Page 166 - DMGT409Basic Financial Management

Unit 9: Basics of Receivables

Notes

Collection Policy

The collection of a firm is the procedures passed to collect amount receivables, when they
become due. It is needed because all customers do not pay the bill receivables in time
collection procedures includes monitoring the state of receivables, dispatch of letters to
customers whose due date is approaching, electronic and telephonic advice to customers
around the due date, threat of legal action to overdue customers, and legal action against
overdue accounts.
Customers may be divided into two categories. Such as slow payer and non-payers. Hence,
there is a need for accelerating collections from slow payers and reduce bad debt losses.

Collection policies may be divided into two categories.
(i) Strict / rigorous
(ii) lenient/lax collection policy.
Adoption of strict collection policy tends to decrease sales, reduces average collection
period, bad debt percentage, and increases the collection expenses. On the other hand,
lenient collection policy will increase sales average collection period, bad debt losses,

and reduce collection expenses. Financial manager has to see the benefits and costs from

adopting one credit policy, if the change in net profit is positive, he/she has to go with new
credit policy and vice versa.
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 Outstanding (`) Percentage of Debtors
to total Debtors
Less than 30 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

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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