Ebook The controllers function - The work of the managerial accountant (third edition): Part 2

12 RECEIVABLES Accounts receivable are an important item in the balance sheets of most business concerns and must be carefully controlled to avoid excessive work-ing capital requirements. Proper procedures and adequate safeguards on these accounts are essential not only to the continued success of the enter-prise but also to satisfactory customer relationships. Control of accounts receivable begins before the agreement to ship the merchandise, continues through the preparation and issuance of the billing, and ends with the collec-tion of all sums due. The procedure is closely related to cash receipts control and inventory control, acting as the link between the two. This chapter intro-duces ways to measure, manage, and control the receivables function. FUNCTIONS OF THE CREDIT DEPARTMENT The credit manager should assist in stimulating business through a wise extension of credit and also keep bad debt losses at a reasonably low level. The credit manager is also responsible for collecting receivables. In detail, the credit department’s tasks are to: • Establish credit policies. This involves such questions as the class of risk to accept, rigidity of credit term enforcement, and adjustment pol-icies to be followed. • Investigate credit. This requires a continuous procedure for securing and analyzing information concerning the responsibility of present and prospective customers. Information about customers can be collected from: C Commercial credit reporting agencies, such as Dun & Bradstreet 219 220 Receivables C Trade references supplied by the customer C Banks that hold a customer’s loans, investments, and checking accounts C Collection agencies C The SEC’s reports on any companies that issue stock or bonds to the public C The annual financial report files of the stock exchanges for those companies they list for trade • Approve credit. This requires a procedure by which the credit depart-ment definitely approves new customers and regularly reviews the credit of old ones. • Establish credit limits. Usually approval is limited to a certain amount, and a plan must be designed to check the extension of credit at this point or at least to notify the proper authority when the limit is reached. In addition, there will be situations when credit terms should not be granted, but the sale can still be made. In these cases, the company can either sell for cash or have backup guarantees by an individual, a second corporation, or a standby letter of credit. • Enforce discount terms. Customers frequently take discounts offered for prompt payment after the time allowed. A policy must be estab-lished and a procedure designed for the enforcement of the discount terms. • Collect receivables. Definite collection steps must be arranged for slow and delinquent accounts. This involves schedules of collection letters, follow-up procedures, and suspension of accounts from approved lists. In addition, the collections staff should be updated regularly on special col-lection techniques (i.e., attention-getting telegrams) and sent to trade association meetings to swap information with collection personnel from other companies. • Adjust credit. This involves settlement of accounts, participation in creditors’ committees, and representation in receivership and bank-ruptcy proceedings. Also, responsibility for writing off bad accounts must begin with the credit departments, although final approval may be required from the treasurer or controller, in the interest of sound internal accounting control. • Maintain credit records. Files, reports, and ratings must be main-tained as part of the credit analysis and collection effort. Functions of the Credit Department 221 • Manage the collection process. These items contribute to a tightly managed collections process: C Rapid billings. Quick billings lead to shorter days’ receivables outstanding, whereas extremely delayed billings may be difficult to collect. C Rapid cash application. The job of the collections clerk is greatly facilitated when cash receipt information is quickly updated and for-warded to the collections staff. This avoids unnecessary calls on sup-posedly delinquent accounts that have actually already been paid. C Tickler file. This file informs the collections clerk of the need to call customers on specific dates. C Confirmation letters. When a collection agreement is compli-cated, it is best to summarize the agreement terms in a letter and send it to the customer immediately, so there will be no confusion regarding payment. • Measure the collection process. Understanding of the collection department’s performance must be gained not only through quantita-tive measures, such as days’ sales outstanding (DSO) and the percent-age of overdue invoices. A review of bad-debt write-offs will indicate other problems, such as the reasons why credit was granted to cus-tomers who later defaulted. If these problems are tracked and cor-rected, then the volume of collection items will decline, thereby enhancing the quantitative performance measures. An in-depth knowledge of the business may reveal reasons for large receiv-ables balances that have nothing to do with high-risk customer accounts. For example, the DSO can be skewed by one very large invoice or by a large cluster of billings that occur at one time, such as at month-end. Also, a factoring arrangement may cause an abnormally low DSO. The credit analyst typically makes credit decisions with the assistance of customer financial statements. When doing so, these are the items to look for: • Ratios. These ratios show where cash is being tied up in a customer’s organization, thereby not allowing cash availability for debt payments: C Days’ sales outstanding. If the customer’s DSO is greater than its days of selling terms plus a third, then too much cash is tied up in receivables. C Quick ratio. If the customer’s quick ratio falls below 2 to 1, then the ability to pay may be hindered. 