Management of Accounts Receivables
Accounts receivable is the largest asset on the balance sheet in most of the organizations. (Smith, C. W. 1992) This is considered to be the expensive asset. Even though this is short term in nature this has a long term impact on the organizations working capital and financial structure, consequently the prerequisite for an effective management system becomes imperative. The most important objective of receivables management is to maximize the significance of the endeavor by striking stability between liquidity, risk and profitability. While Hrishikes Bhattacharya (2001) highlights setting credit terms, selecting the customers, establishing appropriate collection and monitoring system and financing the receivables would be the major goals of receivables management. To maintain an effective control of trade receivables well experienced qualified workforce, an appropriate collection policies, procedures, clearly defined objectives, timely precise information system and regular executive review of performance and receivables audit is vital to ensure compliance (W.Thomas Cooper 1992).
Even though the credit and collection process is aggressive in an organization, some uncollected amounts from customers would exist inevitably. The transformation of receivables into cash is a daunting and a divisive task. Thus the companies must be equipped with a set of well defined polices to manage collections appropriately. Mian and Smith (1992, 1994), provide a systematic exploration of the determinants of accounts receivables policy, but they provided only tangible determinants due to a lack of clarification.
Healy and Wahlen (1999) demonstrates that accounts receivables management occurs when managers use decisions in financial reporting and in organizing transactions to modify financial information to either mislead some stakeholders regarding the fundamental economic performance of the organization or to influence contractual outcomes that depend on reported accounting practices. Healy and Wahlen (1999), Fudenberg and Tirole (1995), and Dechow and Skinner (2000) revels that the speeding up of sales, adjustments in consignment schedules, and delaying of research and development and maintenance expenditures as receivables management techniques available to managers.
Rational for receivables management
The primary objective of trade receivables management is to collect what is unsettled in accordance to the sales contract as some times businesses will be strapped for cash. Extremely low levels of receivables would limit flexibility to manage earnings through either accruals or real activities. Roychowdhury (2004). Risk of postponed payment and non payment is involved here. The managers should minimize the delay and collect the payments from customers in due course. Strategies like early settlement discount schemes can be notified in advance to the customers on the way to induce them for an early settlement. Cash discount is considered as a handy tool for receivables management. (Agral, N. K 1983).
Subsequent objective would be to economically conduct the credit and collection processes. The cost of collection should not surpass the benefit. Cost such as credit review cost, bad debt expenses and collection cost will be the cost involved in the management of accounts receivables. Some organizations outsource their collection activities to a factor. In this instance, the factor pays the particular company certain percentage of sales. The factor would charge certain amount from the company and this would be another added cost involved in the management of trade receivables (James S. Sanger 2007).
Guidelines for managing receivables (AICPA 1992)
First and foremost organisation should pay special consideration to the treatment of customers. According to the 80 20 rule, 20 percent of the customers account for the 80 percent of the accounts receivables. Exceptional attention should be paid to these special customers. Payment decisions should be altered to accommodate and provide easy payment terms for the valid customers.
Subsequently organisation should shorten the sales cycle. This would vary from days, week and even for years. Inventory will be converted to collected payments definitely to extent time frame is shortened. The control points would be decision made to buy, credit endorsement, distribution, invoicing, sending statements, payments in the form of bank deposits, deliveries and finally dealing with problematic customers. Shortened cycle would reduce the cost of working capital for a greater extent.
The accounts receivable collection period should not surpass the accounts payable time frame these periods should be matched accordingly. Finances an organisation grants should be matched with finances granted to this particular organisation. The netting result would reduce the cost of working capital.
Finally recovering the unsettled debts will be significant. Customers breaching the sales contact without paying named in the payment schedule to collect the over dues. Organisation should issue dunning letters. Legal advice and assistance have to be obtained. In worst cases repossess the goods will have to take place.
Funds receivable has an opportunity cost component. Funds invested in accounts receivables are an input which is scares in nature. These scares resources can be invested in diverse ventures that would earn profits for the organisations. Favourable alternative will influence this decision. So the organisation’s decision should consider this point in decision making.
Marketing and the collection department interact directly with receivables management process. Inherent conflict between both the departments would exist. The marketing department’s zest will be to sell products without considering the creditworthiness and their prime goal would be to reach the monthly sales target whiles the collection department will have to suffer from postponed and non payments. Monitoring department should properly organize, must provide inputs to other related department and have to conduct audits to manage the situation effectively in terms of getting the work done without damaging the organisational goals. Economic and organizational resources in receivables management, polices concerning the trade must be decided by the top management preferable at the board level. Forecasting becomes very important for fund planning as trade receivables assert major part of working capital. Markov Analysis as a management tool will be useful in decision making. The company should have a good documentation to gain better results. An effective communication system should be implemented at all the levels of the management and should review policies regularly for the applicability and relevancy. If not management decisions will suffer from short term deliberations and ad-hocism. This would certainly cause rigorous intermittent liquidity crisis. Holistic receivables management has been proven to have a transformative effect on working capital management and customer satisfaction (Sanjay Srivastava 2005).