FIN4320_Lecture_8_AR_Management(49p)

FIN4320_Lecture_8_AR_Management(49p) - Managing Credit and...

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Unformatted text preview: Managing Credit and Managing Credit and Accounts Receivable Lecture 8 Creating and collecting A/R Establishing the firm’s credit policy and terms of sales Determining creditworthiness of customers Provide prompt and accurate customer billing Maintain A/R records Collect overdue accounts Objectives of Credit and A/R Objectives of Credit and A/R Management The Credit and A/R Management The Credit and A/R Management Functions Responsibility Credit Management Establish credit standards, terms, collection policy, etc. Billing and processing payments, collecting past due accounts. Work with Credit Manager Accounts Receivable Management Sales and Customer Service Outsourcing Credit and A/R Management Captive Finance Companies and Factors The Credit and A/R Management The Credit and A/R Management Functions Role of the Cash Manager Organizational Relationship Information Links Cash manager and credit manager must work together Track Customer Payments Forecast Impact on Cash Flows Process Collections/Apply Payments Monitoring Credit and Collections Monitoring Credit and Collections Collections Goal Minimize Total Collection Costs Trade­off between administrative costs and bad debt. Two Basic Questions How are credit terms monitored? What information is available to assist in controlling receivables. Credit Terms Credit Terms Considerations Penalty Fees Credit Limits Eligibility for Discount Offering Discounts Gross Method Gross revenue is booked as income and discounts are booked as expenses Receivables and Revenue are booked net of discounts. Discounts forgone are booked as income. Net Method A/R Monitoring and Control A/R Monitoring and Control Reasons for Monitoring Individual Accounts Some may wait for call to pay Late payments may indicate change in financial condition Forecasting cash flows Reflects changes in: Aggregate A/R Sales Credit Terms Economic Conditions A/R Monitoring and Control A/R Monitoring and Control Simple Example Days’ Sales Outstanding (DSO) Measures the average time it takes for an average customer to pay. Outstanding A/R / Average Daily Credit Sales Average Past Due DSO ­ Average Credit Terms A/R Monitoring and Control A/R Monitoring and Control Current Outstanding A/R $175,000 Credit Sales History (Net terms 30 days) Month 1 $120,000 Month 2 $180,000 Month 3 $135,000 Total $435,000 Average Daily Credit Sales = $435,000 / 91 days = $4,780.22 DSO = $175,000/$4,780.22 = 36.61 days A/R Monitoring and Control A/R Monitoring and Control Aging Schedule: Identifies the pattern of A/R payments Aging Schedule Age of Accounts A/R % of A/R 0 ­ 30 days $112,525 64.3% 31 ­ 60 days $ 54,950 31.4% Over 60 days $ 7,525 4.3% Total $175,000 100.0% A/R Monitoring and Control A/R Monitoring and Control Accounts Receivable Balance Pattern Looks at how sales are collected Example: 10% of sales are collected in the month of sale 50% of sales are collected 1 month after the sale 35% of sales are collected 2 months after the sale 5% of sales are collected 3 months after the A/R Monitoring and Control A/R Monitoring and Control Accounts Receivable Balance Pattern If March sales were $150,000, what amount remains uncollected at the end of May? Collected in: March = $150,000 X .10 = $ 15,000 April = $150,000 X .50 = $ 75,000 May = $150,000 X .35 = $ 52,500 Total $142,500 Uncollected March Sales = A/R Monitoring and Control A/R Monitoring and Control Uncollected March