Last updated on October 14th, 2024 at 03:35 pm
The objective of any business is to generate profit by managing the cash flow system effectively. The entire gamut of activities which an organisation initiates from a sale process on credit is known as receivables management. The process is based on a credit policy determining the credit amount and credit days.
The process is customer-specific, and the term of this policy is a function of the credibility of the customer. After the organisation offers goods or services on credit, the transaction is tracked as per the credit policy guidance and periodical follow-ups are conducted till the due payment or receivables are paid back by the customer.
Receivables management meaning can be understood in terms of liquid assets an organisation owes to its clients against deliverables on credit. Thus, this credit process is equivalent to an investment decision in trade debtors by the organisation.
Objectives of Receivables Management
Every business needs cash and an organisation can make a profit when the cash (out) flow can be balanced periodically by receivables from clients. Though receivables management may seem to be an easy activity superficially, it becomes a difficult task given the complex nature and volume of the business. All reputed organisations engage advanced software to closely and effectively monitor the receivables management.
Some of the key objectives of receivables management are as follows -
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Helps improve cash flow
The credit policy of an organisation is designed to strike a balance between improving the top line i.e. sales or revenue and maintaining a healthy cash flow. A better control of receivables management helps the organisation with more inward cash flow. This supports the company to pay its outstanding bills timely.
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Reduces losses incurred due to bad debts
No company would like to come across a poor bottom line although have a robust top line. One of the key reasons for poor bottom line is bad debts, that pile up due to poor receivables management. Thus, a strong receivables management ensures timely collection keeping bad debts and write-offs at bay. In the process, the bottom line improves, and the organisation gets liquid cash for day-to-day activities.
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Increased customer satisfaction
When an organisation improves its bottom line through a robust receivables management system, it has an opportunity to satisfy its customers further. The company can offer special discounts upon a certain benchmark of invoicing, and this makes the customer happy. Business transparency increases mutual trust and creates a strong relationship bond.
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Increased sales volume
With a credit policy in place, sales are bound to increase. Receivables management ensures a shorter cycle of inward cash flow from the customer. With increased profit, organisations often choose to offer discounts to the customer. This is the second reason why sales are boosted.
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Optimise working capital
With the standard liquid collection in place, organisations manage regular operational expenses. However, with an accelerated receivables management system, the organisation attempts to free up the working capital and moves on to further investment, expansion or acquisition.
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Credit policy control
Receivables management is guided by a credit policy. The volume of credit to be allowed and the number of days of credit allowance to certain customers is determined by this policy. The receivables management team keeps a vigil on the credibility or the CIBIL score of the client to control both the parameters of the credit policy.
Read about the job role of a Financial Intermediary to learn more.
Dimensions of Receivable Management
Receivables management enforces a system within the organisation that tracks unpaid invoices and retrieves outstanding payments from the customer within the stipulated time frame. There are quite a few dimensions of receivables management that are instrumental to a business that offers credit to its customers.
These aspects determine the business profit after fulfilling financial obligations like paying employees, and vendors and investing in expansion opportunities. Various dimensions of receivables management are as follows -
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Credit policy
This is the robust structure upon which the receivables management system is built. The policy empowers the organisation to offer goods or services on credit to its customers. However, the volume of the credit to be offered and the number of days for which the credit lasts are all well stipulated.
A good customer pays back the billed amount to the organisation before the fixed time and thereby earns a good credit score. A well-defined credit policy reduces the probability of bad debts and ensures timely collection. It also boosts up business.
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Credit monitoring
A customer is offered a certain amount of credit based on their credentials. However, the activities of this customer should be monitored whenever the organisation offers this customer a credit. Over a period, when the organisation feels that the customer has set good precedence by making timely payments, it may feel so as to increase its credit limit.
On the other hand, the organisation may also take a call to decrease or cancel the credit facility to any customer, whose payment records show irregularity. Thus, credit monitoring is a process that prevents serious bad debts.
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Invoicing and billing
These are crucial aspects of receivables management. Organisations must follow timeliness while invoicing a customer. The invoices should contain all essential information like product or service value, taxes, and final invoice value along with due dates before which the customer must pay the amount in full.
It should also mention the rate of interest to be charged per month as a penalty if the customer fails to pay the amount on or before the due date mentioned in the invoice.
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Collection procedures
Collection procedures are continuous processes and are initiated after a reasonable period of offering credit to the customer. The process may be telephonic, through emails or letters and even in person, depending on the age of the outstanding. The process should contain the element of sensitivity such that customer complaints and legal actions may be avoided.
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Payment processing
Payment processing is an internal process of the organisation. A payment made by a customer must be allocated to the correct invoice. Correct reconciliation is a sign of a healthy accounting procedure.
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Reporting and analysis
Last but not least, proper reporting is a must. Regular information regarding billed age-wise outstanding invoices and payments received should be forwarded to the management for review and analysis.
Relationship between Sales and Cash Flow
Sales is very intimately with cash flow, which is the best index to measure the viability of the business. The understanding of this multidimensional relationship helps us to comprehend what is receivables management. The correlation of these two topics may be better realised with the following points –
- Keeping sales constant, businesses with more cash inflow create more profit than those with poor cash inflow. Thus, a healthy cash inflow is an indicator of organisational profit and sustainability.
- As per business standards, the ratio of the operating cash flow (OCF) to net sales gives a fair indication of the financial health of the organisation during any given range of time.
- The operating cash flow (OCF) is essentially the difference between the total cash received (cash inflows) from sales and the operating expenses (cash outflows) to generate such sales.
- In the case of a steady business revenue, wherein the organisation does not borrow any money from outside sources, the OCF/Net Sales ratio should be ideally smaller than one. However, it may be noted that with the expansion of business and borrowing of money from outside financial institutions, the ratio varies drastically and hence predicting a good value for it will be unreasonable.
- The standard of any organisation can be measured by studying its three financial statements – the profit and loss statement, the balance sheet and the statement of cash flows.
- The age of the business, the scale of the business and the type of industry determine the OCF/ net sales ratio.
All these critical elements in receivables management are to be mastered and delivered by professionals in this subject. Several reputed institutes in this country teach advanced financial accounting courses to prospective candidates. Aspirants should enrol themselves in one of these institutes to chase their dream career in receivables management.
Conclusion
Accounts receivable management is a vast subject and requires due diligence by hard-core professionals. There are a few simple steps to get things in the right direction. The selection of key performance indicators is a must to monitor the receivables management process.
Parameters such as Day Sales Outstanding (DSO), Average Day Delinquent (ADD), Turnover Ratio, Collection Effective Index (CEI) etc. should be set as meaningful KPIs. The bill should have all the relevant and adequate information so that no confusion is created in the customer’s mind.
The organisation must stick to the credit policy and amend it periodically as required. Setting up automated polite reminders for payments is also a good practice. And finally, the organisation must engage relevant employees across departments in this process.
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FAQs
- What is the biggest risk associated with accounts receivables?
The biggest risk factors are late payment from clients and excessively high days sales outstanding (DSOs).
- What are the 5 C’s of accounts receivables management?
The 5 C’s of credit in accounts receivables management are character, capacity, capital, collateral and conditions.
- What are the basic issues in receivables management?
Critical issues to be handled are keeping accurate records of transactions and client information, handling client disputes or conflicts of interest, adapting to alternative payment methods and dealing with late payments.
- What are the factors affecting receivables management?
The factors affecting receivables management are credit terms, credit volume, credit days and cash discount offered.
