Service Management System
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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS
DETERMINANTS OF ACCOUNTS RECEIVABLE
AND ACCOUNTS PAYABLE: A CASE OF
PAKISTAN TEXTILE SECTOR
MUBASHIR ALI KHAN
(Corresponding Author)
MS Scholar
Sukkur Institute of Business Administration
Airport Road Sukkur, Sindh, Pakistan
GHULAM ABBAS TRAGAR
MS Scholar
Sukkur Institute of Business Administration
Airport Road Sukkur, Sindh, Pakistan
NIAZ AHMED BHUTTO
Associate Professor
Sukkur Institute of Business Administration
Airport Road Sukkur, Sindh, Pakistan
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Abstract
The objective of this study is to analyze the determinants of Pakistani listed
companies’ accounts receivable and accounts payable focusing the textile
sector. It is evident from the findings that accounts receivable are strongly
affected by the firm’s incentive to use trade credit as a means of price
discrimination and level of internal financing. Additionally, the size of the firm
also affects the level of accounts receivable a firm maintains. Whereas, most
significant determinants of accounts payable are size of the firm, level of
purchases and market interest rate.
Keywords: Trade Credit, Price Discrimination, Accounts Payable, Textile Sector
•
INTRODUCTION
In corporate finance trade credit has been supposed to be a nonissue for a long
time, at least in the context of
perfect markets (Sartoris and Hill, 1988). Nevertheless, it is observed that a
significant quantity of cash is
invested in accounts receivable and an enormous amount of accounts payable, as a
source of financing in nearly
all non-financial firms (Deloof and Jegers, 1999). Significance of trade credit differs
among the countries and it
is expected to be higher in the countries which produce more manufacturing
products, although there is
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substantial difference across them (Marotta, 1998). Rajan and Zingales (1995)
compared non-financial
companies in the G7 countries and found that relative part of accounts receivable
differs between 29% Italy and
13% Canada, on the other hand, the respective limits for accounts payable were
17% France and 11.5%
Germany. Mian and Smith (1992) reported that in 1986 US manufacturing firms had
21 percent of accounts
receivable of their total assets and about 40% of account payable of their total
liabilities. Deloof and Jegers,
(1999) reported that in 1995 Belgian non-financial firms’ accounts receivable were
16% of total assets, and
accounts payable 12% of total liabilities. Several studies have been conducted
to simply analyze the existence of trade credit (see a.o. Schwartz, 1974; Feriss,
1981; Frank and Maksimovic, 1998; Long, Malitz and Ravid, 1993; Brennan,
Maksimovic and Zechner, 1988; Brick and Fung, 1984; and Emery, 1984 and
1987), but very few studies have discussed the reason behind the trade credit
is offered or which corporations use it or delivers it most (Petersen and Rajan,
1997). Storey (1994) analyzed earlier work on the financing patterns of UK
small companies and found that for small firms trade credit is more valuable
than for large firms. Whereas Walker (1991) investigated the US small firms
and found that US small firms are also relying on trade and bank credit and
these two financing sources are being used as substitutes.
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Furthermore, it is always argued that borrowing at rational rates is an issue for
corporate decision makers. Berger and Udell (1998) suggested that when
borrowing outside the firm, small firms face particular restrictions. Borrowing a
small amount of capital from external capital markets becomes their obstacle,
which is usually called as Macmillan gap, and for this reason they are being
offered higher interest rates (Storey, 1994). While market imperfections, just as,
agency costs and asymmetric information, are the reasons of these issues as
proposed by several economic theorists. Even risky debt has a preference
when information asymmetries are not favorable. Mayers (1984) pointed out
this situation as ‘pecking order’ theory of financing in which a firm first raises
capital internally by reinvesting its net income and selling off its short-term
marketable securities. When that supply of funds is exhausted, the firm will
issue debt and perhaps preferred stock. Only as a last resort will the firm issue
common stock. Whereas, it has also been reported by several studies that
close bank-borrower association improves credit accessibility (Niskanen and
Niskanen, 2006). Other studies propose that the availability of credit is affected
positively by bank-borrower relationship (Petersen and Rajan, 1994).
•
LITERATURE REVIEW
Danielson and Scott (2004) investigated the effect of bank loan availability on
the trade credit and credit card demand of small firms and found that firms
increase their demand for trade credit and credit card debt when facing credit
constraints are imposed by banks. Deloof and Jegers (1999) investigated the
role of trade credit as source of financing for Belgian firms focusing accounts
payable and found that trade credit plays a significant role in the corporate
financing policy. They found that the amount of trade credit a customer takes is
determined by the need for funds and by the internally available funds. Finally
they found that trade credit can act as a vital substitute for short term as well as
long term financial debt. Atanasova (2007) tested for the existence of credit
constraints and their effect on the corporate financing policies and found that
credit constrained firms substitute trade credit to institutional finance especially
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during tight money periods. Huyghebaert (2006) tested hypothesis that why
firms use trade credit on business start-ups and find that more trade credit is
used when firms face financial constraints and suppliers have a financing
advantage over banks in financing high risk firms. Niskanen and Niskanen
(2006) analyzed credit policies of Finnish small firms functioning in bank
dominated environment. Creditworthiness and access to capital markets were
found as important determinants of trade credit extended by the sellers. Firm’s
age, size and level of internal financing were found to be negatively correlated
to the trade credit usage, whereas level of current assets to total assets and
loan availability were found negatively correlated with the trade credit usage. In
addition to it, the level of purchases was found positively correlated with level of
accounts payable. Niskanen and Niskanen (2000b) analyzed the accounts
receivable and accounts payable of Finnish listed firms and found that accounts
receivable are most likely to be influenced by the firms’ incentive to use trade
credit as a means of price discrimination. Through increased demand for the
trade credit level of accounts receivable increases with the increase in the
interest rate level. Additionally, they found that the level of accounts payable is
affected by the firm size, supply of trade credit, interest rate level, the ratio of
current assets to the total assets, and insufficient internal financing. Blasio
(2005) tested the Meltzer (1960) trade credit – bank credit substitution
hypothesis on Italian manufacturing firms’ inventory behavior and found that
during money tightening Italian manufacturing firms are more constrained than
normal macroeconomic conditions.
