Page 173 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes 1. Receivable Turnover: Receivables turnover provides relationship between credit sales
and debtors (receivables) of a firm. It indicates how quickly receivables or debtors are
converted into cash. Ramamurthy observes “collection of debtors is the concluding stage
for process of sales transaction”. The liquidity of receivables is therefore, is measured
through the receivables (debtors) turnover rate.
Debtors or Receivable Turnover Rate = Credit Sales ÷ Average Debtors or receivables

!

Caution Debtors’ turnover rate is expressed in terms of times. Analyst may not be able to
access credit sales information, average debtors and bills receivables.
To avoid of non-availability of the above information and to evaluate receivables turnover
there is another method available for analyst.
Debtors or Receivables Turnover Rate = Total Net Sales ÷ Average Debtors
2. Average Collection Period (ACP): Turnover rate converted into average collection period
is a significant measure of how long it takes from the time sales is made to the time to cash
is collected from the customers.
ACP = 365 ÷ Debtors or Receivables turnover

3. Aging Schedule: As we have seen in the above average collection period measures quality
of receivables in an aggregate manner, which is the limitation of ACP. This can be overcome
by preparing aging schedule. Aging schedule is a statement that shows age wise grouping
of debtors. In other words, it breaks down debtors according to the length of time for
which they have been outstanding.

Example: A hypothetical aging schedule is as follows:
Age Group (in days) Amount Percentage of Debtors
Outstanding (`) to total Debtors
Less than 40,00,000 40
31–45 20,00,000 20
46–60 30,00,000 30
Above 60 10,00,000 10
Total 1,00,00,000 100
Aging schedule is helpful for identifying slow pay debtors, with which firm may have to
encounter a stringent collection policy. The actual aging schedule of the firm is compared
with industry standard aging schedule or with bench mark aging schedule for deciding
whether the debtors are in control or not.

4. Collection Matrix: Traditional methods (debtors’ turnover rate, average collection period)
of receivables management are very popular, but they have limitations, that they are on
aggregate data and fail to relate the outstanding accounts receivables of a period with
credit sales of the same period. The problem of aggregating data can be eliminated by
preparing and analyzing collection matrix. Collection matrix is a method (statement)
showing percentage of receivables collected during the month of sales and subsequent
months. It helps in studying the efficiency of collections whether they are improving or
deteriorating.

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