The profit is directly proportional to the volume of sales, provided that all your business transactions are carried out in cash. Is it possible for a manufacturer, wholesaler or retailer to conduct business without offering credit, in this competitive business environment? The answer is a resounding “no”, because the extension of credit improves your sales and, therefore, your profits. Problems arise only when a company cannot recover debt from clients within the stipulated time period.
What is the management of accounts receivable or management of debtors?
It covers two aspects. One, the type of money that is invested in the debt rotation. Second, the risk factor that includes the loss of money or the opportunity cost that the company gives up. If these funds had not been linked, the company would have received the same elsewhere and would have earned income from them. An all-cash transaction is definitely a possible option, but if it is profitable in the long term it should be subject to consideration. When customers are not offered credit, they choose concerns that expand credit facilities, and therefore, you may lose your previous customers and also expose yourself to the risk of declining sales ratios.
In credit sales, the supplier offers credit for a specified period of time, which is an investment from the supplier’s point of view and the single largest source of short-term financing from the customer’s point of view. The provider must be able to recover the amount of interest on the loan investment it has made. How?
- Debt recovery within the stipulated credit period
- Interest the client for the delay period
- Dirty volume
- Surplus capital to offset these negative impacts on fund turnover
- Adequate formulation and execution of credit policies by the financial manager.
- Discipline in the collection policy and its execution.
Many companies offer prompt payment discounts, quantity discounts, and trade discounts to customers to encourage credit sales, favoring bulk purchases. A business cannot be expected to survive long by following the cash sales policy, while similar businesses can outgrow it by adopting liberal credit policies.
The main aspects of accounts receivable management decisions are as follows:
- Credit time period
- Customer credibility
- Discounts for prompt payment
- Commercial discounts
Credit policy, on the one hand, stimulates sales and therefore also your gross profit, but on the other hand, it can be accompanied by additional costs, such as:
1) office expenses related to investigating additional accounts and maintaining the additional volume of accounts receivable,
2) increased losses due to bad debts due to the extension of credit to less creditworthy clients,
3) higher cost of capital.
Additional gains from increased sales should be combined with additional costs arising due to credit terms, to avoid funds being tied up in accounts receivable. Over time, it would deprive you of your benefits. The fundamental consideration of your credit policy would be the selection of creditworthy clients or debtors. If your funds become stiff, recovery is by no means a mundane endeavor and you must proceed legally to claim your rights. Vouchers and accounting records duly maintained will constitute a testimony in your favor in the court of law.