Management of Receivables
Different costs involved in maintaining the debtors:1. Interest. 2. Discount.
3. Collection Charges. 4. Bad Debts.
Different approaches of calculating Interest: Total Cost approach.(Priority) Marginal Cost approach.(Variable) Sales Value approach.
Interest on increased amount of Working Capital other than debtors. Interest is to be calculated on following amount :
Increase in Stock xxx
Less: Increase in Creditors xxx
xxx
Note:
Interest will be calculated for the full year.
Concept of Discount
2/10 Net 30
The above term “2/10 Net 30” means usual credit period is 30 days but if anyone pays within 10 days, then he will be getting Discount @ 2%.
Calculation of Interest in case of discount in different cases:
Case I
When average collection period is given.
Case II
CaseI
When avg. collection period is given.
Interest will be calculated of average collection period on total sales.
CaseII
When avg. collection period is not given.
In case Average collection period is not given then we require to calculate interest separately for:
a. Customers availing discount.
b. Customers not availing discount.
Implicit cost of discount.
Definition:
It is the cost of discount in terms of percentage (%) per annum for using the funds.
Purpose:
Implicit cost of discount is to be compared with prevailing interest rates for taking decision whether to take loan or to give discount.
Factoring
In factoring, accounts receivables are generally sold to a financial institution (factor), who charges commission and bears the credit risks associated with the accounts receivables purchased by it.
• Cost
1) Interest on amount advanced (For full yr.)
2) Factoring commission (Total Cr. Sale for the yr.)
• Savings
1) Monitoring Cost.
2) Bad Debts cost (in case of non-recourse factoring)
Net Effective Cost = Cost - Savings
Conversion of net effective cost in terms of percentage (%) p.a.
(Net Effective Cost÷ Amount Advanced)× 100
Objective of Management of Receivables
The basic objective of management of sundry debtors is to optimize the return on investments on these assets known as receivables. Large amounts are tied up in sundry debtors, there are chances of bad debts and there will be cost of collection of debtors.
On the contrary, if the investments in sundry debtors is low, the sales may be restricted, since the competitors may offer more liberal terms.
Therefore, management of sundry debtors is an important issue and requires proper policies and their implementation.
Aspects of management of sundry debtors
Credit Policy: The set of parameters and principles that govern the extension of credit to the customers is called credit policy.
Credit Analysis: Credit analysis determines the degree of risk associated with the capacity of the customers to borrow and his ability and willingness to pay.
Control of receivables: controlling the receivables means collections of dues from customer.
Credit Rating: It implies taking decisions regarding individual debtors so as to ascertain the quantum of credit and the credit period.
The five “C’s” of Credit are as follows:
A. Character refers to a borrower's reputation.
B. Capacity measures a borrower's ability to repay a loan by comparing income against recurring debts.
C. The lender will consider any Capital the borrower puts toward a potential investment. D. Collateral, such as property or large assets, helps to secure the loan.
E. Finally, the Conditions of the loan, such as the interest rate and amount of principal, will influence the lender's desire to finance the borrower.
Advantages of factoring:
Accounts receivables can be converted into cash without bothering about repayment. Factoring ensures a definite pattern of cash inflows.
Eliminates the need for the credit department. Limitations of Factoring:
The cost of factoring sometimes tends to be higher than the cost of other forms of short term borrowing.
Types of Factoring
• Recourse Factoring: The factor purchases the receivables on the condition that any loss arising out of irrecoverable receivables will be borne by the client.
• Non-recourse Factoring: The factor has no recourse to the client if receivables are not recovered.
• Maturity Factoring: The factor pays the client either on a guaranteed payment date or on the date of collection from customer.
• Invoice Discounting: The factor provides a pre payment to the client against the purchase of receivables and collects interest for the period extending from the date of prepayment to the date of collection.
• Agency Factoring: The factor does not carry the service elements of factoring but provides a pre payment to the client against the book debts purchased.
• Cross border Factoring: Only Export receivables are factored and that too only on recourse basis.
Difference between Factoring & Bill Discounting
1. Factoring is called as “Invoice Factoring’ whereas Bills discounting is known as ‘Invoice discounting.”
2. In Factoring, the parties are known as the client, factor and debtor whereas in Bills discounting, they are known as drawer, drawee and payee.
3. Factoring is a sort of management of book debts whereas bills discounting is a sort of borrowing from commercial banks.
4. For factoring there is no specific act, whereas in the case of bills discounting, the Negotiable Instruments Act is applicable.
Forfaiting
Forfaiting is a method of trade finance that allows exporters to obtain cash by selling their medium and long-term foreign accounts receivables at a discount on a “without recourse” basis.
Difference between Factoring & Forfaiting
1. In case of factoring, usually 80% of the value of invoice is considered for advance. Whereas in case of forfaiting, 100% of the value of the invoice is financed.
2. In case of factoring, the factor does the credit rating of the counter party in case of non-recourse of factoring transaction. In case of forfaiting, the bank relies on the availing bank.
3. In case of factoring, day to day administration of sales and other allied services are provided. No such services are provided in case of forfaiting.
4. In case of factoring, the advances are short-term in nature. In case of forfaiting, the advances are generally medium term.
Process of Debt Securitization
The originator initially owns the assets engaged in the deal. This is typically a company looking to either raise capital, restructure debt or otherwise adjust its finances.
An entity formed by the originator (i.e. HDFC Bank), for the soul purpose of (i.e. special purpose) holding this debt asset (i.e. home loan).
Debt Securitization
consolidated debt as bonds, pass-through securities, or collateralized mortgage obligation (CMO’s), to various investors.
Accounts Receivable System
Manual systems of recording the transactions and managing receivables are cumbersome and costly. The automated receivable management systems automatically update all the accounting records affected by a transaction.