222 Receivables C Inventory turnover. If the customer’s inventory turns are worse than the industry norm, then too much cash is being tied up in inventory. The presence of obsolete inventory is sometimes indicated by low inventory turns accompanied by a good current ratio (since the excessive inventory appears in the numerator of the current ratio calculation). Alternatively, if a company has good inventory turns but a poor current ratio, it may have too little working capital to support the level of business being transacted (called over-trading); if so, look for high debt levels or call the customer’s bank for information. This type of company is a danger-ous trading partner, for its heavy debt load may cause it to crash quickly if its level of business drops. C Debt ratio. If the customer’s total liabilities are greater than 100% of equity, then the equity cushion available for payments to credi-tors is too small. • Seasonality. Typically a company’s books are closed during the slowest time of the year, when inventories are at their lowest, receiv-ables have been collected, and debt has been paid down. If a company chooses to have its year-end in a different month from other companies in its industry, its key ratios may vary dramatically from industry norms, even though it may operate in a similar manner. • Trends. If possible, the credit analyst should obtain the last three annual financial statements from key customers, and look for these danger signs that indicate where cash is being used and is therefore not available for payments: C Decrease in inventory turnover. C Increase in the collection period. C Increase in the ratio of total liabilities to equity. C Increase in the rate of working capital turnover. This is when sales increase, but the amount of working capital remains the same. Debt is usually substituted for the needed working capital, which increases fixed costs and therefore the risk to the creditor. SHORTENING THE RECEIVABLES CYCLE The cash manager is interested in getting cash payments into the company bank accounts as quickly as possible. The credit manager and the account-ing department require transaction data that permit application of the pay-ment to the proper account and invoice. Hence, cash acceleration procedures Shortening the Receivables Cycle 223 must address both of these concerns. These methods are used to accelerate collections. • Lockbox. A lockbox is a post office box opened in the name of the seller but accessed and serviced by a remittance processor. Banks and others who process the remittances usually do so in a manner and at the time of day that allows funds to be more readily available to the depositor. Lockboxes offer these advantages over processing deposits at the premises of the seller: C Faster availability of the funds. C Greater security over the remittance. C Reduced processing costs. C Greater reliability in deposit processing. C Greater reliability in capturing necessary remittance data. Image pro-cessing involves capturing the image of the check and temporarily stor-ing it in digital form. This enables the bank to immediately dispatch the check for clearing, while it uses the image to complete its work. • Wire transfer. This is a series of telegraphic messages between two banks, usually through a Federal Reserve bank, wherein the sending bank instructs the Federal Reserve bank to charge the account of the receiving bank and advises the receiving bank of the transfer. • ACH (automatic clearinghouse) transfer. This system, operating under the auspices of the National Automatic Clearing House Association, is a method for the commercial banks to exchange electronic payments without the high cost of Federal Reserve wires. In most instances the payroll initiates a payment for credit to the bank account of the payee. • Depository transfer check (DTC). Under this system, a bank prepares a DTC check on behalf of its customer against the customer’s deposi-tory account in another bank. It is a means of getting funds from depository accounts into concentration accounts more quickly. • Preauthorized draft (PAD). This is a draft drawn by the payee against the bank account of the payor. The method often is used by insurance companies or other lenders where the payment is fixed and repetitive. The payor must authorize its bank to honor the draft, which may be in either electronic or paper form. Accelerating the cash collections is one means of reducing the receivables. In fact, if sales personnel are involved in collections, an incentive based on customer payment habits might be considered. However, the amount of funds ... - tailieumienphi.vn