Accounts receivable

Question 1

How Accounts Receivable affects working capital cycles

Answer 1

Management must establish a credit policy. This is money due in from customers.. Optimum level of trade credit represents a balance between profitability ( extending credit periods to encourage additional sales) and liquidity ( collecting receipts as quickly as possible to reduce the cost of financing)

Question 2

What are the factors impacting a credit policy?

Answer 2

• demand for products
• Competitors terms
• Risk of irrecoverable debts
• Financing costs
• Cost of credit control

Question 3

What are the four key aspects of credit management?

Answer 3

1. Assessing creditworthiness of customers. We must perform checks on customers before offering credit and monitor existing customers.
2. Setting credit limits.
3. Invoicing promptly and collecting overdue debts.
4. Monitoring the credit system. This includes monitoring the aging and receivable days ratios.

Question 4

What is the process of collecting overdue debts?

Answer 4

1. Reminder letter.
2. Telephone calls.
3. With holding supplies.
4. Debt collectors.
5. Legal action

If collectors and legal action is necessary, relationships may be ruined at this point

Question 5

What is factoring?

Answer 5

Factoring is outsourcing in the credit controlled department to a third-party

Factoring office three services :
1. Debt collection. (credit control function.)
2. Financing. (Eg pay percentage of receivables upfront as cash)
3. Credit insurance. (may take responsibility for irrecoverable debt however they would dictate who the entity was able to offer credit to)

Question 6

What are the advantages and disadvantages of factoring?

Answer 6

Advantages
- short-term cash boost
- administrative savings

Disadvantages
- Expensive long-term
- Damaged customer relationship as customer is informed and may suggest you are struggling for cash

Question 7

What is invoice discounting?

Answer 7

This is where selected invoices are used as security against funds borrowed by the entity

This is a temporary source of finance repairable when the receivables pay the entity

Question 8

What are the advantages and disadvantages of invoice discounting?

Answer 8

Advantages
Short-term cash boost
Customer is unaware

Disadvantages
Expensive long-term
Extra administration costs as you are still chasing the debt