ACCOUNTS RECEIVABLE MANAGEMENT: FEATURES - DUDAS - 2024

The administration of accounts receivable 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 the pending invoices that a company has to receive its 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 customers.

They are one of the pillars of sales generation and must be managed to ensure that they are ultimately converted to cash inflow. A business that does not efficiently convert its accounts receivable to cash may have poor liquidity, crippling its working capital and facing unpleasant operating difficulties.

characteristics

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.

Evaluate financial and credit history

Before agreeing to do business with a client, the company carries out an analysis of their short-term solvency and liquidity, verifying their credit history, financial statements and the general economic conditions of the client.

If necessary, you should request references from other companies with which the client has previously done business.

Establish clear payment terms

A workable agreement must be negotiated for the client without sacrificing the profitability of the business. For example, the payment term "5% 10 days, net 30 days" allows the customer to pay 30 days after the billing date.

It also offers a 5% discount if 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.

Provide multiple payment methods

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.

Make electronic invoices

Gone are the days when the only way invoices reached customers was through the mail or a courier. Technology has made it possible for businesses 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.

Collection process

The payment collection process is fairly simple if all relevant communications, documentation, accounting and related matters 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.

Delinquent accounts

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 handle delinquent accounts, commonly referred to as "Doubtful Provisions" or "Bad Debt Accounts."

goals

- Provide better cash flow and greater 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 in advance the customer's credit rating, establishing the 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 the profits of the company by reducing bad debts.

- Maintain a good professional relationship with clients.

- Increase the professional image of the company.

Examples

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 proposal to ease 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:

- Losses due to bad debts.

- Increase in the cost of collection.

- Higher opportunity cost due to immobilized working capital in accounts receivable for a longer period of time.

Calculation of additional profitability

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

Bad Debt Loss Calculation

Increase in sales: 60,000x $ 80 = $ 4,800,000

Bad debt loss = $ 4.8 million x 3% = $ 144,000

Opportunity cost calculation

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

Credit Sales with Increase: 360,000 x $ 80 = $ 28,800,000

Current accounts receivable turnover: 360/60 days = 6 times annually

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 current working capital in 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

Feasibility of the proposal

Since the net profit is considerable, Dharma Corp. should relax its credit policy, so the proposal is feasible.

References

1. Investopedia (2018). Accounts Receivable - AR. Taken from: investopedia.com.
2. HTMW Team (2013). Account Receivables Management. How the market Works. Taken from: education.howthemarketworks.com.
3. Graydon (2018). Accounts Receivable Management. Taken from: graydon.nl.
4. Justin Johnson (2018). The Best Practices for Accounts Receivables Management. Small Business - Chron. Taken from: smallbusiness.chron.com.
5. Infinit Accounting (2015). 5 Ways to Manage Your Accounts Receivable More Efficiently. Taken from: infinitaccounting.com.
6. Lie Dharma Putra (2010). Accounts Receivable Management and Decision Making. Accounting Financial & Tax. Taken from: accounting-financial-tax.com.