10.2 Lecture_20_Thursday_1_October_2009

10.2 Lecture_20_Thursday_1_October_2009 - FINC 202 (2009)...

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Unformatted text preview: FINC 202 (2009) Lecture 20 Managing Accounts Receivable 1 Managing Accounts Receivable We will cover: Why it is important Definition of Credit Policy Nature of Credit Terms Calculation of cost of providing discounts Credit Standards and Analysis Collection Policy • • • Management by exception Use of Days Sales Outstanding Aging Schedules Optimal Credit Policy Model for analysing changes in Credit Policy 2 MANAGING ACCOUNTS RECEIVABLE 1. Why is managing A/R important ? A/R a use of funds A/R policy impacts on “cash conversion cycle” A/R policy __________________ A/R policy ___________________ 3 2. Credit Policy Credit policy is set of guidelines covering: • credit terms credit period prompt payment discount • credit standards • ______________________________ 4 Credit terms • statement of credit terms and discount offered Example:2/10, net 30 • Credit customers given 30 days to pay but 2% discount for payment within 10 days. Credit terms influenced by: • credit terms offered by competitors • _____________________________ • credit terms offered by suppliers 5 Credit Terms & Cash Collections: How to calculate cost of discounts: Let _______________________ Gross 1 − Rate of Rate of Disc$$ = × Bad Debt × Disc Sales % % % takers × of Disc 6 Problem 1: Problem 1: Discount & credit arrangements are: 3/10 net 30 Sales (all credit) = $5m Rate of bad debts = 5% Discount­taking customers = 60% Find the total cost of the discount in dollars 7 Solution 1 Gross 1 − Rate of Rate of Disc$$ = × Bad Debt × Disc Sales % % % takers × of Disc . 8 Credit Standards Standard • Customer must attain this to qualify for credit • Character Probability the customer will TRY to pay • Capacity Customer’s apparent ability to pay • Capital ___________________________________ • Collateral Assets offerable as security for credit • Conditions Economic trends Credit analysis focuses on: 9 Sources of credit information: • other suppliers of credit • credit rating agencies Moodys, S&P • credit­reporting agencies _______________________________ _______________________________ 10 10 Collection policy Procedures used to collect A/R Range of procedures • reminder(s) • telephone call • collection agency Must weigh costs/benefits of additional collections effort • ___________________________ Often monitored using DSO and Aging Schedules 11 11 Management by Exception Customers classified into risk class • 5 or 6 classes • ______________________________ Class #1 • Receives automatic credit • Reviewed infrequently (yearly) Class #2 • Receives credit to specified limits • More frequent review of financial condition 12 12 Class #3 & #4 • Receive credit only with authorization granted at the time • Must be granted each time Class #5 • No credit at all • Sales made _______________________ _________________________________ 13 13 Risk Class Uncollectible Customers Risk Class Debts in class % % 1 2 3 4 5 0 ­ 0.5% 0.5 ­ 2% 2 ­ 5% 5 ­ 10% over 10% ______ ______ ______ ______ 5% 14 14 Days Sales Outstanding (DSO) Accounts Receivable DSO = Credit Sales 360 Identify problems by comparing DSO with: • • • historical DSO industry DSO _______________________________ 15 15 Example: Example: DSO as Diagnostic of Credit Policy ABC Ltd has annual credit sales = $3.2m • And the cost of financing A/R = 11% Days Sales Outstanding = 55 days What would annual savings be • If DSO could be reduced to 40 days? 16 16 Solution to Example: Solution DSO as Diagnostic of Credit Policy DSO Daily sales = $3,200,000 = $8,888.89 Reduction in A / R = ( $8,888.89 ) ( 55 − 40 ) = $133,333.33 Annual Savings = ( $133,333) ( (0.11) = $14,667 360 17 17 Comment on Solution: Comment DSO as Diagnostic of Credit Policy DSO But potential costs include: • Discount expense will rise if ___________ __________________________________ • Sales may either rise or fall depending on how customers react to the stricter credit arrangements • Collection costs will probably rise as slow payers are _______________________________________. 18 18 Problem 2 Lynx Ltd has annual credit sales = $81m • And the cost of financing A/R = 9% Days Sales Outstanding = 54 days What would annual savings be • If DSO could be reduced to 30 days? 19 19 Solution to Problem 2 Daily sales = Reduction in A / R = Annual Savings = 20 20 . Example 3: More complex example of DSO as a Example Receivables Policy diagnostic: Receivables A firm sells 36,000 units a year at a price of $200 per unit. The firm’s terms are 2/10, net 30. All sales are on credit. The firm has no bad debt losses. Half of all customers take the discount. • The other half pay on day 30. Work out: • • • DSO Average Daily Sales Build­up of Receivables Ie, Receivables balance at any given time 21 21 Solution to example DSO = ( 0.5) (10 ) + ( 0.5) ( 30 ) = 20 days ( 36,000) ( $200) Average Daily Sales = 360 = $20,000 Receivables = ADS × DSO = ( $20,000) ( 20 ) = $400,000 22 22 Problem 3 A firm sells 900,000 units a year at a price of $300 per unit. The firm’s terms are 3/10, net 30. All sales are on credit. • • • 40% of all customers take the discount. 40% pay on day 30 20% pay on day 50. The firm has no bad debt losses. Work out: • • • a) Daily Sales Build­up of DSO Average Receivables Ie, Receivables balance at any given time b) If the 20% who pay on average at day 50 can be persuaded to pay on average by day 30 23 23 what is the reduction in the Receivables balance? Solution 3 DSO = Average Daily Sales = Receivables Balance = 24 24 . Solution 3 DSONEW = Reduction in Receivables = A 25 25 . Aging Schedule Implied in the previous examle and problem is the importance of an ageing schedule Shows proportion of A/R outstanding for specified period of time identify problems by: • analysing __________________________ • monitoring average age of receivables 26 26 Ageing Schedule Example Age of Accounts Percentage of total value of Accounts Receivable 0 – 10 days 11 – 30 days 31 – 45 days 46 – 60 days Over 60 days Total 52% 100% 27 27 Ageing Schedule Example Post an invoice on day 31 Post a second invoice on day 60 noting that ____________________________ Become more energetic if no payment is received by day 75 • Start phoning perhaps… 28 28 ...
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