Recievable Management

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CHAPTER V

RECEIVABLES MANAGEMENT

Trade credit is the most prominent force of the modern business, it is considered as an essential marketing tools acting as a bridge for the movement of goods through production and distribution stages to customer finally. When the firm sells its products or services and does not receive cash for it immediately, the firm is said to have granted trade credit to customers. Trade credit, thus creates receivables or book debt which the firm is expected to collect in the future. The book debt or receivables arising out of credit has three characteristics. First it involves an element of risk which should be carefully analyzed. Second, it is based on economic value. Third, it implies futurity.

            Effective receivables mgt is essential to attain the following objectives:

1. To maximize return on investment in account receivables

2. To ensure liquidity in respect of this asset.

3. To have a credit policy which can reduce risk and increase profitability

4. To create an effective collection policy

Why do the Companies grant credit?

1. Competition: - Generally the higher the degree of competition, the more the credit granted by a firm. However there are such firms in the electronics industry in India.
2. Buyer’s requirements: - In certain business sections buyers or dealers are not able to operate without extending credit.
3. Company’s bargaining power: - If a company has a higher bargaining power, it may grant no or less credit. The company will have a strong bargaining power of it has a strong product, monopoly power, brand image, large size or strong financial position.
4. Buyer’s status: - Companies normally grant credit to bulk purchasers. Some companies follow a policy of not giving much credit to small retailers since it is quite difficult to collect dues from them.
5. Marketing tool: - Credit is used as a marketing tool, particularly when a new product is launched or when a company wants to push its weak product.
6. Relationship with dealers: - Companies sometimes extend to dealers to build long term relationship with them or to reward there for their loyalty.

COST AND BENEFIT ANALYSIS

            The primary objective investment in trade debt is to increase profit by expanding sales. It is a marketing tool to attract new customers and to retain old customers. The credit sales should be financed up to an optimum level only. Such optimum level is determined by comparing benefit of the additional credit sales with increase in cost owing to cash such incremental sales. A trade by between costs and benefits will determine the optimum level. The various costs include: -

1. Collection Costs: - A business has to engage additional staff for the mgt of receivables. The customers have to be constantly chased to ensure receipt of money as per schedule. Reminders have to be sent, telephone calls to be made, their quires, if any, have to be attended. In addition, a lot of credit information is required to be gathered from internal and external sources.
2. Capital Costs: - The production and selling costs can be described as capital costs pertaining to credit sales funds are required for the purchase of materials, payment of wages, incurring of overheads immediately, where receipts against them are deferred till collection from debtors. It is common phenomenon for a business to raise overdraft to finance credit sales.
3. Delinquency Costs: - In a business there is always a category of customers who do not settle their accounts despite reminders. Lot of procedures is required to persuade them to pay. Repeated letters, telexes faxes are sent. It is then followed by personal contacts. Costs incurred on these accounts are delinquency costs. When the period of payment becomes due (i.e. after the expiry of credit period) but is not received from the customers the same is known as delinquency costs.

       It includes:

i.                    Blocking up of funds / costs of financing for an external period.

ii.                  Cost of extra steps to be taken to collect the over dues. E.g. Legal charges, reminders…etc

4. Default Costs: - Credit sales have got an element of futurity and future always have an inherent risk in it. In the credit sales the risk in the form of bad debts. A liberal credit policy will increase sales, profits and also instances of bad debts. A bad debt is known as default cost. It constitutes a heavy drain on the cash flows of a business since it encompasses all types of costs- capital costs, collection costs and delinquency cost.[some times the firms may not collect the over dues from the customers since they are unable to pay. These debts are treated as bad debts and are to be written off accordingly since the amounts will not be realized in future.]

Optimum level of credit sales is determined by a trade off between benefits and costs. The trade off should be with regard to incremental benefits and costs only. The optimum level is that point where profit is generated by additional investment in credit sales matches with the additional cost incurred because of such sales. However some scholars opine that matching of such incremental profit should be done with the rate of return which a business expects on its funds rather than with additional cost of incremental sale.

