Page 162 - DMGT409Basic Financial Management

Unit 9: Basics of Receivables

9.1 Meaning and Characteristics of Accounts Receivables Notes

The term receivable is defined as “debt owed to the firm by customers arising from sale of goods
or services in the ordinary course of business”.
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Did u know? When the fi rm sells its products services on credit, and it does not receive
cash for it immediately, but would be collected in near future. Till collection they form as
current assets.
The accounts receivables arising out of credit sales have the following characteristics’.
1. Risk Involvement: Receivables involve risk, since payment takes Bajaj in future, and future
is uncertain so they should carefully analyzed.
2. Based on Economic Value: Accounts receivables are based on economic value. The economic
value in goods or services passes to the buyer currently in return the seller expects an
equivalent value from the buyer latter.
3. Implies Futurity: Buyer will make cash payment of the goods or services received by him/
her in a future period. [i.e generally after credit period]

9.2 Concept of Account Receivable Management

Accounts Receivable Management, means making decisions relating to the investment in
current assets as an integral part of operating process. The objectives of the accounts receivables
management are the maximization of return on investment in receivables. In other words,
accounts receivables management involves maintenance of receivables of optimum level, the
degree of credit sales to be made, and the debtor’s collection.

9.2.1 Objectives of Accounts Receivables Management

The following are the main objectives of accounts receivables management:
1. Maximizing the Value of the Firm: The basic objective of debtors’ management is to
maximise the value of the firm by achieving a trade off between liquidity (risk) and return.

The main purpose of receivables management is to minimise the risk of bad debts and not
maximisation of order. Efficient management of receivables expands sales by retaining old

customers and attracting new customers.
2. Optimum Investment in Sundry Debtors: Credit sales expand, but they involve block of
funds, that have an opportunity cost, which can be reduced by optimum investment in

receivables. Providing liberal credit increases sales consequently profits will increase, but
increasing investment in receivables results in increased costs.
3. Control and Cost of Trade Credit: When there are no credit sales, there will not be any
trade credit cost. But credit sale increases profits. It is possible only when the firm is able to

keep the costs at minimum. The costs are discussed below.
9.2.2 Costs of Accounts Receivables Management

Management of accounts receivables is not cost free. The following are the main costs associate
with accounts receivables management:
1. Opportunity Cost/Capital Cost: Providing goods or services on credit involves block of
fi rm’s funds. In other words, the increased level of accounts receivables is an investment
in current assets. These blocked funds or investment in receivables need to be fi nanced, by

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