ONLINE CHAPTERS18-4 ACCOUNTS RECEIVABLE
STANDARDS AND TERMS
Accounts receivable (A/R) result from a company extending trade credit to its customers by selling its
products or services on credit. Receivables affect the cash conversion cycle through the average collection
period (ACP). As noted in Chapter 2, this period is the average length of time from a sale on credit until the
payment becomes usable funds for the company.
The ACP has two parts. The first, and generally the longer, is the credit period. It is measured as the
time from the sale (or customer invoicing) until customers place their payments in the mail. The second
is the time from when the customers place payments in the mail to when the company has spendable
funds in its bank account. The first part of the average collection period involves managing the credit
available to the company’s customers. The second part involves receiving, processing and collecting
payments. This section discusses customer credit; the next chapter discusses receiving, processing and
collecting payments.
As with all current accounts, receivables management requires managers to balance competing
interests. On the one hand, managers (generally the cash or treasury managers) prefer to receive cash
payments sooner rather than later. That preference leads toward strict credit terms and strict enforcement
of those terms. On the other hand, companies can use credit terms as a marketing tool to attract new
customers (or to keep current customers from defecting to another company). This objective argues for
easier credit terms and more flexible enforcement.
It is also important to understand that, in many companies, the credit policy is generally not under
the control of the financial (cash or treasury) managers, but rather is part of the sales or customer-service
functions. For many companies wishing to remain competitive, credit terms are a necessary part of
determining the ultimate sales prices for their products and services.18- 4a EFFECTIVE ACCOUNTS RECEIVABLE MANAGEMENT
Effectively managing the credit and accounts receivable process involves cooperation among sales,
customer service, finance and accounting staffs.
The key areas of concern involve:1 setting and communicating the company’s general credit and collections policies
2 determining who is granted credit and how much credit is extended to each customer
3 managing the billing and collection process in a timely and accurate manner
4 applying payments and updating the accounts receivable ledger
5 monitoring accounts receivable on both an individual and aggregate basis
6 following up on overdue accounts and initiating collection procedures, if required.
In the typical company, the credit and accounts receivable departments handle most of these tasks.
The cash management or treasury area will usually be responsible for managing the actual receipt of
payments. The cash manager usually will also have to collect and organise the remittance data that is
sent along with the payments so that the A/R department can determine what invoices have been paid.
We will cover this cash application process in greater detail later in the chapter.average collection period
(ACP)
The average amount of time
that elapses from a sale
on credit until the payment
becomes usable funds for
a company. Calculated by
dividing accounts receivable
by average daily sales. Also
called the average age of
accounts receivable
LO18.4