Techniques of Receivables Mgt [Area of Receivables Mgt]

            Following are the credit procedure to be followed in managing the accounts of individual debtors.

1.      Establishing Optimum Credit Policy

2.      Collection Policy

3.      Credit Investigation Cell

4.      Credit mgt and administration

5.      Monitoring of Receivables

6.      Financing Investment in Receivables

1. Establishing Optimum Credit Policy

                        A firm’s investment in accounts receivables depends on:

a) The Volume of credit sales, and

b) The collection period

            The investment in receivables may be expressed in terms of costs instead of sales value. The volume of credit sales is a function of the firm’s total sales and the percentage of credit sales to total sales. Tot al sales depend on market size, firm’s market share, product quality, intensity of competition, economic conditions…etc. The financial manager hardly has any control over these variables. The percentage of credit sales to total sales is mostly influenced by nature of business and industry norms.

            The term credit policy is used to refer to the combination of three decision variables on which financial manager has influence.

a. Credit Standards: - Credit standards are criteria to decide the types of customers to whom goods could be sold on credit. If a firm has more slow paying customers, its investment in accounts will increase. The firm will also be exposed to higher risk of default.

b. Credit Terms: - Credit terms specify the duration of credit and terms of payment by customers. Investment in accounts receivables will be high if customers are allowed extended time period for making payment.

c. Collection Efforts: - Collection efforts determine the actual collection period. The lower the collection period, lower the investment in accounts receivables and vice versa.

            A firm may follow a lenient or a stagnant credit policy. The firm following a lenient credit policy tends to sell on credit to customers on very liberal terms and standards, credits are generated for longer period even to those customers whose creditworthiness is not fully known or whose financial position is doubtful. In contrast, a firm following a stringent credit policy sells on credit on a highly selective basis only to those customers who have proven creditworthiness and who are financially strong. In practice, the firms follow credit policies ranging between stringent to lenient.

            Credit policy helps to retain old customers and create new customers by weaning them away from competitors. In a growing market, credit policy is used to increase the firm’s market share. Under a highly competitive situation or recessionary economic condition, a firm may loosen its credit policy to maintain sales or to minimize erosion of sales. The firm will have to evaluate its credit policy in terms of both return and cost of additional sales. Additional sales should add to the firm’s operating profit.

Optimum Credit Policy: - Optimum credit policy is one which maximizes the firms’ value. To achieve this goal, the evaluation of investment in accounts receivables should involve the following four steps:

1.      Estimation of incremental operating profit

2.      Estimation of incremental investment in accounts receivables.

3.      Estimation of the incremental rate of return investment

4.      Comparison of the incremental rate of return with the required rate of return

Credit Policy Variables: - Major controllable decision variable include the following:

a.       Credit Standards

b.      Credit Terms

c.       Collection Effort

The credit policy of a firm may be administered by the financial manager or the credit manager. It should however be appreciated that credit policy has important implications for the firm’s production, marketing and finance functions. Therefore, it is advisable that the firm’s credit policy should be formulated by a committee which consists of executives of production, marketing and finance departments.

The most difficult part of the analysis of the impact of change in the credit policy variables is the estimation of sales and costs. Based on the actual experience, variables may be changed further, or changes may be reversed. It should also be noted that the firm’s credit policy is greatly influenced by economic conditions change, the credit policy of the firm may also change. Thus the credit policy decisions are not one time, static decision. It is a continuously changing decision.

Credit Standards

Credit standards are the criteria which a firm follows in selecting customers for the purpose of credit extension. The firm may have very tight credit standard, i.e. it may sells mostly on cash basis and may extend credit only to the most reliable and financially strong customers. On the contrary, if credit standards are loose, the firm may have larger sales. But the firm will have to carry larger receivables. Credit standards influence the quality of the firm’s customers. There are two aspect of the quality of the customers.

