1. Working Capital Management
Roshankumar S Pimpalkar
roshankumar.2007@rediffmail.com

2. WORKING CAPITAL MANAGEMENT PART 4
Management of Receivables
A firm needs to offer its goods and services on credit to customers as a business
strategy to boost sales. This represents a considerable investment of funds. The
basic objective of Receivables management is to optimize the return on investment
in this asset. If large amounts are tied up in debtors, there will be chances of bad
debts and there will be cost of collection of debts. On the contrary, if the investment
is low, the sales may be restricted. Therefore management of debtors is an important
issue.
Finance manager can affect the volume of credit sales and collection period and
consequently, the investment in receivables through the credit policy. Credit policy is
a combination of three components
Credit a standard which is the criteria to decide the types of customers to
whom goods could be sold on credit.
Credit terms specify the duration of credit and terms of payments by
customers.
Collection efforts determine actual collection period.
Aspects of Management of Debtors
Credit policy
Credit policy is concerned with the profits that could be generated from additional
sales that could be generated by extending credit on one hand and cost of carrying
those debtors and bad debt losses on other hand. There are various factors which
determine credit policy such as effect of credit on sales, credit terms, cash discounts,
paying habits of customers etc.
For example, the credit term may be expressed as “2/15 net 40” means that a 2%
discount will be granted if the customers pays within 15 days; if he does not avail
offer he must make payment within 40 days.
Credit analysis
Finance manager determine as to how risky it is to advance credit to a particular
party.
Control of receivable
It involves follow up of debtors and decides about a suitable credit collection policies.
Maintaining receivables comprises of various costs such as collection cost,
defaulting cost, and administrative cost record keeping.
roshankumar.2007@rediffmail.com

3. Financing Receivable
1. Pledging: firms receivables are used as a security for short term loan as
receivables are most liquid assets and this serve as prime collateral for a
secured loan. The lender scrutinizes the quality of accounts receivables,
selects acceptable accounts, creates a lien on the collateral and fixes a
percentage of financing receivables which ranges around 50 to 90%. The
major advantage of pledging accounts receivable is the ease and flexibility it
provides to the borrower. But the cost of financing is high.
2. Factoring: it is a new concept in financing accounts receivables. This refers
to outright sale of accounts receivables to a factor or a financial agency. A
factor is firm that acquires the receivables of other firms. The factoring lays
down the conditions of the sale in factoring agreement. The factoring agency
bears the right of collection and services the accounts for fee. Normally,
factoring is a non recourse arrangement which means in the event of default
the loss is born by the factor. However in the case of with recourse
arrangement such loss is born by the seller. The biggest advantages of
factoring are immediate conversion of receivables into cash and it helps
company to have liquidity without creating net liability on its financial
condition. Some of the commercial banks provide this service.
Tool and Techniques of Receivable Management
Re-engineering Receivable Process: Re-engineering is a fundamental rethinking and
redesigning of business processes by incorporating modern business approach.
Some of the organizations have achieved real cost savings and performance
improvements through re-engineering receivables.
Centralization of high nature transactions of accounts receivables and
payables is one of the practices for better efficiency.
Alternate payment strategies direct transfer of funds from purchasers bank
account, collection by third party, lock box processing and payments via
internet.
Customer orientation: where individual customers or a group of customers
have some strategic importance to a firm a case study approach may be
followed to develop good customer relationship. A critical study of this group
may lead to formation of a strategy for prompt settlement of debt.
Use of Latest Technology such as E-commerce, Automated receivable management
system.
Use of financial tools/technique such as Credit rating and decision tree analysis of
granting credit.
Example of decision tree analysis: if the chances of recovery are 8 out of 10 then
probability of recovery is 0.8 and that of default is 0.2. Suppose cost of goods is Rs 4
lakh and revenue is Rs 7 lakh. Now weighted net benefit should be calculated
roshankumar.2007@rediffmail.com

4. = [(700000-400000)*0.8] – [400000*0.2]
= 160000
As there is net benefit hence credit should be granted.
Collection policy: if a firm spends more resources on collection of debts, it is likely to
have smaller bad debts. Thus a firm must work out optimum amount that it should
spend on collection of debtors. This involves trade off between the levels of
expenditure on the one hand and decreases in bad debt losses and investment in
debtors on the other hand.
Ageing schedule: When receivables are analysed according to their age, the process
is known as preparing ageing schedules of receivables. The computation of average
age of debtors is a quick and effective method of comparing liquidity of receivables
with the liquidity of receivables in the past and also comparing liquidity of one firm
with it competitor. It also helps the firm to predict the collection pattern of receivable
in future.
The credit collection procedure must answer the following:
How long should a debtor balance be allowed to exist before collection
process is started?
Should there be collection machinery whereby personal calls by company’s
representatives are made?
What should be the procedure of follow up with defaulting customers?
How reminders are to be sent and how should each successive reminder be
drafted?
What should be the procedure for dealing with defaulting customers? Is legal
action to be instituted?
The fundamental rule of sound receivable management should be to reduce the time
lag between the sale and collections, at the same time maintain customer goodwill.
roshankumar.2007@rediffmail.com