1
CHAPTER 1
INTRODUCTION
CHAPTER 1
INTRODUCTION
1.1. INTRODUCTION TO THE STUDY
A sale of credit is an evitable necessity in the business world of today. No business can exist without selling the units in credit. The basic difference between the credit sales and cash sales is the time gap in the receipt of cash.
ManagementoftradecreditiscommonlyknownasManagementofReceivables. Receivablesare oneofthethreeprimarycomponentsofworkingcapital,theotherbeing inventory andcash,the otherbeing inventory andcash.Receivablesoccupy secondimportant placeafterinventoriesandtherebyconstituteasubstantialportionofcurrentassetsinseveral firms.Thecapitalinvestedinreceivablesisalmostofthesameamountasthatinvestedin cashandinventories.Receivablesthus,formaboutonethirdofcurrentassetsinIndia.Trade creditisanimportantmarkettool.As,itactslikeabridgeformobilizationofgoodsfrom productiontodistributionstagesinthefieldofmarketing.Receivablesprovideprotectionto salesfromcompetitions.Itactsnolessthanamagnetinattractingpotentialcustomerstobuy theproductattermsand conditionsfavorabletothemaswellastothefirm.Receivables managementdemandsdueconsideration not financialexecutivenotonlybecausecostand riskareassociatedwiththisinvestmentbutalsoforthereasonthateachrupeecancontribute to firm's net worth.
Thebook debts or receivable arisingout of credithas threedimensions:-
Itinvolvesanelementofrisk,whichshouldbecarefullyassessed.Unlikecashsales creditsales arenot risk less as the cash payment remains undeceived.
Itisbasedoneconomicsvalue.Theeconomicvalueingoodsandservicespassesto thebuyer immediately whenthesaleismadeinreturnforanequivalenteconomic value expected bythe seller from him to be received later on.
Itimplies futurity, as thepayment forthegoods and services received bythe buyer is madebyhimto the firm on a futuredate.
Thecustomerwhorepresentthefirm'sclaimorassets,fromwhomreceivablesor book-debtsaretobecollectedinthenearfuture,areknownasdebtorsortradedebtors.A receivableoriginallycomesintoexistenceattheveryinstancewhenthesaleisaffected.
Receivables may berepresentedbyacceptance;billsornotesandthelikeduefromothersatanassignabledateintheduecourse ofthebusiness.As sale ofgoodsisacontract,receivablestoogetaffectedinaccordancewith thelawofcontracte.g.Boththeparties(buyerandseller)musthavethecapacity tocontract, properconsiderationandmutualassentmustbepresenttopassthetitleofgoodsandabove allcontractofsaletobeenforceablemustbeinwriting.Receivables,asareformsofinvestmentinany enterprisemanufacturingandsellinggoodsoncreditbasis,largesumsoffundsaretiedupin tradedebtors.Hence,agreatdealofcarefulanalysisandpropermanagementisexercisedfor effectiveandefficientmanagementofReceivablestoensureapositivecontributiontowards increasein turnoverandprofits.
Whengoodsandservicesaresoldunderanagreementpermittingthecustomertopay for them at a later date, the amount due from the customer is recorded as accounts receivables;so,receivablesareassetsaccountsrepresentingamountsowedtothefirmasa resultofthecreditsaleofgoodsandservicesintheordinarycourseofbusiness.Thevalueof theseclaimsiscarriedontotheassetssideofthebalancesheetundertitlessuchasaccounts receivable,tradereceivablesorcustomerreceivables.Thistermcanbedefinedas"debtowed tothe firm bycustomers arising from sale of goods or services in ordinary course of business."
Instruments indicating receivables
HarryGrosshassuggestedthreegeneralinstrumentsinaconcernthatprovideproof of receivables relationship. Theyarebrieflydiscussed below:-
Open book account
Thisisanentryintheledgerofacreditor,whichindicatesa credittransaction.Itisno evidenceof the existences of adebt under theSales of Goods.
