Business survival and success depend on reaching the break-even point and remaining in the region where total revenues are consistently more than total costs.
Credit sales contribute a significant portion of sales revenues. Businesses use credit sales as a marketing strategy to retain existing customers and win new ones.
It’s a strategy that creates the current asset item known as Accounts receivable or debtors.
Accounts receivable management is critical to the collection of debts as they fall due.
The collection of debts when they fall due is necessary for the avoidance of the depletion or total loss of working capital.
For this to be obtained, an accounts receivable management process that guarantees the collection of debts when they fall due must be followed.
Accounts receivable management process follows the establishment of:
- A credit policy,
2. Credit terms,
3. Credit analysis and,
4. Collection policy.
What is credit policy?
A business’s credit policy spells out guidelines that regulate the granting of credit, the limits and other terms and conditions.
Certain factors have to be considered before a business formulates a credit policy.
These factors include projected sales volume and expected bad and doubtful debts to be provided for.
Also, what would debt recovery cost in terms of money, personnel and time?
The credit policy should not be too liberal to the extent that it leads to an increase in sales but lead to losses in forms of bad debts and debt recovery costs.
Another point to note is that, an effective credit policy should state credit terms clearly.
The repayment terms which cover credit period, discount percentages and allowed discounts periods should be stated clearly.
The discount period should encourage the consideration of cash purchases and discourage credit purchases.
Another fundamental part of accounts receivable management process is credit analysis.
It is important to assess a customer’s ability and willingness to meet their current maturing liabilities when they fall due.
Before you decide to allow a customer make a credit purchase, find out what the customer’s credit rating is.
Does the customer have a history of being a willful defaulter? The answer to this question is fundamental to understanding the willingness of the customer to meet current liabilities when they fall doe.
What about the financial strength of the customer? The financial strength helps to determine and set a customer’s credit line.
The credit line defines the limits to permitted credit purchase.
In carrying out the credit analysis of a customer, the following are worth considering:
1.Character of the customer,
2. Capacity of the customer to borrow,
3. Conditions under which the customer can make credit purchases,
4. Capital and,
5. Collateral security.
A reliable credit appraisal of a customer requires reliable and sufficient information.
Credit reports, bank reference letters, financial statements and suppliers are places to search for relevant information.
At this point, it should mentioned that an effective accounts receivable management process is incomplete without the formulation of collection policy.
You may regard this as the most important because the liquidity of a business significantly depends on the effectiveness of its debt recovery drive.