RECEIVABLES MANAGEMENT AND FACTORING

CHAPTER 28

LEARNING OBJECTIVES Emphasize the need and goals of establishing a sound

credit policy Show how an optimum credit policy can be established Explain the credit policy variables Indicate the credit procedure for and control of individual

accounts Suggest methods of monitoring receivables Discuss the nature and costs and benefits of factoring

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INTRODUCTION

Trade credit happens when a firm sells its products or services on credit and does not receive cash immediately.

A credit sale has three characteristics: First, it involves an element of risk that should be carefully

analyzed. Second, it is based on economic value. Third, it implies futurity.

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Nature of Credit Policy

Investment in receivable volume of credit sales collection period

Credit policy credit standards credit terms collection efforts

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Goals of Credit Policy

Marketing tool Maximisation of

sales Vs. incremental profit production and selling

costs administration costs bad-debt losses

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Optimum Credit Policy

Estimation of incremental profit

Estimation of incremental investment in receivable

Estimation of incremental rate of return (IRR)

Comparison of incre-mental rate of return with required rate of return (RRR)

Optimum credit policy: IRR = RRR

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Costs of Credit Policy

Credit Policy Variables

Credit standards and analysisCredit termsCollection policy and procedures

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Credit Standards

Credit standards are the criteria which a firm follows in selecting customers for the purpose of credit extension.

The firm may have tight or loose credit standards.

Credit analysis Average collection period (ACP) Default rate

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Cont…9

Customer categories• good accounts• bad accounts• marginal accounts

Numerical credit scoring• ad hoc approach• simple discriminant approach• multiple discriminant approach

Credit-granting Decision

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Credit terms

Credit period Cash discount

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Collection policy and procedures

regularity of collections clarity of collection procedures responsibility for collection and follow-up case-by-case approach cash discount for prompt payment

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CREDIT EVALUATION OF INDIVIDUAL ACCOUNTS

Credit Information Financial statement Bank references Trade references Other sources

Credit Investigation and Analysis Analysis of credit file Analysis of financial ratios Analysis of business and its management

Credit Limit Collection Efforts

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MONITORING RECEIVABLES

Average Collection Period Aging Schedule Collection Experience Matrix

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FACTORING Factoring may be defined as ‘a contract between the

suppliers of goods/services and the factor under which

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Factoring Services

Credit administration Credit collection and protection Financial assistance Other services

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Factoring and Short-term Financing Factoring involves ‘sale’ of book debts. Factoring provides flexibility as regards credit

facility to the client. Factoring is a unique mechanism which not only

provides credit to the client but also undertakes the total management of client’s book debts.

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Factoring and Bills Discounting

1. Bills discounting is a sort of borrowing while factoring is the efficient and specialized management of book debts along with enhancement of the client’s liquidity.

2. The client has to undertake the collection of book debt. Bill discounting is always ‘with recourse’, and as such, the client is not protected from bad-debts.

3. Bills discounting is not a convenient method for companies having large number of buyers with small amounts since it is quite inconvenient to draw a large number of bills.

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Types of Factoring

Full service non-recourse Full service recourse factoring Bulk/agency factoring Non-notification factoring

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Advance factoringMaturity factoring

Costs of Factoring

the factoring commission or service fee the interest on advance granted by the factor to the

firm.

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Benefits of Factoring

Factoring provides specialized service in credit management, and thus, helps the firm’s management to concentrate on manufacturing and marketing.

Factoring helps the firm to save cost of credit administration due to the scale of economics and specialization.

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