Receivables Management Meaning and Importance
The amount that is owing to a firm as a consequence of the company delivering products and/or services to customers on credit is referred to as accounts receivable. There is another phrase that may be used in lieu of accounts receivable, and that is trade receivable.
Accounts Receivable is the name of the account in the company’s general ledger that is used to keep track of the money that is owing to the business. On the balance sheet of the firm, the amount of the unpaid balance in this account is included as a component of the current assets section.
When a consumer purchases items from a vendor on credit, the seller is likely to become the buyer’s unsecured creditor. As a result, the merchant offering the items on credit has to exercise extreme caution.
If you want to maintain accurate financial records, you need to make an estimate for any amount in your Accounts Receivable that is very unlikely to be collected. A credit balance is shown for the expected amount in a contra-receivable account such as the Allowance for Doubtful Accounts account. Due to the presence of this credit balance, the total amount of accounts receivable that is shown on the balance sheet will be decreased. Any change made to the Allowance account will also have an effect on the Uncollectible Accounts Expense that is seen on the income statement.
Example of Accounts Receivable
A manufacturer will record an account receivable when it delivers a truckload of goods to a customer on June 1 and the customer is allowed to pay in 30 days. From June 1 until the company receives the money, the company will have an account receivable (and the customer will have an account payable).
Cost of Maintaining Receivables
Maintaining receivables bears cost. It includes cost of investment in receivables, bad debt losses, collection expenses and cash discount. Costs related with receivables and their calculation are as follows:
1. Cost Of Investment In Receivables
This is the opportunity cost of funds being tied up in receivables, which would otherwise have not been incurred if all sales were in cash. The cost of investment in receivable is calculated as:
Cost of receivables = Investment in receivables X Opportunity costs
Here, investment in receivables = (FC+ VC)/Days in year) X DSO
Where, FC = Fixed Cost, VC = Variable Cost and DSO = Days sales outstanding.
2. Bad Debt Losses
This is the loss due to default customers. Extension of credit to low quality-rate customers results into increase in bad debt losses. Bad debt losses are calculated as a percentage on sales as shown in equation below:
Bad debt losses = Annual credit sales X Percentage default customer
3. Collection Expenses
This is the cost incurred for operating and managing the collection and credit department of a firm. This includes the administrative cost of credit department, salary and commission paid to collection staff, cost paid for telephone and communication and so on.
4. Cash Discount
It is the cost incurred to induce the customer for early payments of their accounts. A firm can offer cash discount to its customers to reduce the average collection period, bad debt losses, and the cost of investment in receivables. The discount cost is calculated as cash discount percentage multiplied by sales to discount customers as given below:
Discount Cost = Annual credit sales X Percentage discount customer X Percentage cash discount
Objectives of Receivables Management
Following are the objectives of receivables management which will help us to understand the purpose of receivables:
- To optimize the amount of sales
2. To minimize cost of credit
3. To optimize investment in receivables.
4. To increase credit sales.
Therefore, the main objective of receivable management is to create a balance between profitability and cost.
Accounts receivable recorded in the financial statements
Usually, the businesses expect to receive money in the future, so it is to be added to the assets in the financial statement of the business. The accurate record keeping of this money that is receivable (accounts receivable) in the books of accounts are required to avoid any default in the payment due.
Few pointers connected to recording accounts receivable are as follows :
a. Establishing the practice of credit transactions:
It’s possible that the company may begin the practise of supplying its customers with a credit insurance. This credit may be extended for a certain amount of time, but there is often a penalty associated with any failure in payment for this credit. In order to make use of this credit facility practise, there must first be an agreement between two parties on the terms and circumstances of such credit transactions. Before agreeing to any terms and conditions, the supplier of this facility need to first ascertain the client’s financial standing and capacity to make payments. to avoid a reduction in the amount of cash coming in.
b. Generating invoices for the customer:
It is necessary of the companies that invoices be generated for any sales that are made or services that are rendered. On the invoice, there must to be specifics on the prices of the products and services that were sold to the consumers. The generation of an invoice guarantees that the credit transaction is recorded precisely and accurately in the company’s books whenever it occurs. In addition, a copy of the invoice is sent to the client so that they may complete the payment in accordance with the conditions that were previously agreed upon.
c. Tracking the payments received and the payment that is due to be received:
An accountant is required to track the payments received or due from the customers. The details of the method of payment and date of receiving payment have to be recorded in the customer’s ledger account. This ensures correctness of accounting of the credit amount. The businesses shall also generate timely reminders for dues pending to the customers.
d. Accounting for the accounts receivable
The accountant or the person responsible for taking due care of the account’s receivables must record all the due dates of the payments to be received. The timely and prompt recording of the accounts receivable leads to receiving the payments on time from the customers. Once the account receivable is recorded and payment is received, the account for the said party can be settled for good.
