Page 163 - DMGT409Basic Financial Management

Basic Financial Management

Notes shareholders funds or from short-term borrowings. They involve some cost. If receivables
are financed by shareholder funds, there involves opportunity cost to shareholders. If they

are financed by borrowed funds, it involves payments of interest, which is also a cost.
2. Collection Cost: Collection of receivable is one of the tasks of receivables management.
Collection costs are those costs that are increased in collecting the debts from the customers
to whom the credit sales have been granted. The collection costs may include, staff, records,
stationary, postage they are related to maintenance credit department, and exposes details
involved in collecting information about prospective customers, from specialized agencies,
for evaluation of prospective customer before going to grant credit.
3. Bad Debts: Some times customer may not be able to honour the dues to the fi rm because
of the inability to pay. Such costs are referred as bad debts, and they have to be written
off, because they cannot be collected. These costs can be reduced to some extent, if the
firm properly evaluates customer before granting credit, but complete avoidance is not

possible.

9.3 Factors Influencing the Size of Investment in Receivables
The level of investment in receivables is affected by the following factors:
1. Volume of Credit Sales: Size of credit sale is the prime factor that affects the level of
investment in receivables. Investment in receivable increase when the firm sells major

portion of goods on credit base and vice versa. In other words an increase in credit sales,
increase the level of receivables and vice versa.
2. Credit Policy of the Firm: There are two types of credit policies such as lenient and

stringent credit policy. A firm that is following lenient credit policy tends to sell on credit
to customers very liberally, which will increase the size of receivables. On the other hand, a

firm that following stringent credit policy will have low size of receivables because the fi rm

is very selective in providing of stringent credit. A firm that is providing string one credit,
may be able to collect debts promptly this will keep the level of receivables under control.
3. Trade Terms: It is the most important factor (variable) in determining the level of investment
in receivables. The important credit terms are credit period and cash discount. If credit
period is more when compared to other companies/industry, then the investment in
receivables will be more. Cash discount reduces the investment in receivables because it
encourages early payments.
4. Seasonality of Business: A firm doing seasonal business has to provide credit sales in

the other seasons. When the firm provides credit automatically the level of investment

in receivables will increase with the comparison of the level of receivables in the season;
because in season firm will sell goods on cash basis only.

For example, refrigerators, air-cooling products will be sold on credit in the winter season
and on cash in summer season.

5. Collection Policy: Collection policy is needed because all customers do not pay the fi rm’s

bill on time. A firm’s liberal collection policy will not be able to reduce investment in

receivables, but in future sales may be increased. On the other hand, a firm that follows

stringent collection policy will definitely reduce receivables, but it may reduce future sales.
Therefore, the collection policy should aim at accelerating collections from slow payers and
reducing bad debt base.
6. Bill Discounting and Endorsement: Bill discounting and endorsing bill to the third party,
which the firm has to pay, will reduce the size of investment in receivables. If the bills

are dishonored on the due date, again the investment in receivable will increase because
discounted bills or endorsed bills have to be paid by the fi rm.

156 LOVELY PROFESSIONAL UNIVERSITY