Negotiable PromissoryNote
Itisanunconditionalwrittenpromisesignedbythemakertopayadefinitesumof moneytothebearer,ortoorderatafixedordeterminabletime.Promissorynotesareused whilegrantinganextensionoftimeforcollectionofreceivables,anddebtorsareunlikelyto dishonor its terms.
Increase in Profit
Asreceivableswillincreasethesales,thesalesexpansionwouldfavorablyraisethe marginalcontributionproportionatelymorethantheadditionalcostsassociatedwithsuchan increase. This in turn would ultimatelyenhancethelevel of profit of the concern.
MeetingCompetition
A concernofferingsaleofgoodsoncreditbasisalwaysfallsinthetopprioritylistof peoplewillingtobuythosegoods.Therefore,afirmmayresortgrantingofcreditfacilityto itscustomersinordertoprotectsalesfromlosingittocompetitors.Receivablesactsasan attractingpotentialcustomersandretainingtheolderonesatthesametimebyweaningthem awayfirm thecompetitors.
Augment Customer'sResources
Receivables are valuable to the customers on the ground that it augments their resources. It is favored particularly by those customers, who find it expensive and cumbersometoborrowfromotherresources.Thus,notonlythepresentcustomersbutalso the Potential creditors are attracted to buy the firm's product at terms and conditions favorableto them.
SpeedyDistribution
Receivablesplayavery importantroleinaccelerating the velocityofdistributions.As a middleman would act quickly enough in mobilizing his quota of goods from the productionsplacefordistributionwithoutanyhassleofimmediatecashpayment.As,hecan pay the full amount after affecting his sales.Similarly, the customers would hurry for purchasingtheirneedfuleveniftheyarenotinapositiontopaycashinstantly.Itisforthese receivables are regarded as a bridge for the movement of goods form production to distributions amongthe ultimate consumer.
Miscellaneous
Theusualpracticecompaniesmayresorttocreditgrantingforvariousotherreasons likeindustrialpractice,dealersrelationship,statusofbuyer,customersrequirements,transits delayetc.Innutshell,theoverallobjectiveofmakingsuchcommitmentoffundsinthename ofaccountsreceivablesaimsatgeneratingalargeflowofoperatingrevenueandearning morethanwhatcouldbepossibleintheabsenceofsuchcommitment.
Costof MaintainingReceivables
Receivables areatypeofinvestmentmade by a firm. Like other investments, receivablestoo featureadrawback,whicharerequiredtobemaintainedforlongthatit knownascreditsanction.Creditsanctionmeanstieupoffundswithnopurposetosolveyet costingcertainamounttothefirm.Suchcosts associatedwithmaintainingreceivablesare detailed below: -
Administrative Cost
Ifafirmliberalizesitscreditpolicyforthegoodreasonsofeithermaximizing sales or minimizingerosion ofsales, it incurs two types ofcosts:
(A) Credit Investigation and Supervision Cost:
Asaresultoflenientcreditpolicy,therehappenstobeasubstantialincreaseinthe numberofdebtors.Asaresultthefirmisrequiredtoanalysisandsupervisesalargevolume ofaccountsatthecostofexpensesrelatedwithacquiringcreditinformationeitherthrough outsidespecialistagencies or formits own staff.
(B)Collection Cost:
Afirmwillhavetointensifyitscollectioneffortssoastocollecttheoutstandingbills especiallyincaseofcustomerswhoare financiallylesssound.Itincludesadditionalexpenses ofcreditdepartmentincurredonthecreationandmaintenanceofstaff,accountingrecords, stationary, postage and other related items.
CapitalCost
Thereisnodenyingthatmaintenanceofreceivablesbyafirmleadstoblockageofits financial resourcesduetothetielogthatexistsbetweenthedateofsaleofgoodstothe customerandthedateofpaymentmadebythecustomer.Butthebitterfactremainsthatthe firmhastomakeseveralpaymentstotheemployees,suppliersofrawmaterialsandthelike evenduringtheperiodoftimelag. Thus,afirminthe course ofexpandingsales through receivables makes wayfor additional capital costs.