1.      Time taken by customers to repay credit obligation and

2.      The default date. The 5c’s like character, capacity and condition, capital and collateral should be considered while allowing credit.

Credit Terms: - The stipulation under which the firm sells on credit to customers are called Credit Terms. These stipulations include: a) The credit period b) The cash discount

Credit Period: - The length of time for which credit is extending to customers is called the credit period. A firm’s credit period may governed by the industry norms. But depending on its objectives, the firm can lengthen the credit period. The firm lengthens the credit period to increase its operating profits through expanded sales. However, there will be net increase in operating profit only when the cost of extended credit period is less than the incremental operating profit. With increased sales and extended credit period, investment in receivables would b increase.

Cash Discount: - A cash discount is a reduction in payment offered to customers to induce them to repay credit obligations with in a specified period of time, which will be less than the normal credit period. It is usually expresses as a percentage of sales. Cash discount terms indicates the rate of discount and the period for which discount is available. If the customer does not avail the offer, he must make payment within the normal credit period.

2. Collection Efforts (Collection Policies): - A collection policy is needed because all customers do not pay the firms bill in time. Some customers are slow-payers while some are non-payers. The collection efforts should, therefore, aim at accelerating collections from slow payers and reducing bad debts losses. The optimum collection policy will maximize the profitability and will be constant with the objective of maximizing the value of the firm.

            In order to collect the slow paying accounts, the firm should follow credit procedures in a clear cut sequence. For e.g., when the normal credit period granted to the customer is over and he has not made the payment, a polite letter reminding the customer that the account is over due should be sent. If the receivables still remain un collected, letters that are progressively strong – worded are sent. This may be followed by telephone, telegram, or the firm’s representative’s personal visit. If the payment is still not made the firm may proceed to legal action. Before taking the legal action, the financial condition of the customer should be examined. If the financial condition of the customer is very weak, legal actions against him may simple help to cost his bankruptcy. This would make the chances of getting any payment from the customer. Under such a situation it is better to be patient or accept reduced payment in settlement of account.

            The firm has to be very cautious in taking the steps in order to collect from the slow paying customers. If the firm is strict units’ collection policy with the permanent customers who are temporarily slow payers due to the economic conditions they will get offended and may shift to competitors. The firm may loss its permanent business. On the contrary, if the firm is lenient in collection, receivables could increase and profitability could reduce. In following an optimum collection policy, the firm should compare the cost and benefits.

            In designing collection policy for the firm, the finance manger faces the problem of determining appropriate amount of collection expenditures to minimize bad debt losses and to shorten the collection period.

3. Credit Procedures for Individual Accounts [Credit Investigation Cell]

            For effective mgt. of credit, the firm should lay down clear cut guidelines and procedures for granting credit to individual customers and collecting individual accounts. The firm should not follow the policy of treating all customers equally for the purpose of extending credit. Each case should be fully examined before offering any credit terms. Similarly, collection procedures will differ from customer to customer. The credit evaluation procedure of the individual accounts should involve the following steps:

a.       Credit Information

b.      Credit Investigation

c.       Credit Analysis

d.      Credit Limits

e.       Collection Procedures

a. Credit Information: - In extending credit to customers, the firm would ensure that receivables are collected in full and on due date. If the firm fails to collect its receivables, there is a greater loss to the firm-loss of bad debt and cost of investment. Therefore credit should be granted to those customers who have the ability to make the payment on due date. To ensure this, the firm should have credit information concerning each customer whom the credit will be granted.

            Collecting credit information involves expenses. The cost of collecting information should, therefore, be less than the potential profitability. In addition to cost, the time required to collect information should also be considered. Depending on these two factors of time and cost, any, or a combination of the following sources may be employed to collect the information.

