What is Receivables Management?

Receivable management is one of the key components of the working capital management of a company. Accounts receivables are the payment due for invoices made in the context of purchases made by customers. These are recorded as bills receivables in the books of accounts of the seller until a final settlement is made. These credit sales are managed efficiently to ensure smooth funds flow and maintaining liquidity position. There is a wholesome process for managing these receivables. All the aspects of receivables such as the term of delay, discount on early payment, discounting of bills, security in case of excessively big transactions, actions on default in receiving payment are carefully taken into consideration while devising monetary policies. At the same time, a close watch on the risk exposure due to credit sales is a crucial function of the finance manager.

Importance of Receivables Management

The basic objective of any business establishment is to maximize its profits which is achievable by increasing its sales. Although there is a general notion to make the payment it's not always practiced in practical life. Sometimes the seller has to agree for allowing to make the payment on a future date. This practice is worldwide and is called a Trade Credit. The need for receivables management is because of the need to manage the collection to maximize profitability. However, there are several issues related to recovering the credit. Hence devising a good monetary policy is important when providing credit to clients.

Receivable management objectives and policies

It is pertinent to note that to manage receivables efficiently, it is important to prioritize collection based on the extent of risk and taking third-party references so that loss of bad debt is minimized. Before providing credit to any client, decide on the number of days and rate of discount, place of delivery, mode of payment, etc. This data-driven policy of collecting receivables makes it clear for the staff to act wisely and save time.

It is important to send invoices to the client right away and account statements so that the customer is aware that a payment is due. Sending well-drafted automated e-mails well before the payment is due ensures proper follow-up and accountability in case of any discrepancy. One person should be made responsible for cross-checking such proper follow-up of the status of the workflow. One person should be assigned the responsibility to ensure the remittance initiated by the client is processed by the bank.

The e-mails sent for reminders to pay shall contain a direct payment because nowadays the trend of payment is shifting from paper cheques. After all, companies prefer to avoid bouncing cheques due to wrong details or signature issues. Even options for receiving payment via UPI, debit card, the credit card will help in smooth workflow and save time.

The slow-paying accounts need to be monitored frequently send more e-mails, make frequent calls to regularize the payments, and evaluate whether in the future giving further credit to these customers is profitable for the company or not.

KPIs of regular recoveries

There are various measures for measuring the performance data such as Day Sales Outstanding, Aging Reports, Collection Effectiveness Index, Receivable Turnover Ratio, Bad Debt Ratio, etc.

Ratio Analysis-forcast change in debt
CC-BY-SA 4.0 | Image Credits: https://commons.wikimedia.org | Farcaster

Aging reports indicate the highest and lowest number of days required to convert receivables into receipts. It highlights which invoice or which client is not making regular payments.

Day sales outstanding often referred to as the average collection period enumerates the average number of days a particular product sale takes to realize payments. It helps determine whether a change in days outstanding than earlier is because of change in sales, or because of errors or miscommunication or quality problems, or because of Disputes. It can be determined or computed at certain regular intervals like on  a monthly, quarterly (four times in a year), or annual, or yearly basis. The day sales outstanding is calculated by dividing the closing date account receivables by the total credit sales that have been made during the period and multiplying by the period of analysis in terms of the number of days.

The Collection effectiveness index is a measure of the quality of the receivables management system. The index near 100% is the ideal effectiveness index. It can be used to measure product-wise, division-wise, branch-wise.

The Accounts receivable turnover ratio is identified as the most prominent accounting ratio to measure the efficiency in giving credit to the customer and its recovery. It is calculated by dividing total credit sales by the average of opening and closing trade receivables.

Automation of receivable management

Accounts receivable automation is the shift towards digitalization of this process of management. Earlier it used to be very time-consuming, calling every client and asking for making payment. If then also not then visit their offices repeatedly and wait for hours. Then came a time when mail is sent but the client doesn't see it so call them to see the mail. Now, bulk mail is sent automatically as per the specific criteria and it usually receives the payment. However, this aspect of financial management has had some innovative developments recently. It turnaround this exercise into a dynamic one.

The replacement of human staff with technology to perform routine tasks has saved a lot of time and costs of human labor costs to businesses. Whenever any dispute arises instead of lengthy interrogations and documentation and revising the invoice manually, resending it via post. Automation makes this easy by simply validating change and just specify the changes. All else will be done itself and mail will be sent. This process has become a lot easier.