Production and SellingCost
Thesecostsaredirectlyproportionatetotheincreaseinsalesvolume.Inotherwords, productionandsellingcostincreasewiththeveryexpansioninthequantumofsales.Inthis respect,afirmconfrontstwosituations;firstlywhenthesalesexpansiontakesplacewithin therangeofexistingproductioncapacity,in thatcaseonlyvariablecostsrelatingtothe productionandsalewouldincrease.Secondly, whentheproductioncapacityisaddeddueto expansionofsalesinexcessofexistingproductioncapacity.Insucha caseincremental production and selling costswould increaseboth variable andfixed costs.
DelinquencyCost
Thistypeofcostarisesonaccountofdelayinpaymentoncustomer'spartorthe failureofthecustomerstomakepaymentsofthereceivablesasandwhentheyfalldueafter the expiryof thecreditperiod. Such debts aretreated as doubtful debts. Theyinvolve:-
(i) Blockingof firm's fundsfor an extended period oftime,
(ii)Costsassociated with the collection ofoverheads,remainders legal expenses andon initiatingother collectionefforts.
Default Cost
Delinquencycostarisesasaresultof customersdelayinpaymentsofcashorhisinabilitytomakethefullpaymentfromthefirm ofthereceivablesduetohim.Defaultcostemergesaresultofcompletefailureofadefaulter (customer)topayanythingtothefirmin return ofthegoodspurchasedbyhimoncredit. Whendespiteofalltheefforts,thefirmfailstorealizetheamountduetoitsdebtorsbecause ofhimcompleteinabilitytopayforthesame.Thefirmtreatssuchdebtsasbaddebts,which areto be written off,as cannot be recovers in anycase.
FACTORS AFFECTING THESIZE OFRECEIVABLES:
Commonfactorsdeterminingthelevel of receivables
Thesizeofreceivablesisdeterminedbyanumberoffactorsforreceivablesbeinga major componentofcurrentassets.Asmostofthemvariesfrombusinessthebusinessin accordancewiththe natureandtypeofbusiness.Somemainandcommonfactorsdeterminingthelevel of receivablearepresented bywayof diagram infiguregiven belowand arediscuses below:
Stabilityof Sales
Stabilityofsalesreferstotheelementsofcontinuityandconsistencyinthesales.In otherwordstheseasonalnatureofsalesviolatesthecontinuityofsalesinbetweentheyear. So,thesaleofsuchabusinessinaparticularseasonwouldbelargeneedingalargeasizeof receivables.Similarly,ifafirmsuppliesgoodson installmentbasisitwillrequirealarge investment in receivables.
Termsof Sale
Afirmmayaffectitssaleseitheroncashbasisoroncreditbasis.Asamatteroffact creditisthesoulofabusiness.Italsoleadstohigherprofitlevelthroughexpansionofsales. Thehigherthevolumeofsalesmadeoncredit,thehigherwillbethevolumeofreceivables and vice-versa.
TheVolume of Credit Sales
Itplaysthemostimportantroleindeterminationofthelevelofreceivables.Astheterms oftraderemainsmoreorlesssimilartomostoftheindustries.So,afirmdealingwithahigh level of sales will havelargevolumeof receivables.
Credit Policy
Afirmpracticinglenientorrelativelyliberalcreditpolicyitssizeofreceivableswillbe comparativelylargethanthefirmwithmorerigidorsignetcreditpolicy.Itisbecauseoftwo prominent reasons:-
Alenientcreditpolicyleadstogreaterdefaultsinpaymentsbyfinanciallyweak customers resultingin bigger volume of receivables.
Alenientcreditpolicyencouragesthefinanciallysoundcustomerstodelaypayments again resultingin theincreasein thesizeof receivables.
Terms of sale
Theperiod forwhich credit is grantedto acustomerdulybrings about increaseor decreaseinreceivables.Theshorterthecreditperiod,thelesseristheamountofreceivables. Asshortterm credittiesthefundsforashortperiodonly.Therefore,acompanydoesnot requireholdingunnecessaryinvestment bywayofreceivables.