•
THEORIES AND EMPIRICAL EVIDENCES ON TRADE CREDIT
Various theoretical studies have tried to investigate the reason of providing
intermediary services by suppliers to their customers and to find out the
rationale to use trade credit as a substitute of less costly bank debt.
3.1. Transaction Costs
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Transaction Costs have been declared to be one rationale to sustain credit
sales. Transaction costs theory describes that paying at once for several
shipments collectively saves transaction costs and permits flexibility in
payments (Ferris, 1981).Furthermore, money can be saved by keeping smaller
cash balances.
3.2. Financial Models
Financial models are based on capital market imperfections concerning
information asymmetries. These imperfections lead to the phenomena in which
firms, with lower cost of financing due to their better access to capital markets,
tender trade credit to other financially constrained firms (Schwartz, 1974).
Furthermore, trade credit facilitates firms to support the growth of their clients. It
is also believed that trade credit can serve to alleviate credit rationing problems
as trade credit plays as a signal on the buyers’ good quality to the financially
intermediary (Frank and Maksimovic, 1998; Biais and Gollier, 1997).
Financial theory proposes that the seller has a lead over financial institutions in
information gaining and controlling the consumer. In European countries, all
these gains speak about the nearer and greater relationship between buyer and
seller than between the financial institutions and buyers. That is supplier have a
threatening tool to stop future supplies when consumer does not pay in time.
On the other hand a financial institution may not have a device like this to have
power over consumers, while warning to depart future lending may not have
instant consequence on the consumers’ attitude (Petersen and rajan, 1997).
3.3. Price Discrimination
Price discrimination is a possibility of charging dissimilar prices for dissimilar
consumers. This can happen in a situation when credit conditions include
discounts on paying before time. These conditions are mostly presented by
leading firms in the industry (Brennan et al., 1988; Mian and Smith, 1992).
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These firms have an advantage to collect extra sales to existing clients without
decreasing price. As a result these firms extend high priced trade credit which
is not acceptable for creditworthy customers. While for low rating companies
this credit may be acceptable as it might be less costly than borrowing from
financial intermediary (Brennan et al., 1988; Petersen and Rajan, 1997).
Additionally, trade credit offers a facility to gauge the quality of products earlier
than paying for it so this becomes an inherent guarantee for the seller’s
manufactured goods (Lee and Stowe, 1993). For small and less reputable
sellers this facility of trade credit may have a great importance (Frank and
Maksimovic, 1998).
3.4. Macroeconomic Conditions
Macroeconomic conditions have also an effect on trade credit usage and
conditions which cannot be ignored and has been highlighted by many
researches. Kashyap et al., (1993) investigated the effect of macroeconomic
factors on trade credit and found that under restrictive monetary policy and
controlled money supply smaller firms are ready to extend trade credit on the
given conditions as increasing borrowing rates create trade credit a
supplementary viable type of short term funding. Petersen and Rajan (1997)
highlighted the same issue and found that firms extend trade credit when loan
from financial intermediaries is not present. They further added that, in this
scenario, the role of financial intermediary will be performed by larger suppliers
as firms having no access to institutionalized financial markets will borrow from
these larger firms.
•
DATA DESCRIPTION AND DEPENDANT VARIABLES
The data sample of this study comprises of financial accounting information of
the firms listed at Karachi Stock Exchange during 2004 to 2009.This accounting
data is extracted from the Balance Sheet Analysis published by the State Bank
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of Pakistan. After excluding missing firm year data from analysis 891
observations were analyzed from 151 firms.
•
RESULTS
5.1. DETERMINANTS OF ACCOUNTS RECEIVABLE
Carrying receivables has both direct and indirect costs but it also has an
important benefit that is increased sales. Receivable management begins with
the credit policy, but a monitoring system is also important. Corrective action is
often needed, and the only way to know whether the situation is getting out of
hand is with a good receivables control system.
•
Demand for Trade Credit
A firms’ decision on how much to lend to its customers is determined from the
level of firms’ accounts receivables. Still the quantity of trade credit, a firm
offers, is influenced by a demand component (Petersen and Rajan, 1997). This
demand on the whole is not possible to compute directly as approaches of
nearly all firms’ consumers to trade credit varies. This is due to the reason that,
just for example, a retail company can contain thousands of credit consumers
which can be either persons or other firms. Whereas, the accounts payable of a
particular company, can be similar in greater part as they are payable to the
other companies which are comparatively little in number in any particular
industry. As the demand curve for trade credit is not identified, interpretation of
estimated coefficients can help in understanding this problem.
Petersen and Rajan (1997) found that large firms maintain higher accounts
receivables. One reason for this result can be, the greater access of larger firms
to capital markets which makes them less capital reserved. Second reason can
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be the demand component from capital rationed firms that causes the accounts
receivable of larger firms higher than average.
