Debtors

1
Debtors

• Total level of credit - credit policy
• Measuring debtors
• Managing debtors Credit and profit
• Credit control policy
• Creditworthiness
• Using debtor info.
• Foreign trade

2
Total level of credit

• Essentially a balance between
• profit from attracting / retaining customers
• and
• cost of extending credit
• Should be seen as an element in marketing
• Thus firm should establish a credit policy

3
Measuring debtors

• Debtors collection period
• Trade debtors x 365
• Annual sales on credit
• Shorter period faster collection, thus better
  cash flow

4
Credit and profit

• Bad debts
• cost is total debt opportunity cost
• Interest cost
• debtors x interest rate x period outstanding
• Administration cost
• cost of maintaining ledger / debt collection
• Additional funding
• stock to service additional sales
• additional amounts due to creditors

5
Credit control policy

• Need to set
• credit period
• procedures for granting credit
• controlling credit
• Credit granted to be included in budget
• Recognise that some will be slow payers
• Balance costs against profit

6
Creditworthiness

• References
• Credit ratings
• Press
• Credit scoring
• Initially a low credit level
• Perhaps cash only at first
• Maintain good records
• Aged debtors list
• Review credit limits
• Consider factoring / invoice discounting

7
Using information

• All records must be reliable
• To chase debts we need
• invoices
• receipts posted to ledger quickly
• receipts allocated to invoices
• queries identified and dealt with quickly
• credit limit
• full customer history
• aged debt list
• Debtors should be categorised
• Risk can be assessed by credit taken ratio

8
Cost of discount given

• LEARN THIS!!!
• The cost of an early settlement discount can be
  calculated as
• d . X 365
• (100 d) t
• Where d discount offered
• t difference between normal period and
  period to obtain discount

9
Foreign trade

• Additional risks
• delay
• culture
• lack of knowledge all lead to higher risk
• Risk can be reduced by
• advance payment
• export factoring
• documentary credits
• export credit insurance

10
Example 1

• The accountant of Hanks Ltd is considering a
  proposal from the sales manager to change its
  credit policy from allowing debtors a 3 month
  credit period instead of the current period of 2
  months. Sales are currently 500,000 p.a. and it
  is estimated that the new policy will increase by
  sales by 10. The contribution/sales ratio is
  18 and the cost of capital is 11.
• Should the proposed change be made?

11
Example 1 - Solution

• The proposed system
• Will generate additional contribution
• 500,000 x 10 x 18 9,000
•  
• 2 Will cost to finance
• increase in debtors period for existing sales
• 500,000 x 1/12 x 11 (4,583)
• credit extended to new customers
• 500,000 x 10 x 3/12 x 11 (1,375)
  (5,958)
• A net benefit of 3,042
•  
• NB It was assumed that no other elements of
  working capital changed as a result of the
  increase in sales
•  
• Conclusion On financial grounds the proposed
  change should be introduced because it
  generates a net benefit of 3,042.

12
Example 2

• A company with annual sales of 480m has an
  average collection period of 2 months, with an
  average of 2 of sales becoming bad debts. The
  finance director has negotiated a non-recourse
  factoring agreement (i.e. the factor bears the
  risk of bad debts).
• The factor will provide factoring for a fee of
  2.5 of p.a. turnover.
• As a result of the agreement
• -                     Administration savings of
  8m p.a. will result
• -                     The average credit period
  will remain unchanged.
• Required
• If the cost of capital is 10, is the company
  better off under the agreement?

13
Example 2 - Solution

• Costs
• Financing costs no change
• Factors fee 480m x 2.5 12m
• Savings Bad debts 80 x 2 9.6m
• Admin. 8.0m
• 17.6m
• Net saving 5.6m
• ? Using factor is estimated to save 5.6m p.a.

14
Example 3

• Janus Ltd offers customers a 2 discount for
  payment within 10 days. Normal payment terms are
  45 days.
• What is the cost of the discount to Janus Ltd?

15
Example 3 - Solution

• 2/98 x 365/35 21.3