Page 165 - DMGT409Basic Financial Management

Basic Financial Management

Notes without credit evaluation of individual accounts and identification of their credit worthiness. In

other words, the firm has to evaluate the customers before extension of credit.
The credit evaluation procedure involves three related steps:
1. Obtaining credit information
2. Analyzing the information

3. Making the credit decision
9.6 Monitoring Accounts Receivables

Just evaluation of individual accounts does not help in efficient accounts receivables management
without continuous monitoring and control of receivables. In other words success of collection
effort depends on monitoring and controlling receivables. Then how to monitor and control
receivables? There are traditional techniques available for monitoring accounts receivables. They
are (a) Receivables turnover, (b) Average Collection period, (c) Aging Schedule and (d) Collection
matrix.
1. Receivables 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 Receivables Turnover Rate = Credit Sales ÷ Average Debtors or receivables

Debtor’s 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 (including
receivables)

2. Average Collection Period (ACP): Turnover rate converted into average collection period
is a significant measure of the collection activities of debtors. Average collection period is

a 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.

Example: A company’s credit sales are ` 20 lakhs in a year. The opening debts are `2 lakhs
and closing debtors are `2,10,000. Determine Debtors turnover and ACP.
Solution:
Debtors Turnover Ratio = ` 20,00,000 ÷ (Rs.2,00,000 + `2,10,000)/2 = 9.75 times

ACP = 365 ÷ 9.75 = 37.43 Days

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