Introduction to Corporate Finance

ONLINE CHAPTERS

18-5 COLLECTING, MONITORING AND

APPLYING CASH TO RECEIVABLES

In addition to establishing the company’s accounts receivable standards and terms, the financial manager’s

responsibilities include collecting and monitoring receivables. The collection and monitoring process

is an ongoing operating activity that is also the responsibility of finance personnel. Here we consider

collection policies, credit monitoring and cash applications.

18-5a COLLECTION POLICY

A company must determine what its collection policy will be and how it will implement that policy. As

with credit standards and terms, the approach to collections may be a function of the industry and

the competitive environment. For many delinquent accounts, a reminder, form letter, telephone call or

personal visit may initiate customer payment. At a minimum, the company should generally suspend

further sales to the customer until the delinquent account is brought up to date.

If these actions fail to generate customer payment, it may be necessary to negotiate with the customer

for past-due amounts or report the customer to credit bureaus. It is possible that the company sold the

goods with a lien attached, obtained a pledge of collateral against the account, or had other corporate

or personal guarantees from the customer. In these cases, the company should utilise these options for

obtaining payment. Generally, as a last resort, the account can be turned over to a collection agency or

referred to an attorney for direct legal action. Obviously, a cost–benefit analysis should be made at each

stage to compare the cost of further collection actions against the cost of simply writing off the account

as a bad debt.

18-5b CREDIT MONITORING

Credit monitoring involves ongoing review of a company’s accounts receivable to determine if customers

are paying according to the stated credit terms. If customers are not paying on time, credit monitoring

will alert the company to the problem. Companies must monitor credit on both an individual and an

aggregate basis. Individual monitoring is necessary to determine if each customer is paying in a timely

manner and to assess whether a customer is within its credit limits.

Credit monitoring on an aggregate basis indicates the overall quality of the company’s accounts

receivable. Slow payments are costly to a company, because they increase the average collection period

and thereby the company’s investment in accounts receivable. If a company is also using its accounts

receivable as collateral for a loan, then the lending institution will generally exclude any past-due accounts

from those used as backup for the credit line. Therefore, changes in accounts receivable over time

could diminish the company’s overall liquidity and increase the need for additional financing. Analysis

of accounts receivable payment patterns can also be essential for forecasting future cash receipts in the

cash budget.

The three most frequently cited techniques for monitoring the overall quality of accounts receivable

are: (1) the average collection period; (2) ageing of accounts receivable; and (3) payment-pattern

monitoring.

LO18.6

Jon Olson, Chief Financial

Officer, Xilinx Corp.

‘Because cash is king,

we want to make sure

that we have a high

quality collections

organisation.’

See the entire interview on

the CourseMate website.

COURSEMATE
SMART VIDEO

Source: Cengage Learning

collection policy

The procedures used by a

company to collect overdue

or delinquent accounts

receivable. The approach

used is often a function of the

industry and the competitive

environment

credit monitoring

The ongoing review of a

company’s accounts receivable

to determine if customers are

paying according to the stated

credit terms

LO18.6