•
Creditworthiness and Access to Capital Markets
Firm size and age are used to compute the firm’s creditworthiness and access
to capital markets. The natural log of firm age (Ln(1+ firm age)) is used as
proxy for creditworthiness and natural log of total assets (Ln(book value of
assets)) is taken to proxy the suppliers’ access to external capital. The results
in the Table 1 show that size is significant variable with (p = 0.000102129).
These results are consistent with earlier studies like Petersen and
Rajan’s(1997).
•
Internal Financing
The study uses operating cash flow (earnings before depreciation and interest
minus taxes) divided y assets to gauge the firm’s capability to produce cash
from internal sources to fund the trade credit which it extends to its customers.
The results indiate that internal financing effects positively to the level of
accounts receivables. The variable is positive and significant at (p=
0.00000000) which indicates that the larger the positive cash flow the supplier
has, the higher the trade credit he is ready to offer to its customers. The results
are consistent with findings of Niskanen and Niskanen (2000) and are
contradictory to the findings of Petersen and Rajan (1997).
AR = β0 + β1CF + β2CM + β3GR + β4KIB + β5SIZE
Model I:
Table 1: Dependant Variable:
Accounts Receivable/Assets
β0
β1
Accounts Payable and Receivable
β2
β3
β4
β5
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Coefficient 42.702
1.457* -698.612* 0.0533
0.634
15.291*
S.E
26.690
0.110 123.976
0.179
1.197
3.892
P-Value
(0.110) (0.000) (0.000)
(0.766)
R-Square
(0.596) (0.000)
0.384
F-Value 45.596*
R2
0.376
(0.000)
DW
1.037
Adjusted-
*Significant at
α = 0. 01 **
Significant at
α = 0. 05
•
Price Discrimination
Price discrimination is an act of billing the same product to different clients with
different prices, even when the costs of supplying them are same. This practice
is mostly observed by monopolists as they exploit their leading power for
discrimination. This study uses ratio of contribution margin (sales minus
variable costs) to assets to proxy for monopoly power to carry out price
discrimination. In our sample of all textile firms existing on Karachi Stock
Exchange, it is found that a significant but a negative relationship exist between
price discrimination and accounts receivable management policies which is
validated by a p value of (p= 0.00000004). These results are contradictory to
the findings of Niskanen & Niskanen (2000).
•
Cost Of Alternative Capital
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The study uses annual average three month KIBOR rate to compute the basic
cost of capital. A positive relationship is expected between accounts receivable
level and level of interest rate. The reason behind this can be the demand for
trade credit which can be expected to be high when the cost of alternative
capital is increased. An insignificant coefficient is found in the results Table 1
with value of (p= 0.59654834).
•
Growth
Normally firm’s target growth rates are attached with its trade credit policies.
Generally, credit conditions just as discounts and duration of payments play a
role of competitive instruments. In order to increase sales, firm may select a
policy of offering trade credit with delayed due periods than its competitors are
offering. This proposes that there is a positive relationship between growth and
the level of accounts receivable. Though, trade credit may be used to boost
sales of those firms which could not maintain a smooth rise in their sales. Even
in conditions of declining sales a firm may offer more trade credit than an
average company in the industry (Petersen and Rajan, 1997).This study
computes growth by the annual sales growth percentage. Empirically, it is found
that sales growth is insignificant (p= 0.766271766) which can be interpreted as
the sales growth does not affect the level of trade credit offered.
5.2. DETERMINANTS OF ACCOUNTS PAYABLE (TRADE CREDIT)
Firms generally make purchases from other firms on credit, recording the debt as
an account payable. Accounts payable, or trade credit, is the largest single
category of operating current liabilities, representing about 40% of the current
liabilities of the average US nonfinancial corporations. The percentage is
somewhat larger for smaller firms. Because small companies often do not qualify
for financing from other sources, they rely especially heavily on trade credit. Table
2 presents the outcome of proposed determinants on which the accounts payable
is regressed. This model uses the same variables (including the control variables)
used for accounts receivable model. Besides these variables, two more variables
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are added in this model. First, to determine the asset maturity RATIO OF
CURRENT ASSETS (INVENTORIES AND FINANCIAL ASSETS) TO TOTAL
ASSETS is used. Second, to assess the supply of trade credit PURCHASES TO
TOTAL ASSETS is used.
•
Supply of Trade Credit
Niskanen and Niskanen (2000) use the annual purchases as a proxy for the
supply of trade credit making an assumption that all purchases are on credit.
They believe that this assumption is not very restrictive, as large companies
normally do not pay their purchases in cash. This study also uses the
purchases as proxy to supply of trade credit and considers the same
assumption. The result relating the supply of trade credit is same as expected:
a significant and positive coefficient is obtained (p= 0.0005) which indicates that
an increase in the supply of trade credit increases the level of its use.
•
Creditworthiness and Access to Capital Markets
Result concerning asset size is quite significant in explaining the accounts
payable level. The coefficient is positive and significance level is also quite high
(p= 0.0000). This positive sign shows that financing of larger firms is comprised
of more trade credit than smaller firms. This may be due to their greater access
to capital markets. This finding is consistent with Niskanen and Niskanen
(2000) where as Petersen and Rajan (1997) found a weak positive relationship
between the firm size and accounts payable.
