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 2

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. 3

Nature of Credit Policy  Investment in receivable  volume of credit sales  collection period  Credit policy  credit standards  credit terms  collection efforts 4

Goals of Credit Policy  Marketing tool  Maximisation of sales Vs. incremental profit  production and selling costs  administration costs  bad-debt losses 5

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 6 Costs of Credit Policy

Credit Policy Variables  Credit standards and analysis  Credit terms  Collection policy and procedures 7

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 8

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 10

Credit terms  Credit period  Cash discount 11

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 12

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 13

MONITORING RECEIVABLES  Average Collection Period  Aging Schedule  Collection Experience Matrix 14

FACTORING  Factoring may be defined as ‘a contract between the suppliers of goods/services and the factor under which 15

Factoring Services  Credit administration  Credit collection and protection  Financial assistance  Other services 16

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. 17

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. 18

Types of Factoring  Full service non-recourse  Full service recourse factoring  Bulk/agency factoring  Non-notification factoring 19 Advance factoring Maturity factoring

Costs of Factoring  the factoring commission or service fee  the interest on advance granted by the factor to the firm. 20

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. 21