The accounts receivable management refers to the set of policies, procedures and practices used by a company with respect to the management of sales offered on credit. It is the management of all pending invoices that a company has to receive payment after having delivered a product or service.
That is, it is the management of the collection of money that customers owe a company. Most companies offer their customers the opportunity to buy their products and services on credit. When properly designed, such an arrangement can be mutually beneficial to both the company and its clients..
They are one of the pillars of sales generation and must be managed to ensure that they are ultimately converted into cash inflow. A company that does not efficiently convert its accounts receivable to cash may be illiquid, crippling its working capital and facing unpleasant operating difficulties..
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It includes the evaluation of the solvency and risk of the client, the establishment of credit terms and policies, and the design of an adequate collection process for these accounts..
Before agreeing to do business with a client, the company carries out a short-term solvency and liquidity analysis, verifying the client's credit history, financial statements and general economic conditions..
If necessary, you should request references from other companies with which the client has previously done business..
A workable agreement must be negotiated for the client without sacrificing the profitability of the business. For example, the payment term "5% at 10 days, net at 30 days" allows the customer to pay 30 days after the invoice date..
It also offers a 5% discount in case the payment is made within 10 days of the invoice date..
Businesses must balance the benefit of extending terms to customers with their cash flow needs.
Sales discounts to encourage prepayment are a good practice that can improve a company's cash flow.
The discount offered should be attractive to incentivize the customer to pay the invoice within the specified time period, but small enough to avoid a deterioration of the profit margin.
Payment delays are often caused by inconvenience of payment methods for customers. Different options can be added to the company's payment system.
The bank-to-bank payment method through the electronic funds transfer system is much more accessible to customers.
Gone are the days when the only way invoices reached customers was through the mail or a courier. Technology has made it possible for companies to send scanned invoices via email.
So invoices can be sent as soon as projects are completed. Timely invoice submission can help clients prepare for the stipulated due date.
The payment collection process is quite simple if all communications, documentation, accounting and pertinent matters related to this are kept up to date..
Upon receiving payments, an accounting entry is made, in which the accounts receivable account is credited and the cash account is debited..
In the event of non-payment, it may be effective to hire collection agencies (or the company's department) to recover all or part of the bad debts.
Most companies create a specific account to deal with delinquent accounts, commonly referred to as "Provisions for doubtful accounts" or "Bad debt accounts.".
- Provide better cash flow and more liquidity available for use in investments or acquisitions, reducing the total outstanding balance of accounts receivable.
- Use procedures that ensure that the financial potential of the company's accounts receivable is maximized.
- Determine the customer's credit rating in advance, establishing credit and payment terms for each type of customer.
- Frequently monitor clients for credit risks.
- Detect late payments or expiration of credits in due time.
- Contribute directly to company profits by reducing bad debts.
- Maintain a good professional relationship with clients.
- Increase the professional image of the company.
The company Dharma Corp. is considering relaxing its credit policy to offer credit to clients with a high risk rating and thus be able to sell 20% more, since it has an idle production capacity.
The following data is presented:
With the proposed easing of credit policy, it is expected:
To know if it is feasible, you must calculate the profitability resulting from the additional sales and see if it is greater or less than the total sum of:
- Bad debt losses.
- Increase in the cost of collection.
- Higher opportunity cost for working capital tied up in accounts receivable for a longer period of time.
Sales increase in units: 300,000 x 20% = 60,000 units
When there is idle production capacity, the additional profitability is the incremental contribution margin, since the fixed costs remain the same.
Unit contribution margin: $ 80 - $ 50 = $ 30.
Additional Return = 60,000 x $ 30 = $ 1,800,000
Increase in sales: 60,000x $ 80 = $ 4,800,000
Bad debt loss = $ 4.8 million x 3% = $ 144,000
The average amount of working capital in accounts receivable is given by:
(credit sales / accounts receivable turnover) x (unit cost / sale price)
Then we proceed to calculate the components of the formula.
Current Credit Sales: 300,000 x $ 80 = $ 24,000,000
Sales on credit with the increase: 360,000 x $ 80 = $ 28,800,000
Current accounts receivable turnover: 360/60 days = 6 times per year
Turnover of accounts receivable with the increase: 360/90 days = 4 times per year
Since there is idle capacity, the unit cost for the increase in sales is only the variable cost: $ 50.
New average unit cost = $ 21,000,000 / 360,000 = $ 58.33
Average amount of working capital in current accounts receivable:
($ 24,000,000 / 6) x ($ 60 / $ 80) = $ 3,000,000
Average amount of working capital in accounts receivable with the new scenario is:
($ 28,800,000 / 4) x ($ 58.33 / $ 80) = $ 5,249,700
Increase in average amount of working capital in accounts receivable = $ 5,249,700 - $ 3,000,000 = $ 2,249,700
Return rate = 16%
Opportunity cost = $ 2,249,700 * 16% = $ 359,952
Given that the net profit is considerable, Dharma Corp. should relax its credit policy, so the proposal is feasible.
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