AP = β0 + β1GR + β2CA + β3SIZE + β4KIB +
Model No
β5CF + β6PUR
II:
Table 2: Dependant Variable:
Accounts Payable
β0
β1
Accounts Payable and Receivable
β2
β3
β4
β5
β6
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-
-
Coefficien 1273.16 0.84828 2.22140 225.909 9.69028
t
1
6 9
89.4942 0.26570
S.E
1
P-Value
5 0.592596
2 8
0.10307
0.426306
14.8522 2.51317
1 1
7
0.02944
0.156219
1
(0.0000) (0.0015) (0.0002) (0.0000) (0.0001) (0.0066) (0.0005)
0.64379
R-Square
0
Adjusted-
0.63970
(0.000
4
)
R2
F-Value 157.5394*
0.83927
DW
6
*Significant at
α = 0. 01 **
Significant at
α = 0. 05
•
Growth
Theory suggests that healthier investment opportunities are available to the
firms which are growing and these firms require increased financing for these
new investment opportunities. It is assumed that trade credit may be used as
fractional source of financing for these growing firms. However, opposite is
found from empirical results. Sales growth is found to have a negative but
significant coefficient (p= 0. 0015) which implies that faster a firm is growing the
less it uses trade credit in its financing. Hence, firms growing slowly or not
growing at all utilize the trade credit most. Furthermore, these results are
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consistent with Niskanen and Niskanen (2000) and contradictory to the findings
of Rajan and Zingales (1997).
•
Internal Financing
The results reveal that operating cash flow is a significant variable in explaining
the accounts payable level with p-value of (p= 0066).
•
Asset Maturity
In explaining the level of accounts payable the asset maturity, measured by the
ratio of current assets to the total assets, is found to have a greater proportion
with a significant positive variable (p= 0002). This finding is consistent with the
view that firm’s assets are financed with funds having same maturities. This is
carried out to plan repayments of the funding to match with the decline in the
value of firm’s assets (Diamond, 1991). As a result, short-term assets are
usually financed with short-term debt just as accounts payable, while long-term
assets are financed with long-term debt or equity.
•
Cost of Alternative Capital
Market interest rate, measured as average 3 month KIBOR rate, is appeared to
be quite significant explanatory variable in explaining accounts payable (p=
0001). Positive coefficient of market interest rate shows that higher the interest
rates the higher the demand for trade credit will be. As it is vivid from the results
that market interest rate is not significant in accounts receivable model, this
may support the idea that demand side is more affected by the fluctuations in
the market interest rate.
•
CONCLUSION
This study empirically analyzed the determinants of Pakistani listed firms
accounts receivable and accounts payable management policies. The results
show that accounts receivable are strongly affected by the firms’ incentive to
use trade credit as a means of price discrimination and level of internal
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financing. Furthermore, size of the firm also affects the level of accounts
receivable a firm maintains. The results of the accounts payable model show
that all the variables, which were taken to determine the level of accounts
payable, were statistically significant. Additionally, most significant determinants
of accounts payable were size of the firm, level of purchases and market
interest rate. Dissimilarity in the results of this study to earlier studies may
greatly be due to the variation among Pakistani, U.S., UK and Finnish capital
markets. As it is evident, that ban-borrower relationship, when analyzed as
financial intermediaries, is supposed to be a substitute source of capital for
trade credit. This relationship can be studied as further research line in this
area. But the unavailability of data on this relationship makes it bit a difficult
task as statistics regarding relationship between banks and firms are not
publicly available.
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Author: Mubashir Ali Khan
Title: Determinants of Accounts Receivable and Accounts Payable: A Case of
Pakistan Textile Sector
URL: www.journal-archieves14.webs.com/240-251.pdf
Date Published: January 2012
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9TH INTERNATIONAL ASECU CONFERENCE ON
“SYSTEMIC ECONOMIC CRISIS: CURRENT ISSUES AND PERSPECTIVES”
Ksenija Denčić-Mihajlov
University of Niš, Faculty of Economic, Serbia
IMPACT OF ACCOUNTS RECEIVABLE MANAGEMENT ON THE
PROFITABILITY DURING THE FINANCIAL CRISIS: EVIDENCE FROM SERBIA
UDC:658.155(497.11)
Abstract:
The competitive nature of the business environment requires firms to adjust their
strategies and apply financial policies to survive and enable growth. In most firms,
receivables represent large financial sources invested in asset and involve significant
volume of transactions and decisions. This paper investigates how public companies
listed at the regulated market in the Republic of Serbia manage their accounts
receivables during the recession times. A sample of 108 firms is used, which are the
most successful Serbian firms listed at the Prime and Standard Listing as well as the
Multilateral Trading Platform of the Belgrade Stock Exchange. The accounts receivables
policies are examined in the crisis period of 2008-2011. In order to explore the relation
between accounts receivables and firm’s profitability, the short-term effects are tested.
The study shows that between accounts receivables and two dependent variables on
profitability, return on total asset and operating profit margin, there is a positive but no
significant relation. This suggests that the impact of receivables on firm’s profitability is
changing in times of a crisis.
Key words: accounts receivable, profitability, management, financial crisis, Belgrade
Stock Exchange.
