Page 170 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 10: Receivable Management

Self Assessment Notes

Fill in the blanks:
3. ........................... is the amount of money coming into a business in comparison with the
amount of money going out.

4. Firms grant credit to ........................... its sales from the competitors and ........................... the
potential customers.
5. ........................... is the rate of return earned on a security if it is held till maturity.

6. A ........................... cash flow enables a smoother business operation.
7. ........................... is the purchase of accounts receivables at a discount.

10.3 Dimensions of Receivable Management

The important dimensions of receivables management are:

1. Credit policy,
2. Credit evaluation, and
3. Credit control.
Let us go through each of them one by one.

1. Credit policy: A firm requires a suitable and effective credit policy to control the level of
total investment in receivables. As already discussed, the credit policy may be defined as
setting the principles that govern the extent of credit and the terms to be extended to the
customers. They require credit standards i.e. the conditions that are required for granting
credit. In other words, who can give credit and to what extent the credit terms, the period
of credit and the rate of cash discount to be allowed for early payment.
2. Credit Evaluation: Proper evaluation of the credit worthiness of the customer is an
important element of credit management. In assessing credit risks two types of error may
occur:

Type 1: Classifying a good customer as less credit worthy.
Type 2: Classifying a bad customer as a creditworthy customer.
Type 1 error leads to loss of profit on sales to a good customer who is denied credit. Type
2 error may result in bad debts loss or heavy collection costs on account of extending
credit to an unworthy customer. To reduce the risk of both types of errors evaluation of
the applicant’s credit standing is important.
The credit evaluation involves three steps:
(a) Obtaining credit information,
(b) Analyzing information obtained, and

(c) Taking a decision regarding the amount of credit to be given and the period of
credit.

Task Discuss what activities you would precisely undertake under each of the step of the
evaluation process if you are to make the credit evaluation for your organization.

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