Chapter 6
Credit Policy and Collections
Order
Placed
Order
Received
< Inventory >
Sale
Payment Sent Cash
Received
Accounts
Collection
< Receivable > < Float >
Time ==>
Accounts
< Payable >
Invoice Received
Disbursement
<
Float
>
Payment Sent
Cash Disbursed
Copyright  2005 by Thomson Learning, Inc.
Objectives
Specify advantages of NPV in evaluating credit
policy alternatives.
 Calculate the NPV of alternative credit policies and
select the best policy.
 Identify the 3 major traditional measures of
collection patterns, calculate them, and understand
their flaws.
 Calculate and interpret uncollected balance
percentages and relate to traditional measures.
 Describe present corporate credit policy practices.
 List and explain the major differences encountered
when extending credit internationally.

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Evaluate Changes in Credit Policy

Credit term change decision variables
–
–
–
–

effect on dollar profits
sales effect
receivables effect
return on investment effect
84% can estimate:
–
–
–
–
default probability
credit limits
opportunity cost of funds invested in receivables
company’s overall cost of capital
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Incremental Profit vs NPV
Financial statement approach
 NPV approach

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Changing Credit Terms, EQ 6.1
ZN =
[(1+g)SE](1-dN)PN(1-bN) / (1 + iDPN)
PV discount pmts
+ [(1+g)SE](1-PN)(1-bN) / (1 + iCPN)
PV non-discount pmts
- VCR [(1+g)SE]
PV variable cost pmts
- EXPN[(1+g)SE] / (1 + iCPN)
PV credit expense pmts
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Changing Credit Terms, EQ 6.2
ZE =
SE(1-dE)PE(1-bE) / (1 + iDPE)
PV discount pmts
+ SE(1-PE)(1-bE) / (1 + iCPE)
PV non-discount pmts
- VCR (SE)
PV variable cost pmts
- EXPE SE / (1 + iCPE)
PV credit expense pmts
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Changing Credit Terms, EQ 6.3, 6.4
EQ 6.3 Z = ZN - ZE
Decision Rule:
IF Z > 0 then Accept policy change
IF Z < 0 then Reject policy change
EQ 6.4 NPV = Z / i
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Monitoring Collections

Receivables turnover
– least favored technique

Days sales outstanding, DSO
– ranked almost as high as aging schedules

Aging schedules
– ranked as most favored technique
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Problem

All three traditional measures have a serious flaw
– All three are influenced by sales trends
– Choice of averaging period impact turnover and DSO

Increasing sales tends to:
– improve aging schedules
– worsen DSO and turnover
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Solution

Uncollected Balance Percentage
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Collection Procedures

Typical collection effort
–
–
–
–

initial contact within 10 days of delinquency
then reminder letter followed by phone call
sales force notified
last resort, reference to collection agency/legal action
Collection agency
– Phase 1 - computer generated collection letter, when accounts
are 45 to 90 days past due
– Phase 2 - commissioned collectors used
Companies tend to be more aggressive the larger
the receivables balance
 Companies understand the good-will tradeoff when
selecting collection methods

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Evaluating the Credit Department

Reducing investment in receivables
–
–
–
–
–

reduce invoice float
fine-tune credit administration and credit policy
outsourcing and automating
reduce discrepancies and deductions
improve monitoring and collections using benchmark data
Organizational integration and key account
management
– develop better understanding of needs and wants of key
accounts
– prioritize accounts by potential value
– make credit terms and policies integral part of well designed
sales and marketing offering
Copyright  2005 by Thomson Learning, Inc.
International Credit Management

Credit policy analysis
–
–
–
–

lengthening terms increases exchange rate risk
also increases default risk
harder to get D&B reports
harder to get bank credit information
Modifying monitoring and collections
– legal remedies for late payment or nonpayment differ by
country
Copyright  2005 by Thomson Learning, Inc.
Summary
This chapter developed the framework for
applying the NPV model to credit policy decisions.
 The NPV approach was applied to changes in
credit standards, the credit period, cash discounts.
 Traditional monitoring tools include aging, DSO
and receivables turnover.
 Improved monitoring measure

– uncollected balance percentage
– a reliable and unbiased measure of customer payment behavior
Collection procedures were reviewed.
 The chapter concluded with a look at
benchmarking and the impact of foreign sales.

Copyright  2005 by Thomson Learning, Inc.