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8/6/2019 Working Capital,Credit and Accounts Receivable Management
http://slidepdf.com/reader/full/working-capitalcredit-and-accounts-receivable-management 1/31
Working Capital, Credit andWorking Capital, Credit and
Accounts ReceivableAccounts ReceivableManagementManagement
8/6/2019 Working Capital,Credit and Accounts Receivable Management
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Cash Flow Cycle of aCash Flow Cycle of a
BusinessBusinessPurchase of
Materials
Payment for
Materials
Sale of
Product Collect A/R
Days¶ Inventory
Cash Conversion Cycle
Days¶Receivables
Days¶ Payables
Day 1 Day 30 Day 45 Day 75
8/6/2019 Working Capital,Credit and Accounts Receivable Management
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Working Capital Cash FlowWorking Capital Cash Flow
Cycle:Cycle:
Cash Conversion CycleCash Conversion Cycle
Inventory
Days' Inventory = × 365 DaysCost of Goods Sold
Accounts ReceivableDays' Receivables = × 365 Days
Annual Sales
Accounts PayableDays' Payables = × 365 DaysCost of Goods Sold
Cash Conversion Cycle = Days' Inv. + Days' Recs. - Days' Payables
Formulas for three time periods are necessary to calculateFormulas for three time periods are necessary to calculate
the cash conversion cycle.the cash conversion cycle.
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Credit Policy andCredit Policy and
CollectionsCollections
OrderOrder OrderOrder SaleSale CashCashPlacedPlaced ReceivedReceived ReceivedReceived
Accounts Accounts CollectionCollection
< Inventory > << Inventory > < Receivable Receivable > < Float >> < Float >
Time ==>Time ==>
Accounts DisbursementAccounts Disbursement
< Payable > < Float >< Payable > < Float >
InvoiceInvoice PaymentPayment CashCash
Received Sent PaidReceived Sent Paid
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Objectives of Credit ManagementObjectives of Credit Management
Creating, preserving, and collecting A/R.Creating, preserving, and collecting A/R.
Establishing and communicating credit policies.Establishing and communicating credit policies.
Evaluation of customers and setting creditEvaluation of customers and setting creditlines.lines.
Ensuring prompt and accurate billing.Ensuring prompt and accurate billing.
Maintaining upMaintaining up--toto--date records of accountsdate records of accounts
receivables.receivables. Initiating collection procedures on overdueInitiating collection procedures on overdue
accountsaccounts..
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Reasons to Offer CreditReasons to Offer Credit
CompetitionCompetition
Market ShareMarket Share
PromotionPromotion
Credit Availability to CustomersCredit Availability to Customers
Customer ConvenienceCustomer Convenience
ProfitProfit
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Credit and A/R Management:Credit and A/R Management:Fit Into the Financial OrganizationFit Into the Financial Organization
A credit manager or a captive finance company A credit manager or a captive finance companyis the administrator of credit policies.is the administrator of credit policies.
Credit policies and collections will impact cashCredit policies and collections will impact cashflows so credit and cash managers must workflows so credit and cash managers must worktogether.together.
Reasons for credit and cash manager Reasons for credit and cash manager
interaction include the accuracy of cash flowinteraction include the accuracy of cash flowforecast, banking network management, andforecast, banking network management, andaccounts receivable updating.accounts receivable updating.
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Cost Associated With aCost Associated With a
Credit PolicyCredit Policy
Credit Department CostsCredit Department Costs
Credit Evaluation CostsCredit Evaluation Costs A/R Carrying Cost A/R Carrying Cost
Discounted PaymentsDiscounted Payments
Selling and Production CostSelling and Production Cost
Collection ExpensesCollection Expenses
Bad DebtsBad Debts
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Analysis of CreditAnalysis of Credit
ExtensionExtension
NPV =NPV = SalesSales ± ± Collection ExpenseCollection Expense --VariableVariable
1+(Cost of Cap. X Coll. Days)1+(Cost of Cap. X Coll. Days)
CostsCosts
If NPV > 0 then Extend CreditIf NPV > 0 then Extend Credit
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Forms of Credit ExtensionForms of Credit Extension
Installment CreditInstallment Credit Revolving CreditRevolving Credit
Letters of CreditLetters of Credit
Open AccountOpen Account
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Common Terms of SalesCommon Terms of Sales
Cash Before Delivery (CBD)Cash Before Delivery (CBD)
Cash on Delivery (COD)Cash on Delivery (COD)
Cash TermsCash Terms Net TermsNet Terms
Discount TermsDiscount Terms
Monthly BillingMonthly Billing
Bill of Lading or Documentary CollectionBill of Lading or Documentary Collection Seasonal DatingSeasonal Dating
ConsignmentConsignment
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The Five C·s of CreditThe Five C·s of Credit Character Character
CapacityCapacity
CapitalCapital
CollateralCollateral
ConditionsConditions
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Cost of Trade CreditCost of Trade Credit
From a seller¶s viewpoint, the cost of theFrom a seller¶s viewpoint, the cost of thediscount must be weighted against the benefitdiscount must be weighted against the benefitof receiving early payment.of receiving early payment.