Cash
Cashdiscountononehandattractsthecustomersforpaymentsbeforethelapseof creditperiod.Asatemptingofferoflesserpaymentsisproposedtothecustomerinthis system,ifa customersucceedsinpayingwithinthestipulatedperiod.Ontheotherhand reducestheworkingcapital requirementsoftheconcern.Thus,decreasingthereceivables management.
Collection policy
Thepolicy,practiceandprocedureadoptedbyabusinessenterpriseingranting credit, decidingastotheamountofcreditandtheprocedureselectedforthecollectionofthesame alsogreatlyinfluencethelevelofreceivablesofaconcern.Themorelenientorliberalto creditand collection policies themorereceivablesarerequiredforthe purpose of investment.
Collection collected
Ifanenterpriseisefficientenoughinencasing thepaymentattachedtothereceivables withinthestipulatedperiodgrantedtothecustomer.Then,itwilloptforkeepingthelevelof receivableslow.Whereas,enterpriseexperiencingunduedelay incollectionofpaymentswill always haveto maintainlargereceivables.
Bills discounting and endorsement
Ifthefirmoptsfordiscountingitsbills,withthebankorendorsingthebillstothe thirdparty,formeetingitsobligations.Insuchcircumstances,itwouldlowerthelevelof receivables required in conductingbusiness.
Quality of customer
Ifacompanydealsspecificallywithfinanciallysoundandcreditworthycustomers thenitwoulddefinitelyreceiveallthepaymentsinduetime.Asaresultthefirmcan comfortablydowithalesseramountofreceivablesthanincasewhereacompanydealswith customers havingfinanciallyweaker position.
Miscellaneous
There are certain general factors such as price level variations, attitude of management type and nature of business, availability of funds and the lies that play considerablyimportant role in determiningthe quantumof receivables.
PRINCIPLESOFCREDIT MANAGEMENT:
Inordertoaddprofitability,soundnessandeffectivenesstoreceivablesmanagement, anenterprise mustmakeitapointtofollowcertainwell-establishedanddulyrecognized principlesofcredit management.
Thefirstoftheseprinciplesrelatetotheallocationof authoritypertainingto creditand collectionsof somespecificmanagement.
Thesecond principleputsstressontheselectionofpropercreditterms.
Thethirdprinciplesemphasizesa throughcreditinvestigationbeforeadecisionongrantingacredit is taken.Andthelast principletouchesupontheestablishmentofsoundcollectionpoliciesand procedures.
Inthe light of this quotation, the principles of receivables management can bestated as:
1. AllocationorAuthority
2.Selectionof Proper Credit Terms
3. CreditInvestigation
4.Sound CollectionPoliciesand Procedures
OBJECTIVES OF CREDIT MANAGEMENT:
- To attain not maximum possible but optimum volume of sales
- To exercise control over the cost of credit and maintain it on a minimum possible level.
- To keep investment at an optimum level in form of the receivables
- To plan and maintain a short average collection period.
The period goal of receivables managementistostrikeagoldenmeanamongrisk,liquidityandprofitabilityturnsouttobe effectivemarketingtool.Asithelpsincapturingsalesvolumebywinningnewcustomers besides retainingto old ones.
CREDIT POLICY:
Creditpolicyofeverycompanyisatlargeinfluencedbytwoconflictingobjectives irrespectiveofthenativeandtypeofcompany.Theyareliquidityandprofitability.Liquidity canbedirectlylinkedtobook debts.Liquiditypositionofafirmcanbeeasilyimproved withoutaffectingprofitabilitybyreducingthedurationoftheperiodforwhichthecreditisgrantedandfurtherbycollectingtherealizedvalueofreceivablesassoonastheyfailsdue. Toimproveprofitabilityonecanresorttolenientcreditpolicyasaboosterofsales,butthe implications are:-
1. Changes of extendingcreditto thosewith week creditrating.
2. Undulylongcreditterms.
3. Tendencyto expand creditto suitcustomer's needs; and
4. Lack ofattention to overdues accounts.
Thethreeimportant decisionsvariables ofcreditpolicyare:
1. Credit terms,
2.Creditstandards, and
3.Collection policy.