As a benefit of automation, the cash register is already free from human errors and there is no need to do lengthy calculations. Daily cash collection and bank receipts and all payments are available with one click to get a bird's eye view.

Customer satisfaction increases as a result of their issues being addressed in no time. All the customers can simultaneously ask for their account statement but there is no problem because the system is always at work. The decision of selecting an appropriate software is as important as reducing the loopholes. The ease of usage, interface with customers, accessibility, security, and reliability.

Role of finance manager

The function of financial management starts even before the company has begun existing and prevails after the end. Every company spends on its regular operations. Sound management of business processes is a must for the business to operate costs at their lowest. The accounts department maintains a record of all the business data and financial managers use that data for decision making.

Accounts maintained simply for keeping a record are not enough. The finance manager uses this data to perform various analyses, looks for loopholes, and prepares future forecasts. As for the data from credit sales and accounts receivable, the finance manager will assess the effect of credit sales on the overall liquidity position, the proportion of expenses on recovery, future rate of discount that can be given to customers. The growth in sales other than on account of credit sales. To what extent the credit needs to be reduced, who is paying the bills on time, and to what proportion.

A finance manager is answerable to the stakeholders for a percentage of recovery and the efficiency of Receivables management, compliance to the policies, credit report needs to be submitted.

Outsourcing of receivables management function

The receivable management function requires expert advised and streamlined processes and appropriate resources in terms of technology and manpower. Where it is distraught in these, it is logical to outsource the function to obtain the required results. An expert in receivables management is well known about the laws and regular practices in the industry which are used by customers for obtaining deals that are unfair to the seller. The expert deals in such a way as beneficial for the company and also gain customer satisfaction. Experts help in complying with laws and legislative requirements to improve the credit rating of the company. As a result of this, the company can focus on its core business rather than being fixated on the inflow of funds.

Related Concepts

While studying receivables management, it is important to read the following to get a better knowledge:

  • Payables management
  • Working Capital Management
  • Inventory Management
  • Production Planning

Context and Applications

The aspiring students can pursue further specialization in this field into the following streams:

  • Banking
  • Chartered Accountancy
  • MBA (Masters of Business Administration)

Common Mistake

It is often observed that the students ignore the topic. It is one of the core topics of financial management as well as  accounting. Understanding the calculation of the turnover ratio is very important.

Practice Problems

  1. A partnership firm has both trade receivables and non-trade receivables. Where are these two recorded in the balance sheet?
    1. Current Asset and Non-Current Assets
    2. Non-current Assets and Current Assets
    3. Current assets
    4. Non-current assets

Correct Answer: a. Current Asset and Non-Current Assets. 

Explanation- The trade receivables are recorded under the head current assets and the non-trade receivables are recorded under the head non-current assets.

2. The finance manager of Speed Ltd. wants to know the average period of credit allowed to its customers. Where should he look for it in the books of accounts?

    1. Sales Register
    2. Aging Report
    3. Profit and Loss Account
    4. Day Book

Correct Answer: b. Aging report

Explanation- Aging report explains the period of credit to various customers and classifies them as due up to 90 days and due over 90 days.

3. What is the right credit policy for a wholesaler who wants to increase his turnover?

    1. No credit policy
    2. Cash discount offers up to a week
    3. Bulk discount offer
    4. None of these

Correct Answer: c. Bulk discount offer

Explanation- A wholesaler always seeks bulk discount because their payments terms with the suppliers are usually settled generally out of the contracts but the discount can increase the sales of the supplier.

4. A Ltd. has a receivable turnover ratio of 7.5 times whereas the industry average is 5.9 times. What does it indicate?

    1. It indicates high efficiency in receivables collection.
    2. It indicates low efficiency in receivables collection.
    3. It indicates low efficiency in paying the creditors.
    4. It indicates high efficiency in paying the creditors.

Correct Answer: a. it indicates high efficiency in receivables collection.

Explanation- A high receivable turnover ratio indicates that the flow of funds between the receivables and the business is frequent which shows a lower risk of bad debts and high liquidity.

5. What is the effect of keeping fewer credit sales?

    1. Lower sales
    2. Lower profit
    3. Customer Disappointment
    4. All of the above

Correct Answer: d. All of the above

Explanation- The only reason for distributing less credit is to lower the bad debts which may annoy some customers to an extent which will cause all of the above-mentioned effects on the business.

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