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1. Introduction
Accounts receivable measures the unpaid claims a firm has over its customers at a
given time, usually comes in the form of operating line of credit and is mainly due within
a relatively short time period (up to one year). The volume of accounts receivable
indicates firm's supply of trade credit while accounts payable shows its demand of trade
credit. The study of accounts receivable and accounts payable during periods of
financial crisis is an important topic, particularly when the global economy is going
through a credit shock. During global financial crisis, characterized by high liquidity risk
faced by the banks, trade credits may increase, operating as a substitute for bank
credits, or decrease - acting as their complement. Bastos and Pindado (2012), for
example, suggest that credit constraints during a financial crisis cause firms holding
high levels of accounts receivable to postpone payments to suppliers, which act in the
same manner with their suppliers. This gives rise to a trade credit contagion in the
supply chain characterized by a cascading effect. The current financial crisis provides
economists a unique opportunity to study the role of alternative financial sources during
periods of breakdown of institutional financing.
Accounts receivables are one of the most important part of working capital. Receivables
often represent large investment in asset and involve significant volume of transactions
and decisions. However, there are considerable differences in the level of receivables in
firms around the world. Demirgüç-Kunt and Maksimovic (2001)present evidence that in
countries such as France, Germany, and Italy accounts receivable exceeds a quarter of
firms' total assets, while Rajan and Zingales (1995) find that 18% of the total assets of
US firms consists of receivables. In different theories, the existence of receivables is
explained by commercial reasons, transaction-cost motivations, and financial incentives
(Bastos & Pindado, 2007; Deloof & Jegers, 1999; Marotta, 2005; Petersen & Rajan,
1997).Accounts receivable management is a crucial filed of corporate finance because
of its effects on a firm’s profitability and risk, and consequently on the firm's value. Yet,
the main body of the literature of accounts receivables focuses on studying the relation
with firm’s profitability at the developed capital markets and during the non-crisis period.
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Understanding the effects of a financial crisis on receivables management is especially
important to Serbia as a transition country. Trade credit is an important source of
finance for Serbian firms and, therefore, it can make a strong contribution to firms'
profitability and the development of the whole economy. In this context, the aim of this
paper is to examine the impact of accounts receivable management on the profitability
of the Serbian companies during the financial crisis, in the period 2008-2011. The study
investigates whether companies have to change their non-crisis accounts receivables
management policies when the economy is into a recession. In order to test the relation
between accounts receivables and a firm’s profitability, the short-term effects will be
tested in times of a crisis.
The contribution of the paper is twofold. Firstly, it extends the existing empirical
literature on relationship between firm's profitability and accounts receivables in
developing and transitional economies in the crisis period, by focusing the analysis on
the Serbian listed firms where, up to now, no research has been conducted. Secondly,
this study verifies some of the previous findings by testing the relationship between
accounts receivables management and the profitability of the sample firms, and thus
broadens the possibilities for cross-country comparisons in the field of profitability
determinants.
The structure of this paper is as follows. In Section 1,a summary of previous research
on the effects of accounts receivable management on firm's profitability is given. In the
next section we describe the sample, define the measures of profitability as well as the
explanatory variables, and finally, test the potential determinants of on profitability. In
Section 3we provide conclusions, emphasise some limitations of the study and propose
the objectives of future research.
2. Literature review
The goal of accounts receivables management is to maximize shareholders wealth.
Receivables are large investments in firm's asset, which are, like capital budgeting
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projects, measured in terms of their net present values (Emery et al., 2004).
Receivables stimulates sales because it allows customers to assess product quality
before paying, but on the other hand, debtors involve funds, which have an opportunity
cost. The three characteristics of receivables – the element of risk, economic value and
futurity explain the basis and the need for efficient management of receivables.
According to Berry and Jarvis (2006) a firm setting up a policy for determining the
optimal amount of account receivables have to take in account the following:
The trade-off between the securing of sales and profits and the amount of
opportunity cost and administrative costs of the increasing account
receivables.
The level of risk the firm is prepared to take when extending credit to a
customer, because this customer could default when payment is due.
The investment in debt collection management.
Academicians have studied accounts receivable individually, but mostly as a part of
working capital management, from various points of view. Bougheas et al. (2009), for
example, focuses the research on the response of accounts receivable to changes in
the cost of inventories, profitability, risk and liquidity. The other authors explore the
impact of an optimal receivables management, i.e. the optimal way of managing
accounts receivables that leads to profit maximization. Researches realized by Deloof
(2003), Laziridis and Tryfonidis (2006), Gill et al (2010), Garcia-Teruel and MartinezSolano (2007), Samiloglu and Demirgunes (2008) andMathuva (2010) done in Belgium,
Greece, USA, Spain, Turkey, and Kenyarespectively, all point out to a negative relation
between accounts receivables and firm profitability (Table 1). In other words, having an
accounts receivable policy which leads to a low as possible accounts receivables has
as a result the highest profitability. Contradicting evidence is found by Sharma and
Kumar (2011), who find a positive relation between ROA and accounts receivables.