Sales = $150,000 ­ $142,500 = $7,500 or $150,000 X .05 = $ 7,500 A/R Monitoring and Control A/R Monitoring and Control Accounts Receivable Balance Pattern Determining a month’s cash inflows Month Sales March $150,000 April $137,500 May $125,000 End of May A/R Remaining Remaining A/R ($) A/R (%) $ 7,500 5% $ 55,000 40% $112,500 90% $175,000 A/R Monitoring and Control A/R Monitoring and Control Accounts Receivable Balance Pattern What is the expected cash inflow for June if June’s sales are expected to be $125,000? % of Sales $ Sales Month Sales Collected Collected June $125,000 10% $ 12,500 May $125,000 50% $ 62,500 April $137,500 35% $ 48,125 March $150,000 5% $ 7,500 A/R Monitoring and Control A/R Monitoring and Control Accounts Receivable Balance Pattern Changes in the A/R as a % of sales indicates changes in the aggregate customer payment patterns Dollar changes in A/R is sensitive to changes in sales and may not indicate an underlying change in payment patterns Complex Example Sales $200 $250 $450 $100 $175 $225 $275 Jan $20.00 $37.50 $202.50 $30.00 Sales, Cash Flows, And Sales, Cash Flows, And Receivables Cash Flow Matrix Feb Mar $25.00 $67.50 $45.00 $52.50 Apr May June July Month of Sale October November December January February March April Total $45.00 $15.00 $78.75 $22.50 $161.25 $290.00 $190.00 $10.00 $26.25 $112.50 $27.50 $176.25 $17.50 $56.25 $137.50 $33.75 $68.75 $41.25 Sales, Cash Flows, And Sales, Cash Flows, And Receivables Month of Sale October November December January February March April Total Sales $200 $250 $450 $100 $175 $225 $275 Jan $25.00 $112.50 $70.00 Receivables Matrix Feb Mar Apr May June July $45.00 $25.00 $122.50 $10.00 $43.75 $202.50 $256.25 $207.50 $192.50 $17.50 $90.00 $247.50 $355.00 $33.75 $110.00 $41.25 Aging Schedules Aging Schedules Aging Schedule Feb Dollar Amount Percent $122.50 63.64% $25.00 12.99% $45.00 23.38% $192.50 100.00% Jan Age Current 1-30 Days 31-60 Days Total Dollar Amount $70.00 $112.50 $25.00 $207.50 Percent 33.73% 54.22% 12.05% 100.00% Mar Dollar Amount $202.50 $43.75 $10.00 $256.25 Percent 79.02% 17.07% 3.90% 100.00% Apr Dollar Amount $247.50 $90.00 $17.50 $355.00 Percent 69.72% 25.35% 4.93% 100.00% Did Collections Get Worse in February And Then Better In March? Days Sales Outstanding Days Sales Outstanding Days Sales Outstanding Or Average Days Outstanding Or Days Receivables AR/Sales * Days Yearly Days Sales Outstanding AR/Annual Sales * 365 Quarterly Days Sales Outstanding AR/Quarterly Sales*91 Days Sales Outstanding Days Sales Outstanding Month January February March April Quarterly Days Sales Outstanding 23.60 24.16 46.64 47.86 Jan: $207.50/($100+$450+$250)*91= 23.60 Feb: $192.50/($175+$100+$450)*91= 24.16 Mar: $256.25/($225+$175+$100)*91= 46.64 Mar: Apr: $355.00/($275+$225+$175)*91= 47.86 Average Collection Period Average Collection Period Average Collection Period (ACP) is a weighted average of how long it takes to collect the receivables. January April ($10*90 days)]/$100 = 31.5 days [($30*0 days) + ($45*30 days) + ($15*60days) + [($27.50*0 days) + ($137.50*30 days) + ($68.75*60days) + ($41.25*90 days)]/$275 = 43.5 days Cash Flow Fractions Cash Flow Fractions Month of Sale January February March April Cash Flow Fractions Current 30 Days 60 Days 30.00% 45.00% 15.00% 30.00% 45.00% 15.00% 10.00% 50.00% 25.00% 10.00% 50.00% 25.00% 90 Days 10.00% 10.00% 15.00% 15.00% Month of Sale October November December January February March April Total Derived From The Cash Flow Matrix Jan $20.00 $37.50 $202.50 $30.00 Cash Flow Matrix Feb Mar $25.00 $67.50 $45.00 $52.50 Apr May June