1. Credit Terms
Credittermsrefertothestipulationsrecognizedbythefirmsformakingcreditsaleof thegoodstoitsbuyers.Inotherwords,credittermsliterallymeanthetermsofpaymentsof thereceivables
Therearetwoimportantcomponentsofcreditterms which aredetailed below:-
(A)Creditperiodand
(B)Cash discount terms
A) Credit period
"Creditperiodisthedurationoftimeforwhichtrade creditisextended.Duringthistimetheoverdueamountmustbepaidbythecustomers."
Whiledeterminingacreditperiodacompanyisboundtotakeinto considerationvariousfactorslikebuyer'srateofstockturnover, competitorsapproach,the natureofcommodity, margin of profitand availabilityoffunds etc.
Thegeneralwayofexpressingcreditperiodofafirmistocoinitintermsof netdatethatis,ifafirm'scredittermsare"Net30",itmeansthatthecustomerisexpectedto repayhiscreditobligationwithin30days.
Afirmmaytightenitscreditperiodifitconfrontsfaultcasestoooftenandfears occurrenceofbaddebtlosses.Ontheotherside,itmaylengthenthecreditperiodfor enhancingoperatingprofitthroughsalesexpansion.Anyhow,thenetoperatingprofitwould increaseonly ifthecostofextendingcreditperiodwillbelessthantheincrementaloperating profit. But the increase in sales alone with extended credit period would increase the investment in receivablestoo because of the followingtwo reasons:-
(i) Incrementalsales resultinto incremental receivables,
(ii)Theaveragecollection periodwill getextended, asthecustomerswillbegranted moretime to repaycreditobligation.
(B)Cash Discount Terms
Thecashdiscountisgrantedbythefirmtoitsdebtors,inordertoinducethemto makethepaymentearlierthantheexpiry ofcreditperiodallowedtothem.Grantingdiscount meansreductioninpricesentitledtothedebtorssoastoencouragethemforearlypayment beforethetimestipulatedtothei.e.thecreditperiod.
Cash discount is expressed is apercentage of sales. A cash discount term is accompaniedby(a)therateofcashdiscount,(b)thecashdiscountperiod,and(c)thenet creditperiod.Forinstance,acredittermmaybegivenas"1/10Net30"thatmeanadebtoris granted1percentdiscountifsettleshis accountswiththecreditorbeforethetenthday startingfromadayafterthedateofinvoice.Butincasethedebtordoesnotoptfordiscount heis bound to terminatehis obligation within the creditperiod ofthirtydays.
Tomakecashdiscountaneffectivetoolof creditcontrol,abusinessenterpriseshouldalsoseethatisallowedtoonlythosecustomers whomakepaymentsatduedate.Andfinally,thecredittermsofanenterpriseonthereceipt ofsecuritieswhilegrantingcredittoitscustomers.Creditsalesmaybegotsecuredbybeing furnishedwithinstruments such as trade acceptance, promissory notes or bank guarantees
2. Credit Standards
Creditstandardsreferstotheminimumcriteriaadoptedbyafirmforthepurposeof shortlistingitscustomersforextensionofcreditduringaperiodoftime.Creditrating,credit reference,averagepaymentsperiodsaquantitativebasisforestablishingandenforcingcredit standards. Optimumcreditstandardscanbedeterminedandmaintainedbyinducing tradeoff between incremental returns and incremental costs.
Analysisof Customers
Thequalityoffirm'scustomerslargelydependsuponcreditstandards.Thequalityof customerscanbediscussedundertoomainaspects;averagecollectionperiodanddefault rate.
(i)Average Collection Period
(ii)DefaultRate
I.M. Pandey has cited three Cs of credit termed as character, capacity and condition that estimate the likelihood of default and its effect on the firms' managementcreditstandards. Two moreCshasbeenaddedtothethreeCsof I.M. Pandey,namely;capitalandcollateral.