1. Financial Statement: - One of the easiest ways to obtain information regarding the financial condition and performance of the prospective customer is to scrutinize his financial statement. There is no difficult in obtaining the published financial statements of companies. The credit granting firm should always insist on the audited financial statements.
2. Bank References: - Another source of collecting credit information is the bank where the customer maintains his accounts. Even if the bank provides information to the firm about the proper conduct of customer’s account it cannot be taken as a basis for delivering that the customer will be able to settle his dues in time. More information from other sources may be collected to supplement it.
3. Trade references: - The firms can the prospective customer to give trade references. The firm may insist to give the names of such persons or firms with whom the customer has current dealings. This is a useful source to obtain credit information at no cost. The trade refers may be conducted personally to obtain all relevant information required by the firm.
4. Credit Bureau Reports: - The above mentioned sources can be biased. To get comprehensive and correct information, credit bureau organizations, which specialize in providing credit information, are employed in advanced countries. Various trade associations and chambers of commerce can be developed to provide the useful credit information to their members.

b. Credit Investigation: - After having obtained the credit information, the firm will get an idea regarding matters which should be further investigated. The factors that affect the extent and nature of credit investigation are: -

1. The type of customer, whether new or existing
2. The customer’s business line, background and the released trade risks
3. The nature of the product – perishable or seasonal
4. Size of customer’s order and expected further volumes of business with him.
5. Company’s credit policies and practices.

A comprehensive and meaningful investigation can be carried only when adequate data are available. The data should be promptly gathered. The customer can be directly approached to provide information about him. Another way to investigate the credit worthiness of the customer can be to examine his financial statements of last three-four years.

The firm, which is up to date on credit mgt, can maintain each customer’s credit file. The credit file should be up dated with the information about the customer collected from the reports of salesman, bankers and directly from the customer. Credit investigation should be carried so long as the savings in terms of speedy collections and prevention of bad debt losses resulting from it exceed its costs.

c. Credit Analysis: - The next step is to conduct the credit analysis of the applicant. The evaluation of the applicant’s financial conditions should be done very carefully. The applicant should be asked to provide the financial statements which will form a basis to analyse the performance and trends of applicant’s business activities. Ratios should be calculated to determine the applicant’s liquidity position and ability to repay debts. Besides appraising the financial strength of the applicant, the analyst should also consider the quality of mgt and the nature of the applicant’s business. More expected in future with a fast growth of trade credit and companies and with a difficulty in finding out competent credit analysts.

Credit Analysis – Broadly debts can be classified into 3 categories:

1. Undue debts: - These are debts which have come into existence but have not become due contractually.
2. Due debts: - These cover debts which have become due as per the terms and conditions of the mutually greed contracts.
3. Overdue debts: - These are the debts which have remained unsettled despite the fact that a long period has elapsed after the due date.

4. Credit Limits: - Once the firm has taken a decision to extend credit to applicant, the amount and duration of the credit have to be decided. The decision on the magnitude of credit will depend up on the amount of contemplated sale and the customer’s financial strength. In case of the customer who is a frequent buyer of the firm’s goods, a line of credit can be established. A line of credit is a maximum amount of credit which the firm will extend at a point of time. Depending up on the regularity of payment, a line of credit for customer can be fixed on the basis of his normal buying pattern.

The firm has not only to determine the amount of credit but also the duration of credit. Keeping in view the industry norm the normal collection period should be determined.

e. Collection Procedure: - The collection procedure of the firm should be clear – cut and well administered. The purpose of collection policy should be spend be speed up the collection of dues. The firm should lay down collection procedures for the individual accounts. The collection procedures for past due or delinquent accounts should also be established in very clear terms. The slow paying customs need be handled very fact fully.

      The collection procedure should be carefully established. The responsibility for follow-up and collection should be clearly fixed. The responsibility may be entrusted to the account or sales department or to a separate credit department.