From buyer¶s viewpoint, the cost of tradeF
rom buyer¶s viewpoint, the cost of tradecredit is an opportunity cost.credit is an opportunity cost.
A buyer should take the discount if its cost of A buyer should take the discount if its cost of borrowing is less than the cost of foregoingborrowing is less than the cost of foregoing
the discount.the discount. Alternatively, a buyer should forego the Alternatively, a buyer should forego the
discount if investment rates are higher thandiscount if investment rates are higher thanthe cost of foregoing the discount.the cost of foregoing the discount.
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Cost of Trade CreditCost of Trade Credit
Cost of Trade Credit =Cost of Trade Credit =
Early Payment Discount x 365Early Payment Discount x 365
------------------------------------------------------------------ ------------------------------------------------------------------
(1(1 ± ± Early Payment Discount) (Net Payment PeriodEarly Payment Discount) (Net Payment Period--
Discount PaymentDiscount PaymentPeriod)Period)
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Annualized Cost of TradeAnnualized Cost of Trade
CreditCreditExample
Assuming terms of 2/10, net 45, the cost of not taking the
discount can be determined as follows:
21.28%=.2128=
10.428571.0204081=35
365
.98
.02 =
10-45
365
.02-1
.02 =
PeriodPmtDiscount-PeriodPmtNet365
DiscountPmtEarly-1DiscountPmtEarly =CreditTradeof Cost
vvv
v
If the company can borrow at less than 21.28%, it should do so anduse the borrowed funds to pay early and take the discount.
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Account ReceivableAccount Receivable
Monitoring and ControlMonitoring and Control
Monitoring and control is the responsibility of Monitoring and control is the responsibility of the credit manager.the credit manager.
Receivables turnover Receivables turnover
least favored techniqueleast favored technique
Monitoring conducted on individual accountsMonitoring conducted on individual accountsthroughthrough aging schedulesaging schedules..
Monitoring conducted at the aggregate levelMonitoring conducted at the aggregate level
usingusing days¶ sales outstandingdays¶ sales outstanding (DSO).(DSO).
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DSODSO
Can give an indication of overallCan give an indication of overallcollection efficiency.collection efficiency.
Changes in sales volume, paymentChanges in sales volume, payment
patterns, or strong seasonality in salespatterns, or strong seasonality in sales
can distort DSO.can distort DSO.
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Days· SalesDays· Sales
Outstanding (DSO) Outstanding (DSO)
Assume that a company has outstanding receivables of Assume that a company has outstanding receivables of Rs350,000 at the end of the first quarter and credit sales of Rs350,000 at the end of the first quarter and credit sales of Rs425,000 for the quarter. Using a 90Rs425,000 for the quarter. Using a 90--day averagingday averagingperiod, the DSO for this company can be computed asperiod, the DSO for this company can be computed asfollows:follows: Sales During Period $425,000Avg. Daily Credit Sales = = = $4,722.22
Number of Days in Period 90
Outstanding A/R $350,000DSO = = = 74.11 Days
Avg. Daily Credit Sales $4,722.22
Average Past Due = DSO - Avg. Days of Credit Terms
= 74.11 Days - 60 Days = 14.11 Days
If the company¶s credit terms are net 60, the average past due iscomputed as follows:
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Aging ScheduleAging Schedule
Is a list of the percentage and/or amounts of Is a list of the percentage and/or amounts of
outstanding A/R classified as current or pastoutstanding A/R classified as current or past
due.due.
Used primarily to identify past due accounts.Used primarily to identify past due accounts.
Can be prepared at the aggregate level or Can be prepared at the aggregate level or
customer customer--byby--customer.customer.
Subject to distortions due to sales variations.Subject to distortions due to sales variations.
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Aging ScheduleAging Schedule
Age of Accounts A/R % of A/R
0 ± 30 days
31 ± 60 days
61 ± 90 days
91 + days
Total
Rs1,750,000
Rs375,000
Rs250,000
Rs125,000
Rs2,500,000
70%
15%
10%
5%
100%
S eparates A/R into current and past due receivables
in 30-day increments (on a customer or aggregate
basis) and can determine the percent past due
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A/R Balance PatternA/R Balance Pattern
Gives the percent of credit sales in a timeGives the percent of credit sales in a timeperiod that remains outstanding at the end of period that remains outstanding at the end of each time period.each time period.
Based on aging schedules.Based on aging schedules.
It is not directly affected by sales variations.It is not directly affected by sales variations.
A useful tool in cash flow forecasting because it A useful tool in cash flow forecasting because it
can be used to project A/R levels andcan be used to project A/R levels andcollections.collections.