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Table 1 Summary of previous research on the effects of receivables turnover
on firm’s profitability
Research
Deloof (2003)
Sample, period
Type of relation
1009 large Belgian non-financial firms for the
Significant negative
1992-1996 period
relation on
profitability
Lazaridis and
131 companies listed in the Athens Stock
Significant negative
Tryfonidis (2006)
Exchange (ASE) for the period of 2001-2004
relation on
profitability
Gill et al (2010)
88 American firms listed on New York Stock
Significant negative
Exchange for the period 2005 - 2007
relation on
profitability
García-Teruel and
8,872 Spanish SMEs for the period 1996-2002
Significant negative
Martínez-
relation on
Solano(2007)
profitability
Samiloglu and
Istanbul Stock Exchange (ISE) listed
Significant negative
Demirgunes (2008)
manufacturing firms for the period of 1998-2007
relation on
profitability
Mathuva (2010)
30 firms listed on the Nairobi Stock Exchange
Significant negative
(NSE) for the periods 1993 to 2008
relation on
263 non-financial BSE 500 firms listed at the
Significant positive
Bombay Stock (BSE) from 2000 to 2008
relation on
profitability
Sharma and Kumar
(2011)
profitability
Baveld (2012)
37 large firms in The Netherlands, during the
Significant negative
non-crisis period of 2004-2006 and during the
relation on
Financial Crisis of 2008 and 2009
profitability
However, the main body of the literature of accounts receivables focuses on studying in the environment of
developed capital markets and during the non-crisis period. The consequences of a
financial crisis on receivables is of enormous relevance, since a crisis causes trade
credit contagion as a consequence of financial contagion between financial
intermediaries (Bastos and Pindado, 2012). Researches on trade credit during
financial crises are done in case on Japan's crisis (Fukuda et al., 2006), for the Asian
crisis (Love et al 2007) and for the recent global financial crisis (Yang, 2001, Bastos
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and Pindado, 2012). As to researches that study relationship between profitability
and accounts receivables during current global crisis period, it is worth mentioning
the study done by Baveld (2012). It this study that investigates how public listed firms
in The Netherlands manage their working capital, two periods are compared - the
non-crisis period of 2004-2006 and the financial crisis period of 2008 - 2009.
Baveld's study indicate a statistically significant negative relation between accounts
receivables and gross operating profit during non-crisis period. On the other hand,
during crisis period, no significant relation between these two variables is observed.
This result may suggest that the relation between accounts receivables and firm’s
profitability is changed in times of a crisis in the way that some firms should not keep
their accounts receivables at minimum in order to maximize profitability during crisis
periods.
Taking into consideration the results of study done by Baveld (2012) and the others
above mention studies, the aim of this research is to examine the impact of accounts
receivable management on the profitability of the Serbian companies during the
financial crisis, in the period 2008-2011.
3. Empirical Analysis
3.1 Sample and Data Description
We tested the regression model of profitability on the sample consisting of real-sector
publicly traded companies whose shares are quoted on the regulated market of the
Belgrade Stock Exchange. We compiled the basis of financial statements (source:
Serbian Business Registers Agency - SBRA) for those publicly-listed companies that
were quoted in all the segments of regulated stock exchange market, that met the size
criterion in all analyzed years (meaning big or medium enterprises) and operated in real
sector (financial firms are excluded from the sample). In such an initial stadium of
defining the sample, we had 432 firms in total. After the Decision on Stock Exchange
Reorganization, brought on 27/04/2012, we excluded from the sample all the companies
shifted from OTC market to be quoted in MTP (Multilateral Trading Platform) segment,
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since they did not belong to Regulated market and were not active in the previous 180
days regarding share trading of the particular issuer. We also excluded companies with
consolidated financial statements in any of the analyzed years, as well as those
companies whose loss was over the amount of capital so that they were practically
financed only from borrowed sources, and accordingly, the value of financial leverage
equals one.
The sample contains the financial data for 4 years in sequence, in period from 2008 to
2011. The final sample, representing the basis for the empirical study, comprises a total
of 108 big and medium publicly-listed non-financial companies, whose shares are
quoted on the regulated segment of the Belgrade Stock Exchange. These companies
are mostly the result of mass corporatization in Serbia at the beginning of 21st century,
as a part of the process of Serbian transition to market economy and private property.
The most significant share in the sample structure by the criterion of sector or business
belongs to companies from processing industry (52%), agriculture, forestry and fishing
(14,9%), transportation and storage (10,2%) and construction (8,4%).Financial
statements of these companies are prepared following the International Accounting
Standards (IAS), or International Financial Reporting Standards (IFRS).
Total number of observations for each variable is 432 (108*4). When we consider the
four-year value average or the value for one year only, total number of observations is
108. We have processed the data from companies’ financial statements and calculated
dependent and independent variables within the regression model, which is defined in
the following text.
3.2. Descriptive statistics
The ratio analysis mainly uses two types of profitabilitymeasures – margins and returns.
Margins ratios(Gross profit margin, Operating profit margin, Net profit margin, Cash-flow
margin)describe the firm's ability to translate sales into profits at various stages of
measurement. Ratios that calculate returns represent the firm's ability to measure the
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overall efficiency of the firm in generating returns for its shareholders (Return on asset,
Return on equity, Return on capital, Cash return on assets and so on). Many different
measurements of firm profitability are used by the researchers who studied the relation
between accounts receivable and profitability. The simplest and the most used ratio,
that relates the profitability of a company with its assets, is Return on Assets (ROA). It is
calculated as net income divided by total assets.
Two profitability measures are used in this study: Operating Profit Margin (OPM),
calculated as operating profit divided by total assets and Return on Total Assets
(ROTA) calculated as earnings before interest and tax divided by total assets. ROTA
measures the ability of general management to utilize the total assets of the business in
order to generate profits, while Operating Profit Margin shows the profitability of sales
resulting from regular business. Operating income results from ordinary business
operations and excludes other revenue or losses, extraordinary items, interest on long
term liabilities and income taxes.
The descriptive statistics of two profitability measures and explanatory variables are
reported in Table 2, while the correlation matrix is presented in Table3. The measures
of profitability, as well as the explanatory variables (receivables turnover ratio, accounts
receivable to revenue ratio, size and liquidity), are averaged for the period 2008-2011.
