions) is kept up to date.

If it is held electronically:

2) there must be restricted access,
3) it must be held securely,
4) regularly backed up and
5) free from viruses.

Question 16

Security and systems:

What is a vital part of effective credit control wether using a different system or using the same system?

Answer 16

Where different systems (either manual or computerised) are maintained by the sales, accounts and credit control departments, regular communication is vital.

Even if the same system is used by all departments the importance of communication between the three departments is an essential part of an effective credit control function.

Question 17

Trade receivables analysis – taking action:

What is set out in the Credit control policy?

Answer 17

Most organisations will have a Credit Control Policy which sets out the procedures for chasing debts and guidelines for the timing.

Question 18

What does it mean when the organisation have standard communications for credit control?

Answer 18

The organisation is likely to have a set of standard letters which will vary in tone from the polite request for payment to the formal threatening of legal action.

Question 19

Trade receivables analysis – taking action: Standard communications: why is it important to use the standard letters?

Answer 19

It is important that the standard letters are used as they will be designed to place the organisation that issues the invoices in a strong position if legal action becomes necessary.

Question 20

Trade receivables analysis – taking action: Standard communications: how should the person act?

Answer 20

It is important in all methods of communication to be polite, unbiased and represent well the organisation in an appropriate and professional manner.

Question 21

Trade receivables analysis – taking action: Using the telephone

Why is it an efficient and useful mean of communication?

What should be aware of the person chasing the debt?

Answer 21

The telephone is a very efficient means of communicating a message and assessing reasons for non-payment. The telephone is normally resorted to when statements and letters fail to have any effect.

The telephone is a useful means of communication because it demands an immediate reply.

Organisations with a poor payment record will often come up with a variety of lame and blatantly untrue excuses on the telephone. It is the job of the person chasing the debts to have ready answers for all of these.

Question 22

What does it mean to use discretion during the trade receivables analysis?

Answer 22

It is important to appreciate that the debt-chasing actions carried out as a result of the monthly check through the trade receivables analysis should reflect the standing and payment record of each customer. Any Credit Control Policy cannot be relied upon to work “by formula”.

Question 23

What information is available to credit control to detect doubtful and irrecoverable debts ?

Answer 23

The available information might include:

1) The trade receivables analysis
2) Internal information provided by the sales team
3) Internal information provided by the credit control staff
4) Comments from other organisations in the trade

Question 24

Doubtful and irrecoverable debts: what should credit control assess from the information available?

Answer 24

Part of the job of the person working in credit control is to assess from the information to hand if a customer is going to default and not pay the balance due.

Question 25

Doubtful debts: what does it mean?

Answer 25

If a customer looks like is going to default, the debt is said to be “doubtful”. This means that the organisation, weighing up the possibilities, reckons that it is unlikely that it will get paid. There is still a possibility that the money will come in, but it is “doubtful”.

Question 26

Methods of making provision for doubtful debts

Answer 26

1) A set percentage of the total trade receivables

2) Carry out the process for individual debts rather than relying on a percentage of total trade receivables.

Question 27

How does an organisation make a provision for doubtful debts?

Answer 27

Organisations adjust their accounting records by making provision for doubtful debts and setting the provision off against profits in a “provision for doubtful debts account”.

Question 28

Methods of making provision for doubtful debts: explain the provision as a set percentage of the total trade receivables.

How does it affects the day to day running of credit control?

Answer 28

This provision is often a set percentage of the total trade receivables, the percentage being based on experience within that type of organisation.

If this method is adopted, the day to day running of credit control based on the trade receivables analysis will not be affected by the making of the provision.

Question 29

Methods of making provision for doubtful debts: explain the provision for individual debts.

Answer 29

Another method of making provisions for doubtful debts is to carry out the process for individual debts rather than relying on a percentage of total trade receivables.

This means that each time the organisation assesses the trade receivables analysis, individual accounts which look unlikely to pay up are marked up for a doubtful debt provision, referred to management and entered in a “provision for doubtful debts accounts”.

This is a less common method, because it is far more involved and time-consuming.

Question 30

What are irrecoverable debts and how the organisation deals with these debts?

Answer 30

Irrecoverable debts are doubtful debts which have lost the element of doubt – it is considered by the organization that they will definitely not be paid and will need to be written off in the accounts against profits in an “irrecoverable debts written off account”.

Question 31

What fundamental principles of professional ethics should be adhered to when dealing with doubtful or irrecoverable debts?

Answer 31

1) Objectivity: make decisions based on true facts, not opinions
2) Confidentiality: do not disclose the details to others
3) Professional behaviour: whatever an individual’s opinion may be on the situation, continue to treat the customer in a polite, appropriate and professional manner

Question 32

Other methods of collecting trade debts:

What kind of service do they provide?

Which institutions provide that service?

How they will help the organisation?

Answer 32

There are a number of financial services available to organisations which can help them with debt collection and the avoidance of irrecoverable debts.

These services are provided by banks, insurance and other financial institutions.

They will improve or safeguard the liquidity of the organisation, but at a cost.

Question 33

Other methods of collecting trade debts:

What is credit insurance?

What options are available?

Answer 33

Replaces cash lost when a debt becomes irrecoverable.

Typical options include:

1) Whole turnover insurance: general coverage in the case of receivable default
2) Insurance limited to key accounts
3) Single account insurance
4) Catastrophe: protection against natural disasters
5) Overseas credit insurance: is also available to cover the risk of non-payment by overseas customers either through customer default or through political events.

Question 34

Other methods of collecting trade debts:

What is factoring?

Answer 34

A factoring company lends money against the invoices received from trade receivables of the business, providing liquidity before the invoice due dates. The factoring company takes over the administration of the sales ledger.

Factoring companies also provide an optional irrecoverable debt protection scheme known as “non-recourse” factoring, for which a further charge is payable. Factoring without irrecoverable debt protection is known as “recourse” factoring.

Question 35

Other methods of collecting trade debts:

What is invoice discounting?

Answer 35

A finance house lends money against invoices issued to selected customers of the organisation, but the organisation continues to operate its own sales ledger and credit management system.

The finance house will normally only be prepared to set up invoice discounting for an organisation which has good credit management procedures in place.

Question 36

What other methods of collecting trade debts are there?

Answer 36

1) Credit insurance
2) Factoring
3) Invoice discounting

Question 37

What effect on liquidity management will have using Credit insurance?

Answer 37

Credit insurance safeguards liquidity and avoids the danger of a substantial customer default, an event which could have a catastrophic effect on liquidity and profitability.

Question 38

What effect on liquidity management will have using Factoring and invoice discounting?

Answer 38

Factoring and invoice discounting will improve liquidity because income from sales will be received sooner rather than later. The organisation will have a reduced working capital financing cost, but will also incur charges for the services.

The organisation will need to consider carefully the cost/benefit situation.

Question 39

How are analysed the “credit limit” and “balance” columns?

Answer 39

These two columns are compared to find out whether any customer is exceeding the allocated credit limit.

Question 40

What does the “Invoice age” columns show?

Answer 40

They show how long the invoices which make up the total balance column have been outstanding.

Question 41

Which 3 departments of the organisation share information about credit control?

Answer 41

1) sales
2) accounts
3) credit control