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A/R Balance PatternA/R Balance Pattern
Month Sales Sales
Remaining A/Rfrom Month Sales
at End of March
February
January
March
April
Rs250,000
Rs300,000
Rs400,000
Rs500,000
20%
55%
95%
Remaining A/Ras a % of
Month Sales
Rs50,000
Rs165,000
Rs380,000
The total outstanding A/R balance at the end of March is:
Rs595,000 = (Rs50,000 + Rs165,000 + Rs380,000)The estimate of cash inflows for April = 5% of April sales + 40% of March
sales + 35% of February sales + 20% of January sales:
Estimated April inflows = (0.05 x Rs500,000) + (0.40 x Rs400,000)
+ (0.35 x Rs300,000) + (0.20 x Rs250,000) = Rs340,
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A/R FinancingA/R Financing
Unsecured Bank BorrowingUnsecured Bank Borrowing
Secured Bank BorrowingSecured Bank Borrowing
Captive Finance CompanyCaptive Finance Company
Third Party Financing InstitutionsThird Party Financing Institutions
Credit CardCredit Card
FactoringFactoring
Private Label FinancingPrivate Label Financing
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Evaluate Changes inEvaluate Changes in
Credit PolicyCredit Policy Credit term change decision variablesCredit term change decision variables
effect on dollar profitseffect on dollar profits
sales effectsales effect
receivables effectreceivables effect
return on investment effectreturn on investment effect
default probabilitydefault probability
credit limitscredit limits
opportunity cost of funds invested in receivablesopportunity cost of funds invested in receivables
company¶s overall cost of capitalcompany¶s overall cost of capital
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Cash ApplicationCash Application
Cash applicationCash application is the process of is the process of
matching and applying a customer¶smatching and applying a customer¶s
payment against accounts receivable.payment against accounts receivable.
Done via anDone via an Open ItemOpen Item or aor a BalanceBalance
ForwardForward system.system.
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Open Item SystemOpen Item System
Used in commercial transactions.Used in commercial transactions. Each invoice is recorded separately inEach invoice is recorded separately in
an account receivable file.an account receivable file.
Payments are matched to the particular Payments are matched to the particular invoice in the file.invoice in the file.
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Balance Forward SystemBalance Forward System
Used in retail applications.Used in retail applications.
Credit limits are established for eachCredit limits are established for each
individual.individual.
As purchases are made, A/R increase. As purchases are made, A/R increase.
Payments are applied against thePayments are applied against the
aggregate A/R outstanding.aggregate A/R outstanding.
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Collection ProceduresCollection Procedures
Typical collection effortTypical collection effort initial contact within 10 days of delinquencyinitial contact within 10 days of delinquency
then reminder letter followed by phone callthen reminder letter followed by phone call
sales force notifiedsales force notified
last resort, reference to collection agency/legal actionlast resort, reference to collection agency/legal action
Collection agencyCollection agency Phase 1Phase 1 -- computer generated collection letter, whencomputer generated collection letter, when
accounts are 45 to 90 days past dueaccounts are 45 to 90 days past due Phase 2Phase 2 -- commissioned collectors usedcommissioned collectors used
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Collection ProceduresCollection Procedures
Companies tend to be more aggressiveCompanies tend to be more aggressive
the larger the receivables balancethe larger the receivables balance
Companies understand the goodCompanies understand the good--willwilltradeoff when selecting collection methodstradeoff when selecting collection methods
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International CreditInternational Credit
ManagementManagement Credit policy analysisCredit policy analysis
lengthening terms increases exchange rate risklengthening terms increases exchange rate risk
also increases default riskalso increases default risk
harder to get D&B reportsharder to get D&B reports
harder to get bank credit informationharder to get bank credit information
Modifying monitoring and collectionsModifying monitoring and collections legal remedies for late payment or nonpayment differ legal remedies for late payment or nonpayment differ
by countryby country
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ATTENTION COMMERCEATTENTION COMMERCE
STUDENTSSTUDENTSACCOUNTING(FINANCIAL & COST) OFACCOUNTING(FINANCIAL & COST) OFICMAP STAGE 1,2,3,4ICMAP STAGE 1,2,3,4CA..MODULE B,C,DCA..MODULE B,C,DPIPFA (FOUNDATION,INTERMEDIATE,FINAL)PIPFA (FOUNDATION,INTERMEDIATE,FINAL)ACCAACCA--F1,F2,F3F1,F2,F3BBA,MBABBA,MBAB.COM(FRESH),M.COMB.COM(FRESH),M.COMMAMA--ECONOMICS..O/A LEVELSECONOMICS..O/A LEVELSKHALID AZIZ«..0322KHALID AZIZ«..0322--3385752..kARACHI3385752..kARACHI
JOIN GROUPJOIN GROUPhttp://finance.groups.yahoo.com/group/costhttp://finance.groups.yahoo.com/group/cost--accountantsaccountants