596 CHAPTER 16 Working Capital Management
Receivables Management
Firms would, in general, rather sell for cash than on credit, but competitive pressures
force most firms to offer credit. Thus, goods are shipped, inventories are reduced, and
an account receivableis created.^7 Eventually, the customer will pay the account, at
which time (1) the firm will receive cash and (2) its receivables will decline. Carrying
receivables has both direct and indirect costs, but it also has an important benefit —
increased sales.
Receivables management begins with the credit policy, but a monitoring system is
also important. Corrective action is often needed, and the only way to know whether
the situation is getting out of hand is with a good receivables control system.Credit Policy
The success or failure of a business depends primarily on the demand for its products—
as a rule, the higher its sales, the larger its profits and the higher its stock price. Sales,
in turn, depend on a number of factors, some exogenous but others under the firm’s
control. The major controllable determinants of demand are sales prices, product
quality, advertising, and the firm’s credit policy.Credit policy, in turn, consists of
these four variables:
1.Credit period,which is the length of time buyers are given to pay for their pur-
chases. For example, credit terms of “2/10, net 30” indicates that buyers may take
up to 30 days to pay.
2.Discounts given for early payment, including the discount percentage and how
rapidly payment must be made to qualify for the discount. The credit terms “2/10,
net 30” allow buyers to take a 2 percent discount if they pay within 10 days. Other-
wise, they must pay the full amount within 30 days.- Credit standards, which refer to the required financial strength of acceptable credit
customers. Lower credit standards boost sales, but also increase bad debts.
4.Collection policy, which is measured by its toughness or laxity in attempting to collect
on slow-paying accounts. A tough policy may speed up collections, but it might
also anger customers, causing them to take their business elsewhere.
The credit manager is responsible for administering the firm’s credit policy. How-
ever, because of the pervasive importance of credit, the credit policy itself is normally
established by the executive committee, which usually consists of the president plus
the vice-presidents of finance, marketing, and production.
The Accumulation of Receivables
The total amount of accounts receivable outstanding at any given time is determined
by two factors: (1) the volume of credit sales and (2) the average length of time be-
tween sales and collections. For example, suppose Boston Lumber Company (BLC),
a wholesale distributor of lumber products, opens a warehouse on January 1 and,
starting the first day, makes sales of $1,000 each day. For simplicity, we assume that
all sales are on credit, and customers are given 10 days to pay. At the end of the first(^7) Whenever goods are sold on credit, two accounts are created — an asset item entitled accounts receivable
appears on the books of the selling firm, and a liability item called accounts payableappears on the books of
the purchaser. At this point, we are analyzing the transaction from the viewpoint of the seller, so we are con-
centrating on the variables under its control, in this case, the receivables. We will examine the transaction
from the viewpoint of the purchaser later in this chapter, where we discuss accounts payable as a source of
funds and consider their cost.