1.2. PROBLEM STATEMENT:
The main problem of the study is that the company faces the difficulties of receiving payments from their customers. To determine the reason for the delay in receiving payments from the debtors. To check whether their customers are paying the amount correctly from the actual date of receipt within the payment due date. To find out the number of days delay in receiving payment. Ratio is determined to indicate payment period, collection period, return on owner equity. It throws light on financial strength of the company and whether the trend over the years is favorable or not. In this study, ratios are used for credit analysis. From the given secondary data, trend analysis of sales and debtors for 3 years is to be determined for knowing the impact of receivable in financial liquidity.
1.3. NEED & SCOPE OF THE STUDY
Measurement is another component within account receivable management. Traditional ratios, such as turnover will measure how many times you were able to convert receivables over into cash.
Measurements may need to be modified to account for wide fluctuations within the sales cycle. The use of weights can help ensure comparable measurements.
The following are the scope:
1.Fostering credit awareness
2.Understanding the need for a credit policy
3.Understanding financial statements
4.Applying financial analysis of financial statements
5.Allowing too much credit, or notmanaging the credit policy carefully enough, could result inirrecoverabledebts. This represents a loss of income to the company, affecting both profitability and cash flow.So credit management has to be done.
6.To reduce administrative cost and enhance office productivity
7.To manage your sales process more effectively by measuring trends and analyzing performance.
8.How the managed calculations tofit your business needs
1.4. OBJECTIVE OF THE STUDY
Primary objective:
The objective of the receivables management is to promote sales and profits. Also it focuses on how to augment money to meet the company’s working capital requirements.
Secondary Objective:
i) To examine the receivables management practices followed by the company
ii) To determine the relationship of receivables and sales
iii) To Compare Actual Date of Receipt from customerswith the Payment Due Date.
iv) To find out the reasons for the delay in getting the Payment
v) To find out the impact in the working capital of the company
vi) To offer suggestion to improve the receivables position.
1.5. RESEARCH METHODOLGY
The data that has been collected from various sources and presented in the form of materialistic information is known as research methodology. Research methodology is a systematic way to solve any research problem. It may be understood as a science of studying how research is done scientifically.
1.5.1. RESEARCH DESIGN
This research study adopts an Empirical research methodology. Such research is often conducted to answer a specific question or to test a hypothesis. Any conclusions drawn are based upon hard evidence gathered from information collected from real life experiences or observations. This helps to understand and respond to dynamics of situations. This research is widely used in stock market research, analysis of financial statement, and other socio-science related researches.
1.5.2. DATA COLLECTION METHOD
Data collection methods are an integral part of research design. Problems researched with the use of appropriate methods greatly enhance the value of the research
In this study, the data are collected from the secondary sources. Secondary data are indispensable for most organizational research. Such data can be internal or external to the organization and accessed through the internet or perusal of recorded or published information.
Secondary data can be used, among other things, for forecasting sales by considering models based on past sales figures, and through extrapolation.
There are several sources of secondary data, including books and periodicals, government publications of economic indicators, census data, statistical abstracts, databases, the media, annual reports of companies, etc. Also included in secondary sources are schedules maintained for or by key personnel in organizations, the desk calendar of executives, and speeches delivered by them. Much of such internal data, though, could be proprietary and not accessible to all.
The advantage of seeking secondary data sources is savings in time and costs of acquiring information. Hence it is important to refer to sources that offer current and up-to-date information.
For this research, the data is collected from the annual reports of the company from the year 2008-09 to 2012-13. The annual report can be considered as the most important and reliable source of financial data.
1.5.3. TOOLS USED
The following are the financial tools used for analysis and interpretation of this study which is based on receivables management.
- Ratio analysis tools used here are
1. Liquidity
a)Current ratio
b)Quick ratio
c)Net working capital to sales ratio
2. Profitability
d)Gross profit margin
e)Net profit margin
3. Activity
f)inventory turnover ratio
g)accounts receivable turnover ratio
h)average collection period
- Trend Analysis of Debtors ( in months i.e. from Mar 2012- Apr 2013)
- Trend of sales (from Mar 2012- Apr 2013)
1.6. CHAPTERISATION
The project consists of five chapters as described below:
Chapter 1: Chapter 1 deals with introduction to the study, problem statement, need and scope of the study, Objectives of the study, Research methodology and Limitations of the study.
