Chapter 9 - Working Capital Management - Accounts Receivable And Payable Flashcards

1
Q

Credit limits

A

Credit limits should be set to reflect both the:

  1. Amount of credit available.
  2. Length of time allowed before payment is due.

The ledger account should be monitored to take account of orders in the pipeline as well as invoiced sales, before further credit is given.

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2
Q

Invoicing and collecting overdue debts

A

The longer a debt is allowed to run, the higher the probability of eventual default. A system of follow up procedures is required,

  1. Reminder letters - Relatively poor way of obtaining payment.
  2. Telephone calls - More expensive than reminder letters but can be more efficient.
  3. Withholding supplies - Can encourage rapid settlement of debts.
  4. Debt collectors - Offer services on a fixed fee basis.
  5. Legal action - Seen as a last resort, often prompts payment. Court action is not cost effective but it can discourage other customers from delaying payment.
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3
Q

Monitoring the system

A

The position of receivables should be regularly reviewed as part of overall working capital and corrective action taken when needed.

  1. Age analysis.
  2. Ratios.
  3. Statistical data.
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4
Q

Accounts receivable

A

Finance cost = Receivable balance x Interest (overdraft) rate

Receivable balance = Credit sales x Receivable days/ 365

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5
Q

Early settlement discounts

A

Annual cost of discount = [1 + discount/ amount left to pay] ^ no. of periods -1

Where no. of periods = (365 or 52 or 12)/ no. of days or weeks or months the money is received

The annual cost calculation is always based on the amount left to pay, i.e. The amount net of discount.

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6
Q

Invoice discounting

A

Invoice discounting is a method of raising finance against the security of receivables without using the sales ledger administration services of a factor.

The business retains control over its sales ledger and confidentiality in its dealings with customers. Firms of factors will also provide invoice discounting to clients.

The method:-
1. The business sends out invoices, statements and reminders in the normal way and collects the debts. With confidential invoice discounting, it’s customers are unaware that the business is using invoice discounting.

  1. The invoice discounter provides cash to the business for a proportion of the value of the invoice as soon as it receives a copy of the invoice and agrees to discount it. The discounter will advance cash up to 80% of face value.
  2. When the business eventually collects the payment from its customer, the money must be paid into a bank account controlled by the invoice discounter. The invoice discounter then pays the business the remainder of the invoice, less interest and administration charges.
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7
Q

Factoring

A

Factoring is the outsourcing of the credit control department to a third party.

Debt collection and administration - The factor takes over the whole of the company’s sales ledger, issuing invoices and collecting debts.

Financing provision - In addition to the above, the factor will advance up to 80% of the value of a debt to the company, the remainder (minus finance costs) being paid when the debts are collected. The factor becomes a source of finance.

Credit insurance - The factor agrees to insure the irrecoverable debts of the client and determine to whom the company was able to offer credit.

Factoring is most suitable for:

  1. Small and medium sized firms which cannot afford sophisticated credit and sales accounting systems.
  2. Firms that are expanding rapidly.

Factoring is primarily designed to allow companies to accelerate cash flow providing finance against outstanding trade receivables. This improves cash flow and liquidity.

Factoring can be arranged ‘with or without recourse’ basis.
1. When a factoring is without recourse or non recourse, the factor provides protection for the client against irrecoverable debts. When a customer of the client fails to pay a debt, the factor bears the loss and the client receives the money from the debt.

  1. When factoring is ‘with recourse’, the client must bear the loss from any irrecoverable debt and so has to reimburse the factor for any money it has already received for the debt.
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8
Q

Accounts payable - managing trade credit

A

Trade credit is the simplest and most important source of short term finance for many companies.

By delaying payment to suppliers, companies face possible problems:-

  1. Supplier may refuse to supply in future.
  2. Supplier may only supply on a cash basis.
  3. There may be a loss of reputation.
  4. Supplier may increase price in future.
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9
Q

Credit policy

A

A credit policy has four key aspects:-

  1. Assessing creditworthiness
    A firm should assess the creditworthiness of:
    - All new customers immediately.
    - Existing customers periodically.

Information may come from:-

  1. Bank references - Fairly standardised in UK.
  2. Trade references - Suppliers already giving credit to the customer can give useful information about how good the customer is at paying bills on time.
  3. Competitors - Competitors share information on customers including creditworthiness.
  4. Credit reference agencies - Agencies publish general financial details of many companies for a fee.
  5. Company’s own sales records - For an existing customer, the sales ledgers will show how prompt a payer the company is but not show the ability of the customer to pay.
  6. Credit scoring - Indicators such as family circumstances, home ownership, occupation and age can be used to predict likely creditworthiness.
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