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Credit Control

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					   Credit Control
( AR Management)
  Dr Clive Vlieland-Boddy
  Working Capital Management
 Working capital management requires managing current
  assets (cash balances, accounts receivable and inventory)
  and current liabilities (accounts payable and short-term debt)
  when faced with political, foreign exchange, tax and liquidity
  constraints.
 The overall goal is to reduce funds tied up in working capital
  while simultaneously providing sufficient funding and
  liquidity for the conduct of global business.
 Working capital management should enhance return on
  assets and return on equity and should also improve
  efficiency ratios and other performance measures.


                                                            2
 ACCOUNTS RECEIVABLE MANAGEMENT
The level of accounts receivable is dependant on two factors:
   – The volume of credit sales
   – The average collection period
Economic conditions cannot be controlled, but a business can
control its collection policies with an effect on both sales and
average collection period.
CREDIT POLICIES
There are four elements of a credit policy:
   – Credit Period
   – Cash Discounts
   – Credit Standards
   – Collection Policy                                        3
Accounts Receivable Management:
      The Five Cs of Credit
• Character: The applicant’s record of meeting
  past obligations.
• Capacity: The applicant’s ability to repay the
  requested credit.
• Capital: The applicant’s debt relative to equity.
• Collateral: The amount of assets the applicant
  has available for use in securing the credit.
• Conditions: Current general and industry-
  specific economic conditions.
    The 4 Elements of credit policy
 Credit Period – How long to pay? Shorter period
  reduces DSO and average A/R, but it may
  discourage sales.
 Cash Discounts – Lowers price. Attracts new
  customers and reduces DSO.
 Credit Standards – Tighter standards tend to
  reduce sales, but reduce bad debt expense. Fewer
  bad debts reduce DSO.
 Collection Policy – How tough? Tougher policy will
  reduce DSO but may damage customer
  relationships.
       ACCOUNTS RECEIVABLE MANAGEMENT

Credit Terms

A business may wish to increase its rate of discount for three
    reasons:

   –   To increase sales by attracting new customers;
   –   To encourage existing customers to pay more quickly;
   –   To reduce bad debts.

A business can increase its rate of discount to the point where the
marginal cost of discount equals the marginal profit generated.




                                                                 6
ACCOUNTS RECEIVABLE MANAGEMENT
Collection Policy

•   Is the action a firm takes to recover its overdue
    accounts.
•   A weak collection policy will save on collection costs
    but probably result in bad debts.
•   On the other had a severe collection policy may
    reduce bad debts but may result in high collection
    costs, lost sales and loss of customer goodwill.
•   Most businesses would prefer to tread a middle
    path.
•   A company may increase its collection expenditure
    to a point in which the costs of such effort equal the
    revenues earned as a result.
                                                       7
        AR Management

  Quality of                         Length of
Trade Account                       Credit Period
                    Average
                Collection Period
                    Bad-debt
                     Losses
                                      Firm
Possible Cash                       Collection
  Discount                           Policy
      CASH AND LIQUID ASSET MANAGEMENT

Cash
Businesses must hold sufficient cash to meet its
   debts, but excessive cash balances are
   unproductive, as they could be invested in
   other assets to generate income.
A business will hold cash for
         - transaction motive
         - precautionary motive
         - speculative motive
                                             9
        CASH AND LIQUID ASSET MANAGEMENT

Other Liquid assets
•  Deposits, securities that are easily converted to cash in
   short time
•  Can earn income in meantime until needed

Control Cash via Cash Budget

Synchronising cash
•  Cash sales/purchases
•  Credit sales/purchases
•  Wages, other expenses


                                                           10
 The Risk of tight credit policy?
• Yes, a tighter credit policy may
  discourage sales. Some customers may
  choose to go elsewhere if they are
  pressured to pay their bills sooner.
              Credit Standards

    Costs arising from relaxing credit standards
•   A larger credit department
•   Additional clerical work
•   Servicing additional accounts
•   Bad-debt losses
•   Opportunity costs (Loss of the use of the money)
  Collection Policy and Procedures

                       The firm should increase collection
    Collection     expenditures until the marginal reduction in
                  bad-debt losses equals the marginal outlay to
    Procedures                        collect.
Letters

                       Bad-Debt Losses
Phone calls
Personal visits                                       Saturation
                                                        Point
Legal action


                                         Collection Expenditures
    Analyzing the Credit Applicant
•   Obtaining information on the credit
    applicant
•   Analyzing this information to determine
    the applicant’s creditworthiness
•   Making the credit decision
      Sources of Information
The company must weigh the amount
of information needed versus the time
        and expense required.
  –   Financial statements
  –   Credit ratings and reports
  –   Bank checking
  –   Trade checking
  –   Company’s own experience
  –   May be use a simple matrix
              Credit Analysis
        A credit analyst is likely to utilize
             information regarding:
–   the financial statements of the firm (ratio analysis)
–   the character of the company
–   the character of management
–   the financial strength of the firm
–   other individual issues specific to the firm
     Other Credit Decision Issues
Credit-scoring System
A system using a simple matrix, to decide whether
to grant credit by assigning numerical scores to
various characteristics related to creditworthiness.
Line of Credit
A limit to the amount of credit extended to an
account. Purchaser can buy on credit up to that
limit.
      – Streamlines the procedure for shipping
        goods.
   Trade Credit
( AP Management)
  Dr Clive Vlieland-Boddy
           What is trade credit?
• Trade credit is credit furnished by a firm’s suppliers.
• Trade credit is often the largest source of short-term
  credit, especially for small firms.
• Spontaneous, easy to get, but cost can be high.
Bye for now!      I’m ready for
                some leisure time.




             Please ensure you
          Prepare for next session

				
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