Accounts Receivable Example

Accounts receivable represent enforceable rights arising from sales, services rendered, loan grants or any other similar concept. Likewise, documents receivable from clients that represent enforceable rights, which have been documented with bills of exchange or promissory notes, are included. They represent applications of company resources that will be transformed into cash to end the financial cycle in the short term.

Importance

Accounts receivable are one of the most important concepts of current assets. The importance is directly related to the line of business and the competition.
Accounts receivable represent a very important investment for the company. One of the measures to know the investment that is had in accounts receivable is the relationship of the investment to working capital and current assets, and are obtained through tests of liquidity.

Information needs of accounts receivable

Good administration requires up-to-date information on customer and debtor balances. Therefore, the administrator has a great challenge to control that the operations are captured and recorded truthfully and correctly.

Accounts that are current do not require administration, those that have a problem due to non-payment, excess debt over the approved credit limit, returns of the mail of statements of account by wrong addresses or change of address of the client, Checks returned by banks for payments made by customers, etc., must be dealt with immediately to preserve a healthy purse. When the administration has information that allows it to make firm and agile decisions, it gains confidence capable of driving the customer to increase their consumption.

The level of investment in accounts receivable

Depending on the line of business and the competition, credit is granted to customers, which represents the time that elapses between the date of the sale and the date on which the amount of the sale.

Therefore, sales on credit are transformed into accounts receivable, generally representing a significant investment in current assets in the company. The investment is determined by the volume of credit sales and by the average number of days that elapse between the dates of sale and collection.
The average of collections is obtained based on the result of the accounts receivable to sales ratio multiplied by the days of the year to obtain the credit days. Either way, portfolio days can be related to the terms that the company offers and in this way qualify the investment in accounts receivable. The average number of days that elapse between the sale and collection dates depend on economic conditions and controllable factors known as credit policy variables.

Credit policies

They should aim to maximize return on investment. To evaluate the credit, the administrators must consider the moral solvency of the borrower, the capacity financial payment, the specific guarantees and the general conditions of the economy or the market in which Opera.
There are credit information agencies and an alternative source of information is credit card centers.
The accounts receivable management has to set policies, such as: reduce to the maximum the investment of accounts receivable in portfolio days, manage credit, evaluate credit objectively, keep the investment in accounts receivable current and monitor the exposure of accounts receivable to inflation and devaluation of the currency.
The variables of the credit policies are the credit conditions, the period of the credit, the discounts for early payment and the collection policies.

Credit conditions

They specify the period of the credit, the normal discounts, for cash payment or advance payment. The responsibility for setting these conditions rests with the financial department, in coordination with the sales department. On the other hand, the one in charge of managing the policies is the credit and collections department of the same finance department.

The credit period

The granting of more days of credit stimulates sales, but has a financial cost by immobilizing the investment in accounts receivable, increasing the days of portfolio and reducing turnover.
It is necessary to know what flexibility sales have, because reducing the credit period generally affects the volume and as a consequence a reduction in marginal profits and a lack of absorption of fixed costs and semivariables.
One of the strategies to capture the market and increase sales is to expand credit conditions when there are similar conditions in the quality, service and price of the products.

Prepayment discounts

Generally, companies have the goal of capturing the market and having a greater participation, this leads to granting a credit similar to that of the competition. One strategy is to give the customer a discount when he pays his bills in advance. The discount must be based on the cost of money in the market. In the event that the company has loans with interest, customers can be granted discounts greater than those of the market, but less than what the company is paying to third parties to be able to generate an additional cash flow to the normal operation and to settle in advance the contracted liabilities that are generating interest rates superiors.
Discounts for down payment in cash have a direct benefit in financing accounts receivable, which is offset by the reduction in income. These discounts have an effect on sales promotion, increasing the volume and generally improving the profitability of the company.

Establishment of a credit policy

Firstly, it is necessary to investigate what are the credit policies of the company's line of business in the participating market. Therefore you must have a deep knowledge of the market so that the judgment of the leaders has the desired effect.
Credit policies are appropriate according to the time and economic conditions that the company lives. These are not forever but must be adapted in a dynamic and changing way to maximize the company's return on investment.

Collection policies

They refer to the way the collection should be managed when the client does not pay his debt in terms of the credit granted. This policy is highly variable and is conditioned on the market and line of business in which it operates.
The collection process can be costly, but firmness is required so as not to prolong collection management and to minimize losses from bad debts. This firmness generally means that clients fulfill their commitments with more opportunity.
The costs of non-performing loans are high, and they also immobilize resources that have an opportunity cost and that could be generating benefits in another part of the company's financial structure.
Constant monitoring of accounts receivable is an effective measure to keep accounts current.
In highly competitive markets when supply is greater than demand, a past due portfolio can easily be reached which can lead the company to considerable losses.

Surveillance of the balances pending collection

The credit department is in charge of monitoring and supervising customer accounts so that invoices are presented in your opportunity for collection, and is to manage based on credit policies the collection of customer accounts that are overdue.
Collection management is carried out through a report known as balance aging analysis in which all accounts receivable appear. This contains name and customer number, account balance, sum of all invoices that are within the credit terms, amount due from 1 to 120 days. These lists have a horizontal presentation and at the end you have the totals for each column and you can know with precision the status of the clients' portfolio.
A necessary and very important practice is to communicate the status of their account to customers on a monthly basis for the purposes of information and so that they reconcile their amount with their accounting and keep a portfolio up to date with timely information and truthful.

Financing with accounts receivable

They can be obtained by selling accounts receivable. It is an important source to generate cash flow in financing the company. The sale operation is called factoring, which represents a place or office where the factor resides and does commercial business. The company sells and assigns its accounts receivable to the buyer who assumes the credit risk, as well as the collection procedures.
A rights assignment contract is established by means of which the assignor transmits the rights it has from its debtor to a third party that is a financial institution. In this way, the client continues with the obligation to pay but not to the company but to the entity. The factor charges an interest and a commission taking into account the commercial prestige and the solvency of the client who must pay the invoices, the amount and the term of the credit. Accounts receivable can be documented with bills of exchange or promissory notes, and credit institutions carry out discount operations in this case.

Control of accounts and documents receivable

The administrator must implement all those operational control measures that safeguard the assets and equity of the partners or shareholders, thus maintaining the functionality and integrity of the business. They also establish the verification and accuracy of the data and operations carried out, as well as the development and promotion of efficiency and rules that must be followed in the administration of the business.

Effects of inflation and devaluation on accounts receivable

Accounts receivable are monetary assets because they represent a certain number of monetary units receivable, so they are susceptible to modifying their amount and therefore cannot be corrected since their amount always remains determined by the number of units that represent.
In times of high inflation that can be considered more than one digit, the loss that occurs in accounts receivable when they lose their purchasing power because they are monetary assets must be recognized.
In the event of a devaluation of the currency that represents the official recognition of inflation in relation to a foreign currency, it changes the amount receivable in pesos from accounts receivable in foreign currency and the profit generated by the new exchange rate must be recognized.
Good management in times of inflation and devaluation should measure the company's exposure on an ongoing basis to minimize its effects.

Bibliography
MORENO Hernández Joaquín A., et. to the. , The Financial Management of Working Capital, Mexico: 1997, Ed. I.M.C.P.