Size is the natural logarithm of net sales. Liquidity is measured by current ratio (current
assets/current liabilities). Receivables turnover ratio measures the average period for
which sales revenue will be held in accounts receivable. This ratio is usually used to
describe the efficiency and effectiveness of receivables collection. The trends in
accounts receivable to revenue ratio highlight tendency in the degree of investment in
accounts receivable.
The results of dependent variables, Return on Total Assets (ROTA) and Operating
Profit Margin (OPM), exhibit that the mean of ROTA (OPM) of all firms analyzed is
0.047 (0.032). The distribution of ROTA is positively skewed, with kurtosis of 0.083,
which describes that the scores for the ROTAs are clustered around the mean in the
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right-hand tail. On the other hand, the distribution of OPM is negatively skewed, with
kurtosis of 17.716, which indicates that the more peaked distribution is skewed to the
left. It can be observed that the profitability of Serbian companies whose shares are
traded on a regulated market is not at a significant level. But, having in mind the
analyzed crisis period, the fact that they still operate in profit zone is indicative.
The average number of days accounts receivables for the Serbian companies listed at
the regulated market is 69,5 days. This is far below the value of RTR of the whole
Serbian economy in 2011, which is, according to Euro stat data, 128 days. The natural
consequence of crisis environment is a conservative behavior of Serbian companies.
The most significant crisis effect is related to corporate growth and is reflected in the
fact that companies postpone planned investments. All the attention is concentrated on
providing cash, given that the real sector is primarily faced with liquidity risk, and the
need for working capital is increasing in time of crisis. The difficulties in collection of
receivables are becoming serious as the crisis progresses. The value of receivables
turnover ratio continually increases in the analyzed crisis period, starting from 66, 4
days in 2008, and reaching 73,1 days in 2011. The increase in input prices and
increased exchange rates, together with the problematic collection of receivables
affected the operating result.
Table2 Summary statistics
ROTA
OPM
ARRR
RTR
SIZE
LIQ
Mean
,044636
,032373
,194138
69,50925
5,864046
2,400914
Median
,035425
,03137716
,143752
51,50000
5,816000
1,587933
Std. Deviation
,067246
,13817079
,136127
48,26746
,492433
2,478863
Variance
,005
,019
,019
,100
,242
6,145
Skewness
,369
-2,883
1,120
1,151
,408
2,850
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Std. Error of Skewness
,233
,233
,233
,233
,233
,233
Kurtosis
,083
17,716
,692
,867
,016
9,891
Std. Error of Kurtosis
,461
,461
,461
,461
,461
,461
Minimum
-,109028
-,846249
,027984
10,0000
4,696000
,233524
Maximum
,220683
,377185
,625985
228,000
7,255000 15,843705
The average value of accounts receivable to revenue ratio describes the accounts
receivables management of Serbian companies in the crisis time too. The value of this
ratio for the sample is 19,41%, telling that almost 20% of total sales revenue is related
to the unpaid sales. As the crisis progresses, from 2008 to 2011, the value of ARRR
increases (from 18% to 20,4%), indicating that the amount of cash that is tied up with
the slow paying customers is growing. Yet, this numbers are still below the share of
receivables in the net revenue of 25% evidenced in France, Germany, and Italy by
Demirgüç-Kunt and Maksimovic (2001).
The results on the average collection period for Serbian companies are higher than the
findings of some studies done in non-crisis period. Deloof (2003) find an average of
RTR of 54,64 days in Belgium, Gill et al. (2010) of 53,48 days in the US. On the other
hand, Garcia-Teruel and Martinez-Solano (2007) present evidence on the average
receivables turnover ratio for Spanish firms of 96,82 days, Samiloglu and Demirgunes
(2008) and Lazaridis and Tryfonidis (2006) findaverage receivables turnover ratio in
Turkey and Greece is 139,07 and 148,25 respectively.
Table 3 shows correlation coefficients of all variables. ROTA and OPM are dependent
variables. Concerning the explanatory variables, relatively high correlation coefficients
(higher than 0.5) are observed only in case of ARRR and RTR.The results of the
correlation analysis shows that the number of days accounts receivables as well as
accounts receivable to revenue ratio positively relate to both the dependent variables Accounts Payable and Receivable
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return on total assets and operating profit margin. This indicates that in crisis time, a
higher level of accounts receivables could induce a higher profit in the Serbian case.
Contradicting evidence is found with the correlation analysis of Bavald (2009), who
finds a negative relation between the number of days accounts receivables and a firm’s
profitability in the crisis time in the case of the Netherlands. The results of Bavald's
correlation analysis show a negative relation between the number of days accounts
payables and both return on assets and gross operating profit. This indicates that
managers can create value by keeping the levels of accounts receivables to a
minimum.
Table3 The correlation matrix of profitability and independent variables
ROTA
ROTA
OPM
ARRR
RTR
SIZE
LIQ
1
OPM
(,680)**
1
ARRR
(,329)**
,142
1
RTR
(,293)**
,127*
(,959)**
SIZE
(,385)**
(,436)**
LIQ
(,298)**
(,405)**
1
(,283)** (,253)*
-,116
-,059
1
,086
1
**Correlation is significant at the 0.01 level (2-tailed).
*Correlation is significant at the 0.05 level (2-tailed).
Sales and liquidity show also a positive relation on the dependent variables, which is
consistent with the findings of Deloof (2003), and Baveld (2012). A shortcoming of
Pearson
correlations, that they are
not
able to identify the
causes from
consequences(Deloof, 2003), will be overcome by the regression analysis.
