The profit is directly proportional to the volume of sales, as long as all your business transactions are carried out in cash. Is it possible for a manufacturer, wholesaler or retailer to conduct business without offering credit in this competitive business environment? The answer is a resounding “no”, because the extension of credit improves your sales and, therefore, your profits. Problems arise only when a company is unable to recover the debt within the stipulated period of time from the clients.
What is collection management or debtor management?
It covers two aspects. One, the type of money that is being invested in the debt turnover. Second, the risk factor that includes the loss of money or the opportunity cost that the company gives up. Had these funds not been linked to accounts receivable, the company would have invested the same elsewhere and earned income from it. An all-cash transaction is definitely a possible option, but whether it is lucrative in the long run should be considered. When customers are not offered credit, they choose companies that extend credit facilities and thus may lose their previous customers and also risk lower sales ratios.
In credit sales, the supplier offers credit for a specified period of time, which is an investment from the supplier’s point of view and the largest single source of short-term financing from the customer’s point of view. The provider must be able to recover the amount of interest on the credit investment that it has made. How?
- Debt recovery within the stipulated credit term
- Take customer interest for the period of delay
- Sales volume
- Excess capital to offset these negative impacts on fund turnover
- Appropriate formulation and execution of credit policies by the finance manager
- Discipline in the collection policy and its execution.
Many companies offer prompt payment discounts, quantity discounts, and trade discounts to customers to encourage credit sales, favoring bulk purchases. A company cannot be expected to survive long by following the cash sales policy, while similar companies can outgrow it by adopting liberal credit policies.
The main aspects of accounts receivable management decisions are as follows:
- credit time period
- Customer credibility
- Early payment discounts
- Commercial discounts
The credit policy, on the one hand, stimulates sales and, therefore, also your gross profit, but, on the other hand, it can be accompanied by additional costs, such as:
1) administrative expenses related to the investigation of additional accounts and the servicing of the additional volume of accounts receivable,
2) higher losses due to bad debts due to the extension of credit to less creditworthy clients,
3) higher cost of capital.
The incremental gains from increased sales must match the incremental costs arising due to the terms of the credit, to prevent funds from being tied up in accounts receivable. Over time, it would deprive him of his earnings. The fundamental consideration of your credit policy would be the selection of credit worthy clients or debtors. If your funds become rigid, recovery is not at all a mundane task and you must proceed legally to claim your rights. Accounting records and duly maintained vouchers will be kept as testimony in your favor in the court of law.
