Management of Debtors Homework Help, Tutoring
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Management of Debtors
Debtors arise in the current assets of a firm due to credit sales. Credit sales are inevitable in a business to meet the growing competition and to attract the customers. Accounts Receivables is an alternative term for sundry debtors and is defined as "debts owed to the firm by customers arising from sale of goods or services in the ordinary course of business". As a marketing tool, they are intended to promote sales and thereby profits. However, extension of credit involves risk and cost. Management should weigh the benefits and costs to determine the goal of debtors' management. So, the objective of debtors management is to promote sales and profits until that point is reached where the return on investment in further funding receivables is less than the cost of funds raised to finance the additional credit. The specific costs and benefits which are relevant to the determination of the objectives of debtors' management are given below:
Costs of credit sales
The various costs associated with the extension of credit and accounts receivable are:
- Collection Costs/Administrative Costs
Collection costs are the administrative costs incurred in collecting the payments from the customers to whom credit sales have been made. It includes the following:
- Additional expenses on creation and maintenance of a credit department with staff, accounting records, stationery and related items.
- Expenses involved in acquiring credit information.
- Expenses involved at the time of actual collection of payment (like transportation charges etc.)
- Capital Costs (additional funds requirement)
Capital cost is the cost on the use of additional capital to support credit sales which alternatively could have been employed elsewhere. This cost arises because there is a time lag between credit sales made and the time at which the payment is collected from those customers. The more the time lag, the more would be the capital cost. Additional funds would be required because even during the time lag production and operating activities cannot be stopped and hence funds would be required to carry on those activities.
- Delinquency Cost
Delinquency cost is the cost arising out of failure of customers to pay on due date. The cost involves
- blockage of funds for an extended period and
- cost associated with collection of over-due payments.
- Default Cost
If the customers are unable to pay the dues finally, they result in default costs and have to be written off as bad debts. But before writing off as bad debts, all the collection efforts and final steps like legal action have to be taken.
Benefits of Credit sales
- Increased Sales
Credit sales pave the way for increased sales. A firm may sell on credit to sell more to existing customers or to attract new customers and to face the competition. All these will result in increase in sales and thereby increase in the number of customers.
- Increased Profits
Increase in sales volume will ultimately lead to increase in profits. But the volume of increase in profits depends upon the volume of increase in sales as well as the margin obtained on each unit. Increased profits will increase the wealth of the shareholders.
Thus, Debtors Management also involves the decision to commit funds to receivables based on a comparison of the benefits and the costs involved, while determining the optimum level of receivables. The costs and benefits to be compared are marginal costs and benefits.
Aspects of Debtors Management
- Credit Policies
Credit policy is the determination of credit standards and credit analysis
- Credit Terms
Credit terms specify the repayment terms required of credit customers. It involves credit period and cash discount
A company sells $10,000 worth of goods on credit on terms 2/10, net 30.
This means that if the customer pays within 10 days from the date of invoice, he gets 2% discount. So, the amount he has to pay would be $10,000-2% => $9,800.
Net 30 means the maximum credit period allowed is only 30 days. So, if he pays after 10th day but before/on 30th day, he will have to pay the full value of invoice, i.e., $10,000.
- Collection Policies
Collection policy involves procedures for collecting accounts receivables when they are due. They refer to the procedures followed to collect receivables when and after the expiry of the credit period. It also lays down the degree of collection efforts to be taken. If after the credit period is over and payment remains due, the firm usually takes the following steps:
- letters and reminders to pay
- telephone calls or personal contacts and visits
- collection agencies help and finally
- legal action.
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