Receivables Management Flashcards
Why do firms carry accounts receivable?
Accounts receivable are carried for competitive and investment purposes
A firm almost always must offer credit if its competitors do
Customers who choose to pay beyond the stated time limit can be charged financing fees (interest income to the firm)
Due to the interaction of these 2 factors, managing accounts receivable must involve the sales, finance and accounting functions
What are factors that influence the level of receivables a company may carry?
Factors influencing the level of receivables include the soundness of the:
- Procedures for evaluating customer creditworthiness
- Formula for establishing standard credit terms
- System for tracking accounts receivable and billing customers
- Procedures for following up on overdue accounts
What is Default risk?
Default risk is the probability that a particular customer will be unwilling or unable to pay a debt. To manage (not necessarily minimize) default risk, firms often require written agreements to be signed by the customer, outlining the terms of credit and the consequences for nonpayment
What should a firm optimal credit policy do?
The optimal credit policy does not seek merely to maximize sales. This result could be accomplished by increasing discounts, offering longer payment periods and accepting riskier customers. However, firm cannot ignore the increase in bad debts and its negative effect on cash inflows
Thus, the firm must balance default risk (bad debt experience) and sales maximization
A common analytical tool is an aging schedule developed from an accounts receivable ledger. It stratifies the accounts depending on time outstanding
What is the Cash conversion cycle?
The cash conversion cycle is the time that passes (on average) between the firm’s payment for a purchase of inventory and the collection of cash from a customer on the sale of that inventory
What is the Operating cycle?
The operating cycle is the cash cycle + the time between purchases and payment
What is the Average collection period?
The average collection period (also called the days sales outstanding in receivables) is the average number of days that pass between the time of a sale and payment of the invoice
It can be derived by weighting the collection period for each group of receivables by its collection percentage
What is the Average balance in receivables?
The average balance in receivables is the amount the firm has chosen to invest in extending credit rather than in some alternative use:
= Daily credit sales x Average collection period
In many circumstances, the average balance in receivables is more efficiently calculated on an annual basis
= Annual credit sales x (Average collection period / Days in year)
What is the Accounts receivable turnover ratio?
The accounts receivable turnover ratio is the number of times in a year the average balance of receivables is converted to cash:
Accounts receivable turnover (using dollars) = Annual net credit sales / Average balance in receivables
The turnover ratio also can be stated in terms of days without regard to dollar amounts:
Accounts receivable turnover (using days) = Days in year / Average collection period
How should a firm assess the impact of a change in credit terms?
Amounts of receivables are an opportunity cost (i.e. the return that could be earned if those amounts were invested elsewhere). A key aspect of any change in credit terms is balancing the competitive need to offer credit with the opportunity cost incurred
The increased investment in receivables is calculated with the following formula:
= Incremental variable costs x (Incremental average collection period) / Days in year
How is the cost of a change in credit terms calculated?
Assessing the impact of a change in credit terms
The cost of a change in credit terms is calculated as follows:
= Increased investment in receivables x Opportunity cost of funds
How is the benefit or loss calculated from a change in credit terms?
The benefit or loss resulting from a change in credit terms is calculated as follows:
= Incremental contribution margin - Cost of change
