Working Capital Management Lecture3 By Imran Khan Accounts

Working Capital Management Lecture-3 By Imran Khan

• • Accounts Receivable Management Most competitive firms sell for credit than for cash. As a result, goods are dispatched, inventories are lowered and receivable is created. Customer pays which provides cash to the firm and receivables decline Carrying receivables provide a firm with increased sales

Policy for credit Some of the manageable determinants of demand are product quality, sales prices, advertising and the firm’s credit policy. Credit policy can be divided into the following factors: 1. Credit period: Time period given to the buyers for payment of their purchases. 2. Discounts: Refers to how quickly the payment must be made thus discounts are given for early payment. Attracts new customers and reduces DSO.

Policy for credit 3. Credit standards: Tighter standards tend to reduce sales, but reduce bad debt expense. Fewer bad debts reduce DSO. 4. Collection policy: How tough? Tougher policy will reduce DSO but may damage customer relationships, causing them to take their business elsewhere.

Collection of receivables Total accounts receivable outstanding is determined by two factors: • Average time period between sales and collections • Volume of credit sales

Collection of receivables An XYZ company opens a warehouse on 1 st January and makes sales of $500 from this first day. Assuming all sales on credit and customers are allowed to pay within 10 days. By the first day-end, accounts receivable will be $500, rise to $1000 by the end of second day and by 10 th January, they will be $10(500)= $5000 Accounts receivable= credit sales per day * length of collection period = $500*10= 5000

Accounts Receivable Management • • • Accounts receivable management requires balance between cost of extending credit and benefit received from extending credit. No universal optimization model to determine credit policy for all firms since each firm has unique operating characteristics that affect its credit policy. However, there are numerous general techniques for credit management.

Accounts Receivable Management • Three types of cost: 1. 2. 3. – Financing accounts receivable Offering discounts Bad-debt losses Must analyze relationship of these costs to profitability – Marginal cost of credit must be compared to expected marginal profit resulting from credit terms

Accounts Receivable Management • Supervising collection of accounts receivable – Requires close monitoring of average collection period and aging schedule – Aging schedule groups accounts by age and then identified quantity of past due accounts – Credit manager must develop some skills of diplomacy: balance need to collect account with need to maintain customer goodwill (unless all efforts fail and account cannot pay)