July Sales $200 $250 $450 $100 $175 $225 $275 $45.00 $15.00 $78.75 $22.50 $161.25 $290.00 $190.00 $10.00 $26.25 $112.50 $27.50 $176.25 $17.50 $56.25 $137.50 $33.75 $68.75 $41.25 Receivables Fractions Month of Sale January February March April Receivables Fraction 1st Month 2nd Month 3rd Month 70.00% 25.00% 10.00% 70.00% 25.00% 10.00% 90.00% 40.00% 15.00% 90.00% 40.00% 15.00% Derived from the Cash Flow Fractions Month of Sale January February March April Cash Flow Fractions Current 30 Days 60 Days 30.00% 45.00% 15.00% 30.00% 45.00% 15.00% 10.00% 50.00% 25.00% 10.00% 50.00% 25.00% 90 Days 10.00% 10.00% 15.00% 15.00% Cash Flow Fractions and ACP Cash Flow Fractions and ACP Month of Sale January February March April Cash Flow Fractions Current 30 Days 60 Days 30.00% 45.00% 15.00% 30.00% 45.00% 15.00% 10.00% 50.00% 25.00% 10.00% 50.00% 25.00% 90 Days 10.00% 10.00% 15.00% 15.00% ACP for January and February (.3*0) + (.45*30) + (.15*60) + (.10*90) = 31.5 Days ACP For March and April (.1*0) + (.5*30) + (.25*60) + (.15*90) = 43.5 Days Benchmarking Benchmarking Credit Management Benchmarks Days Sales Outstanding Average Past Due Average Collection Period DSO ­ Average Credit Terms Adjusted ACP Cash Flow Fractions Receivables Fractions ACP ­ Net Terms For January and February: If Credit Terms are Net 15, Adjusted ACP = 16.5 Days If Credit Terms are Net 30, Adjusted ACP = ­1.5 Days Benchmarking Benchmarking Credit Department Benchmarking Sales Per Credit/Collection Employee Active Customer Accounts Per C/C Employee Forecasting Account Receivables Forecasting Account Receivables Important For Several Reasons A/R Is A Major Asset Needed For Budgeting/Cash Flow Planning Often A Factor In Loan Covenants Forecasting Account Receivables Forecasting Account Receivables Percent Of Sale Method Total A/R = α * Credit Sales α = Some Proportionality Factor Receivables Fraction Method If Sales Vary Month To Month, It Is Better To Construct A Receivables Matrix Cash Flows Relevant To Credit Policy Alternatives Evaluating Credit Policy Evaluating Credit Policy Alternatives Invoiced Amount Bad Debts Administrative Costs The Net Price The Buyer Will Pay Credit Evaluation Costs Collection Costs Indirect Cash Flows Evaluating Credit Policy Evaluating Credit Policy Alternatives Changes In Sales Changes In Inventory Changes In A/P Changes In New Equipment Example Cash Flow Time Line And Cash Flow Time Line And Present Value Analysis Assumptions 60% Of Sales Net 30, Invoiced 15 Days Before We Sell The Merchandise. There Are Three Days Of Disbursement Float After We Pay Our Suppliers. Cost Of Goods Sold Supplier's Terms Cost Of Funds 6% Per Year Cash Flow Time Line And Cash Flow Time Line And Present Value Analysis Current Cash Policy Terms Collection Time/Availability Bad Debt Daily Sales Daily Collection Costs Change In Sales Cash (Check) 2 Days 0% $20,000 $0 -Proposed Credit Policy 2/10 Net 30 50% 12 Days, 50% 35 Days 0.5% $22,000 $120 10% Increase Cash Flows Cash Flows Current Terms Day Activity 0 Sale 2 Availability of Cash From Sale 18 Disbursement for Variable Costs Proposed Terms 0 12 18 35 Pay Collection Costs Collect ½ of Payments Pay for Variable Costs Collect ½ of Payments $0 = ($120) .50 * $20,000 * (1 + .10) * (1 - .02) * (1 - .005) = $10,726 .60 * (1 + .10) * $20,000 = ($13,200) .50 * $20,000 * (1 + .10) * (1 - .005) = $10,945 Cash Flow $0 = $0 $20,000 = $20,000 .60 * $20,000 = ($12,000) Cash Flow Time Line Cash Flow Time Line NPV Analysis NPV Analysis Current Terms Day Activity PV of Cash Flow $0 $19,993 ($11,965) $8,029 ($120) $10,705 ($13,161) $10,882 $8,306 $277 $277/(.06/365) $1,686,895 0 Sale 2 Availability of Cash From Sale $20,000/(1 + .06/365)2 18 Disbursement for Variable Costs $12,000/(1 + .06/365)18 NPV Proposed Terms 0 Pay Collection Costs 12 Collect ½ of Payments $10,726/(1 + .06/365)12 18 Pay for Variable Costs (13,200)/(1 + .06/365)18 35 Collect ½ of Payments $10,945/(1 + .06/365)35 NPV Difference NPV of Perpetuity Risk Considerations Risk Considerations Discount Rate Sensitivity Analysis Breakeven Analysis/Indifference Points Point Where The Difference Between NPVs Is Zero Sales 6.38% Bad Debt 1.78% Financing A/R Financing A/R Unsecured Bank Borrowing Secured Bank Borrowing Advantage: Company controls who gets credit. Disadvantage: Costs of A/R department Pledge A/R as collateral Bank selects which accounts to accept as collateral Securitization Bundle receivables and issue securities backed by them Financing A/R Financing A/R Captive Finance Company Wholly owned subsidiary Often more liquid Can borrow at lower rates Third­Party Financing Advantages Avoid A/R department costs No funds tied up Lack of control Fees or discounts may be charged Disadvantages Financing A/R Financing A/R Credit Card (Visa, MC, etc.) Advantages Avoid A/R department costs Little or no funds tied up Usually no bad debt Loss of control Can’t conduct own credit promotions Fees or discounts may be charged Disadvantages Financing A/R Financing A/R Factoring Recourse and Notification Advantages Little or no A/R department costs Factor may have better credit information Factor may have diversification benefit Reduces cash flow uncertainty Relatively high fees/discounts are often charged Loss of control Sign of financial problems Disadvantages Financing A/R Financing A/R Private Label Financing Store Credit Card Advantages No A/R department costs No funds tied up May conduct own credit promotions Fees or discounts may be charged Loss of Control Disadvantages Cash Applications Cash Applications Cash Applications: Matching payments to sales Open Item Payment must be matched to a particular purchase or invoice Balance Forward Purchases increase balance Payments decrease balance No matching is needed Electronic Data Interchange Often used to matching payments and purchases Cash Application Cash Application Importance Determine If Invoices Are Being Paid According To Terms Determine The Payment Status And Total Exposure Of Any Customer Update Payment Information At Remote Locations Legislation Affecting Credit and Legislation Affecting Credit and Collections Pricing and Interest Charge Restrictions Robinson­Putman Act Cannot charge different prices to different customers unless it can be cost justified State­by­State restrictions on interest, fees, and penalties Usury Laws Legislation Affecting Credit and Legislation Affecting Credit and Collections Consumer and Commercial Credit Legislation Truth in Lending Act Fair Credit Reporting Act Fair Credit Billing Act Equal Credit Opportunity Act Fair Debt Collection Practices Act Legislation Affecting Credit and Legislation Affecting Credit and Collections Uniform Commercial Code Bankruptcy and Reorganization Chapter 7 Chapter 11/13 Developments in Credit and A/R Developments in Credit and A/R E­Commerce and EDI Electronic Bill Presentment and Payment (EBPP) Outsourcing of A/R Questions? Questions? ...
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This note was uploaded on 04/02/2009 for the course DEPARTMENT FIN 4320 taught by Professor Sherwoodbishop during the Spring '08 term at Southwestern.

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