44 3 Reduction of External Funding Needs
3.4.3 Management of Accounts Receivable
Introduction
One side of the management of working capital is management of accounts pay-
able (see above). The other side is management of accounts receivable. Accounts
receivable are the key determinant of working capital.
For the seller, accounts receivable are an investment related to the last part of
the operating cycle, that is, the sales of products. Accounts receivable arise from
the terms of payment offered to customers, and their volume depends on the credit
offered to customers.
For customers, accounts receivable are a source of short-term funding con-
nected to the purchase of goods and services (section 3.4.2 above). Large buyers
can benefit from their stronger bargaining position by paying late. Small firms
must, in practice, pay earlier because of their weaker bargaining position.
The credit policy of the firm is an important way to influence its external fund-
ing needs because a major part of the assets of many firms is in receivables. A
change in the firm’s credit policy has a direct effect on turnover and an indirect ef-
fect on other working capital determinants and accounts receivable itself. A hard
line with debtors risks alienating customers temporarily lacking cash. But if the
firm is too soft, it may run short of funds itself.^90
For the same reason, receivables form an important asset from which the firm
may wish to raise funding. Receivables financing can take the form of an outright
sale under arrangements commonly known as factoring and discounting of receiv-
ables. Securitisation is an advanced method of releasing capital. Securitisation
means the sale of receivables to a single purpose vehicle which issues bonds in or-
der to finance the purchase.
Alternatively, the firm may grant a security interest in the receivables (see Vol-
ume II). In practice, the distinction between the outright sale of receivables and
their transfer by way of security can be blurred. If the debt is sold but on a re-
course basis (so that if the debtor fails to pay, the seller must re-purchase the debt
or make good the loss) or if a similar effect is achieved through warranties given
by the assignor, the arrangement is functionally very much like a security interest
in the receivables.^91
In the following section, the credit policy of the firm will be discussed before
factoring, forfeiting and securitisation.
Extension of Trade Credit and Choice of Payment Terms
The primary function of accounts receivable is to enable customers to buy goods
and services even if they temporarily lack funds.
Suppliers extend credit to their customers for financial and commercial reasons.
The financial reason is that firms that have better access to credit markets are able
(^90) See Accounts not receivable, The Economist, September 2008.
(^91) See The Law Commission, Registration of Security Interests, paragraphs 6.24 and 6.25.