      To collect dues from a slow – paying or non-paying customer steps should be taken in a sequence. Initially, a polite letter is sent followed by additional letter that progressively become tough in language. Next step may be a telephone call or a personal visit by the firm’s representative. If all these steps fail, legal action may be taken against the customer. Legal action is costly and may not serve the purpose if the client is forced into bankruptcy. A compromise for some payment would be better course under such a situation.

4. Credit Mgt and Administration: - Credit mgt is a specilised activity and involves a lot of time and effort of a company. Collection of receivables poses a problem, particularly of small scale enterprises. Banks have the policy of financing receivables. However, this support is available for a limited period and the seller of goods and services has to bear the risk of default by debtors. A company can assign its credit mgt and collection to specialist organizations, called factoring organizations. Factoring is a popular mechanism of managing, financing and collecting receivables.

                  Factoring is a unique financial innovation. It is both a financial as well as a mgt support to a client. It is a method of converting a non productive, inactive asset into a productive asset (viz. cash) by selling receivables to a company that specialics in their collection and administration.

                    The factor provides full credit administration services to his client. He helps and advisees them from the stage of deciding credit extension to customers to the final stage of bad debt collection. The factor maintains an account for all customers of all items owing to them, so that collections could be made on due date or before. He prepares a number of reports regarding credit and collection and supplies them to clients for their perusal and action.

5. Monitoring Book Debts: - A firm need continuously monitor and control its book debts to ensure the success of collection efforts. Two traditional methods of evaluating the mgt of book debts are:

                    1. Average Collection Period [ACP] and

                    2. Aging Schedule

            Collection Period: ACP = debtors x 360 / Credit sales

                        The ACP so calculated is compared with firm’s stated credit period to judge the collection efficiency. There are two limitations of this method. First, it provides an average picture of collection experience and is based on aggregate data. For control purposes, one needs specific information about the age of outstanding book debts. Second, it is susceptible to sales variations and the period over which sales and book debts have been aggregated. Thus ACP can provide not very meaningful information about the quality of outstanding book debts.

            A more refined measure of evaluating the efficiency of credit and collection processes is “aging schedule” of accounts receivables as it removes one of the limitations of ACP. Aging schedule is prepared by classifying the amount owned on each account according to the period that it has been due. Aging schedule breaks down book debts according to the length of time of which they have been outstanding.

6. Financing Investment in Receivables: - Accounts receivables block a part of working capital. Efforts should be made that funds are not tied up in receivables for longer period. The finance manager should make efforts to get receivables financed so that working capital needs are met in time. Some of the alternatives which can help a business in harnessing immediate cash against receivables are as follows.

a. Factoring: - It is an arrangement under which the business sells its receivables to a specilised agency known s factor. The credit department of a business is substituted by a factor. The factor undertakes collection, accounting and mgt of debts. The customers at the time of sales are informed about the arrangement so that they make the payment directly to the factor.

            A factor agrees to pay substantial advance against the receivables. The business thus gets the benefit of immediate availability of cash. A factor may purchase receivables without recourse or with recourse then factor becomes liable to bear the loss of bad debts.

b. Borrowing against Receivables: - Another method of raising money against receivables is by pledging receivables to banks as collateral for a loan. The receivables are pledged as resolving security. As soon as collections against receivables reduce its amount, new receivables are assigned to bank in place of the old ones. If some receivables do not materialise bank insist for their substitution with more viable receivables. The bank act only as a financer. Banks are also paid interests and a certain percentage as service charges.

  c. Captive Factoring Unit: - A business having large numbers of customers with high value of receivables will be incurring huge costs. If it factors its receivables to some outside factoring agency. Nor raising of loan against receivables will be in any way cheaper. The best course of action probably will be developing own credit department and credit running it effectively. Once the infrastructure for such a department is developed and manpower trained, the business with little costs can start undertaking factoring activities by buying the receivables of other companies.

d. Captive Finance Unit: - In the present world it is not uncommon for big business to have there own captive finance companies. Such financing companies in due course acquire proficiency in raising finances at lower costs. This in turn helps the business to finance the credit sales at less than normal costs prevalent in the market. The result is a meteoric rise in the volume of sales.

e. Receivables Insurance: - In advanced countries some insurance companies provide risk coverage against un expected large defaults by the customers.