Chapter 2: Chapter 2 deals with review of literature.
Chapter 3: Chapter 3 includes the industry profile and the company profile.
Chapter 4: Chapter 4 includes the data analysis and interpretation of the study.
Chapter 5: Chapter 5 deals with the summary of findings, suggestions and conclusion of the study.
1.7. LIMITATIONS OF THE STUDY
- The study is based on the accounting information. Therefore it is subject to change based on the market to demand conditions.
- The study is basically based on the secondary information that is annual reports of the company. Hence it is difficult to state that the study is flawless when most of the study is based on the secondary data.
- The figures used in reports are taken from annual reports are taken from the annual reports and has it does not have any impact on the current transactions.
- The whole study is based on observations in the past, which can only be related to laws that operated in the past, as there is no evidence that the laws will continue to operate in future also
1
CHAPTER 2
LITERATURE REVIEW
CHAPTER 2
LITERATURE REVIEW
Mamo, David, (1994), Receivables financing as a source of working capital, Nursing Homes, 8, vol.43, 28
Financing through a securitization of receivables does not create a liability. An asset—the receivables --is sold for cash; no loan has been granted.
Banks and finance companies are the most obvious source of receivables financing. Their lending decision is generally driven by an analysis of a borrower's financial statements. Consequently it is common for a company's line of credit to be limited by how its debt compares to its equity base (the ratio of debt-to-worth) or for the lender to set minimum levels of solvency for the company (the current ratio or acid-test ratio).
Under these covenants, a lender limits his willingness to lend funds beyond a predetermined point at which the company would be deemed either excessively indebted or too short of cash for the payments it must meet. The receivables function as part of the total collateral that the company pledges in order to strengthen its corporate commitment to eventually repay the loan. In support of this, the company usually must periodically produce a report (the borrowing base report) showing how much in receivables it carries on its balance sheet.
Strischek, Dev, (2001), Looking for a vital sign in contractor accounts: The receivables ratio, The RMA Journal, 10,vol. 83, 62-66
A contractor's receivables represent two significant elements of contractor cash flow and working capital. Receivables constitute the major source of cash inflow, and payables absorb a big share of cash outflow. A construction company's ability to extend credit to its customers depends on its own trade creditors' willingness to wait for their payments from the contractor's collection of its progress billing receivables. The delicate balance of receivables and payables is key to the financial success of the contractor. Contract receivables take longer to collect, and the trade creditors expect prompt payment. The receivables ratio is a quick-and-easy test of contractor viability.
Colabella, Patrick; Fitzsimons, Adrian P; Shoaf, Victoria,(2009), FASB Proposes Disclosures About the Credit Quality of Financing Receivables and the Allowance for Credit Losses, Commercial Lending Review, 5,vol. 24, 35-40
Specifically, the proposed FAS would require a creditor to disclose information that would allow credit analysts and other financial statement users to understand the following:
* The nature of credit risk inherent in the creditor's portfolio of financing receivables
* How that risk is analyzed and assessed in arriving at the allowance for credit losses
* The changes and reasons for those changes in both the receivables and the allowance for credit losses
The proposed FAS would apply to all financing receivables held by creditors, including all public and nonpublic entities that prepare financial statements.
The FASB states that the term "financing receivables" would include loans defined as a contractual right to receive money on demand or on fixed or determinable dates that are recognized as an asset in the creditor's statement of financial position, whether originated or acquired.
Black, Tom, (1998), Using receivables purchasing to improve cash flow for small businesses, Commercial Lending Review, 4, vol.13, 70-74
Within the last decade, a growing number of bankers have begun supplementing their commercial product line with receivables purchasing programs, boasting both exceptional yields and stable, satisfied customers.
By adhering to these 4 risk-management principles, bankers can significantly mitigate risk in receivables purchasing: 1. Making a prudent initial credit decision, 2. maintaining accurate and timely account information, 3. controlling the cash, 4. Implementing effective monitoring procedures, and 5.providing protection against changing credit circumstances.