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Days' Receivables
Days' Payables
Time ==> Accounts < Payable > Invoice Received Disbursement < Float > Payment Sent
Cash Paid
NPV = Sales Collection Expense Variable 1+(Cost of Cap. X Coll. Days) Costs If NPV > 0 then Extend Credit
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= .2128 = 21.28%
If the company can borrow at less than 21.28%, it should do so and use the borrowed funds to pay early and take the discount.
Monitoring conducted on individual accounts through aging schedules. schedules. Monitoring conducted at the aggregate level using days sales outstanding (DSO).
DSO
Can give an indication of overall collection efficiency. Changes in sales volume, payment patterns, or strong seasonality in sales can distort DSO.
If the companys credit terms are net 60, the average past due is computed as follows:
Average Past Due = DSO - Avg. Days of Credit Terms = 74.11 Days - 60 Days = 14.11 Days
Aging Schedule
Is a list of the percentage and/or amounts of outstanding A/R classified as current or past due. Used primarily to identify past due accounts. Can be prepared at the aggregate level or customer-bycustomer-by-customer. Subject to distortions due to sales variations.
Aging Schedule
Separates A/R into current and past due receivables in 30-day increments (on a customer or aggregate basis) and can determine the percent past due
Age of Accounts
0 30 days 31 60 days 61 90 days 91 + days Total
A/R
Rs1,750,000 Rs375,000 Rs250,000 Rs125,000 Rs2,500,000
% of A/R
70% 15% 10% 5% 100%
Sales
Rs250,000 Rs300,000 Rs400,000 Rs500,000
The total outstanding A/R balance at the end of March is: Rs595,000 = (Rs50,000 + Rs165,000 + Rs380,000) The estimate of cash inflows for April = 5% of April sales + 40% of March sales + 35% of February sales + 20% of January sales: Estimated April inflows = (0.05 x Rs500,000) + (0.40 x Rs400,000) + (0.35 x Rs300,000) + (0.20 x Rs250,000) = Rs340,00
A/R Financing
Unsecured Bank Borrowing Secured Bank Borrowing Captive Finance Company Third Party Financing Institutions Credit Card Factoring Private Label Financing
effect on dollar profits sales effect receivables effect return on investment effect
default probability
credit limits opportunity cost of funds invested in receivables companys overall cost of capital
Cash Application
Cash application is the process of matching and applying a customers payment against accounts receivable. Done via an Open Item or a Balance Forward system.
Used in commercial transactions. Each invoice is recorded separately in an account receivable file. Payments are matched to the particular invoice in the file.
Used in retail applications. Credit limits are established for each individual. As purchases are made, A/R increase. Payments are applied against the aggregate A/R outstanding.
Collection Procedures
Typical collection effort
initial contact within 10 days of delinquency then reminder letter followed by phone call sales force notified last resort, reference to collection agency/legal action Phase 1 - computer generated collection letter, when accounts are 45 to 90 days past due Phase 2 - commissioned collectors used
Collection agency
Collection Procedures
Companies tend to be more aggressive the larger the receivables balance Companies understand the good-will goodtradeoff when selecting collection methods
lengthening terms increases exchange rate risk also increases default risk harder to get D&B reports harder to get bank credit information legal remedies for late payment or nonpayment differ by country