Factoring

            While purchase of book debts is fundamental to the functioning of factoring, the factor provides the following three basic services to clients:

Ø  Sales ledger administration and credit mgt

Ø  Credit collection and protection against default and bad debts losses

Ø  Financial accommodation against the assigned book debts

                        Factoring is becoming popular all over the world on account of various services offered by the institutions engaged in it. Factoring is a tool of receivables mgt employed to release the funds tied up in credit extended to customers and to solve problems relating to collection, delay and default of the receivables.

            A firm that enters into factoring agreement enjoys the following benefits:

a. The factors provides specilised services with regard to sales ledger administration and credit control and relieves the client from the botheration of debt collection. The firm can concentrate on the other major areas of his business and improve his efficiency.

b. The advance payment made by the factor to the client in respect of the bills purchased increases his liquid resources.

c. It provides flexibility to the company to decide about extending better terms to their customers

d. The company itself is in a better position to meet its commitments more promptly due to improved cash flows.

e. Saves the mgt time and effort in collecting the receivables and in sales ledger mgt time and effort in collecting the receivables and in sales ledger mgt

f. Where credit information is also provided by the factor, it helps the company to avoid bad debts.

Types of Factoring

a. Recourse and Non-recourse Factoring: - In a resource factoring, the factor has recourse to the client, if the receivables purchased turnout to be bad i.e. the risk of bad debts is to be borne by the client.

            Where as, in case of non-recourse factoring, the risk or loss on account of non-payment by the customers of the client is to be borne by the factor and he can not claim this amount from the selling firm. Since the factor bears the risk of non-payment, commission or fees charged for the services in case of non-recourse factoring is higher than under the recourse factoring. The additional fee charged by the factor for being the risk of bad debts or non-payment is called del credere commission.

b. Advance and Maturity Factoring: - Under advance factoring, the factor pays a certain percentage (between 75% to 90%) of the receivables in advance to the client, the balance being paid on the guaranteed payment date. As soon as factored receivables are approved, the advance amount is made available to the client by the factor.

            In case of maturity factoring, no advance is paid to client and the payment is made to the client only on collection of receivables or the guaranteed payment date as the case may be agreed between the parties.

c. Conventional / Full Factoring / Old line Factoring: - Under this system the factor performs almost all services of collection of receivables, maintenance of sales ledger, credit collection, credit control and credit insurance. In advanced countries, this method is very popular but in India only a beginning has been made.

d. Limited Factoring: - Under limited factoring, the factor discounts only certain involves on selective basis and converts credit bills in to cash in respect of those bills only.

e. Selected Seller Based Factoring: - The seller sales all his accounts receivables to the factor along with invoice, delivery chellans, contracts etc after invoicing the customers. The factor performs all functions of maintaining the accounts, collecting the debts, sending reminders to the buyers and does all consequential and incidental functions for the seller. The sellers are normally approved by the factor for before entering into factoring agreement.

f. Selected Buyer Based Factoring: - The factor first of all sectors the buyers on the basis of their goodwill and creditworthiness and prepares an approved list of them. The approved buyers of the company approach the factor for discounting their purchases of bills receivables drawn in the favor of the company.

g. Disclosed and Undisclosed Factoring: - IN disclosed factoring, the name of the factor is mentioned in the invoice by the supplier telling the buyer to make the payment to the factor on due date. Under undisclosed factoring, the name of the factor is not disclosed in the invoice. But still the control lies with the factor. Factor maintain sales ledger, provides short term finance against the sales invoices but the entire transactions take place in the name of the supplier company.

Optimum size of Receivables

            The optimum investment in receivables will be at a level where there is a trade off between cost and profitability. When the firm resorts to a liberal credit policy the profitability of the firm increases on account of higher sales. However, such a policy results in increased investment in receivables, increased chances of bad debts and more collection cost. The total investment in receivables increases and, thus, the problem of liquidity is created. On the other hand, a stringent credit policy reduces the profitability but increases the liquidity of the firm. Thus, optimum credit policy occurs at a point where there is a “trade-off” between liquidity and profitability as shown in the chart below.

 

                                   

                                   

                                                Tight ← Credit policy → Loose

 Factors Affecting the Size of Receivables

            There are a number of factors which influence the size of receivables. The following factors directly and indirectly affect the size of receivables:

1. Size of credit sales: - The volume of credit sales is the first factor which increases or decreases the size of receivables. If a concern sells only on cash basis, then there will be no receivables. The higher the part of credit sales out of total sales the receivables will also be more or vice versa.
2. Credit Policies: - A firm with conservative credit policies will have a low size of receivables while a firm with liberal credit policy will be increasing this figure. If collections are prompt then even if credit is liberally extended the size of receivables will outstanding for a longer period, there is always a possibility of bad debts.
3. Terms of trade: - The period of credit allowed and rates of discount given are linked with receivables. If credit period allowed is more then receivables will also be more. Sometimes trade policies of competitors have to be followed otherwise it becomes difficult to expand the sales.
4. Expansion plans: - When a concern wants to expand its activities, it will have to enter new markets. To attract customers it will give incentives in the form credit facilities. In the early stages of expansion more credit becomes essential and size of receivables will be more.
5.  Relation with profits: - Credit policy is followed to increase sales. When sales increases beyond a certain level the additional costs incurred are less than the increase in revenues. It will be beneficial to increase sales beyond a point it will bring more profits. The increase in profit will be followed by an incre4ase in size of receivables.
6. Credit collection effort: - if adequate attention is not paid towards credit collection then the concern can land itself in a serious financial problem. An efficient collection machinery will reduce the size of receivables. If these efforts are slower then outstanding amounts will be more.
7. Habits of customers: - The paying habit of customers influences the size of receivables. The customers may be in the habit of delaying payment even though they are financially sound.

Forecasting the Receivables

            The following factors will help in forecasting receivables:

1. Credit period allowed:- The aging of receivables is helpful in forecasting. The longer the amounts remain due, the higher will be the size of receivables. The increase in receivables will result in more profits as well as higher costs too. The collection expenses and bad debts will also be more. If credit is less than the size of receivables will also be less.
2. Effects of Cost of Goods Sold: - Some times an increase in sales result in decrease in cost of goods sold. If this is so, then sales should be increased to that extent. The increase in sales will also increase the amount of receivables.
3. Forecasting expenses: - The receivables are associated with a number of expenses. These expense are administrative expenses on collection of accounts, cost of funds tied down in receivables, bad debts…etc. At the same time the increase in receivables will bring in more profits by increasing sales. If the revenue earned by increase in sales is more than the cost of receivables, then sales should be expanded.
4. Forecasting Average collection periods and Discounts: - If the average collection period is more then the size of receivables will be more.

ACP = Trade Debtors x No. of working days

            -------------------------------------------------

                                    Net sales

The concern should try to keep average collection period under control. The number of customers availing discount should also be determined.

5. Average size of Receivables: - The determination of average size of receivables will be helpful in forecasting receivables.

Average size of receivables = Estimated annual sales x ACP

Factoring vs Bill discounting

            Factoring should be distinguished from bill discounting. Bill discounting or invoice discounting consists of  the client drawing bills of exchange for goods and services on buyers and then discounted it with bank for a charge. Thus like factoring, bill discounting is a method of financing. Bill discounting has the following limitations in comparison of factoring:

Ø  Bills discounting is a sort of borrowing while factoring is the efficient and specilised mgt of book debts along with enhancing the client’s liquidity.

Ø  Bills discounting is always ‘with recourse’ and as such the client is not protected from bad debts

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