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3.3 Regression model
The regression analysis used in this study is based on the following equations:
•
OPMit = β0 + β1 ARRRit + β2RTRit+ β3 SIZEit + β4LIQit +εit
•
ROTAit = β0 + β1 ARRRit + β2RTRit+ β3 SIZEit + β4LIQit +εit
where OPM and ROA measures the firm profitability, SIZE, the company size as
measured by natural logarithm of sales, ARRR, the accounts receivable to revenue
ratio, RTR, receivables turnover ratio, LIQ, the current liquidity ratio. The analysis
utilizes fixed effect regression model for the whole sample (Table 4).
The results of regression analysis indicate a positive relation between accounts
receivables and return on total assets, which is not statistically significant. Table 4 also
shows a stronger, but positive relation between accounts receivables and the second
dependent variable – operating profit margin. This finding is not surprising taking into
account that operating profit margin describes the profitability of sales resulting from the
core business, which is highly influenced by the amount of receivables and the
collection effectiveness.
As it is pointed out by Baveld (2012), the absence of any significant relation for both
the dependent variables may indicate that the relation between accounts receivables
and firm’s profitability is changed in times of a crisis. These regression results could be
explained by the fact that Serbia is an transition and emerging market where most of
the firms are seen more profitable if they give their clients more trade credit. Indeed,
these finding are contradicting with the results on the impact on receivables on firm's
profitability in many developed counties (see Table 1), but consistent with Sharma and
Kumar (2011), who also find a positive relation between ROA and accounts
receivables in the case of India. The conclusion can be made that large and medium
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listed firms in Serbia use to keep their levels of accounts receivables to a high level
during crisis years.
Table 4 Regression model results for two dependant variables:
Return on Total Asset and Operating Profit Margin
Dependent variable: ROTA
Independent
Std.
Dependent variable: OPM
tstatistic Sig.
Coeff.
Std.
t-
Error
statistic Sig.
variable
Coeff. Error
(Constant)
-,280*
,085
-3,281 ,001
-,908
,167
-5,445 ,000
ARRR
,056
,093
,601 ,549
,306
,181
-1,686 ,095
RTR
,041
,039
1,042 ,300
,184
,077
2,397 ,018
SIZE
,038*
,012
3,219 ,002
,108*
,023
4,659 ,000
LIQ
,008*
,002
3,545 ,001
,020*
,004
4,525 ,000
Weighted
statistics
R square
Adjusted
,300
R
,367
,343
,273
square
SE
of
,112
,057
regression
F-statistic
11,033
14,937
* Significant at 5% level
Table 4 shows that R-squared value is 0.300 (0.367) indicating that 30% (36.7%)
variance in Return on Total Assets (Operating Profit Margin) as dependent variable
can be explained through four independent variables used.
4.Conclusion
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This study explores how large and medium sized companies listed at the regulated
market segment of the Belgrade Stock Exchange manage their accounts receivables in
the most profitable way during a crisis period, from 2008 to 2011.The analysis of the
relation between accounts receivables and two dependent variables on profitability,
return on total asset and operating profit margin, indicates a positive, but no significant
relation. This implies that managers of the most successful Serbian companies are of
the opinion that it’s profitable, and thus beneficial for their firms, to support their
financially constraint customers by increasing the level of the receivables. In this way,
companies secure their future sales and survival in crisis times. Companies take into
account the trade-off between extending trade credits and increasing the default risk
involved on the one hand, and the short-term and the long-term benefits of such a
receivables management on the other hand. Profitability and creation value for
shareholders over crisis time is achieved by increasing the accounts receivable levels.
This study is featured at least by three main limitations. In the first place, it is based on
the data of the Serbian non-financial firms listed at the regulated market. Therefore, a
generalization of the results of this research for the whole economy (financial firms,
non-listed firms) is not acceptable. Secondly, the analysis is limited to a four-year crisis
period, not taking into account the impact on receivables on profitability in a previous,
non-crisis period. It this way, a comparative approach could not be applied and the
differences between non-crisis and crisis period could not be compared and highlighted.
Finally, the correlation and regression analysis is conducted using the Return on Total
Assets and Operating Profit Margin as dependent variables, and four independent
variables. In this respect, future research should comprise a more comprehensive set of
explanatory variables and should be based on a larger and comprehensive database.
REFERENCES
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analysis, Journal of Business Research (2012), doi:10.1016/j.jbusres.2012.03.015
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Baveld, M. B. (2012),Impact of Working Capital Management on the Profitability of
Public
Listed
Firms
in
The
Netherlands
During
the
Financial
Crisis.
http://purl.utwente.nl/essays/61524
Berry, A. AndJarvis, R. (2006),
Accounting in a Business Context, Cengage
Learning EMEA, Andover, UK.
Bougheas S.,Mateut, S, and Mizen, P. (2009),Corporate trade credit and inventories:
New evidence of a trade-off from accounts payable and receivable, Journal of Banking
and Finance 33, 300–307.
Deloof, M. (2003),Does Working Capital Management Affect Profitability of Belgian
Firms?, Journal of Business Finance & Accounting, 30(3-4), 573 – 587.
Deloof, M. and Jeger, M. (1996),Trade Credit, Product Quality, and Intragroup Trade:
Some European Evidence, Financial Management, 25(3), 945-968.
Demirgüç-Kunt, A., and Maksimovic, V. (2001),Firms as financial intermediaries:
Evidence from trade credit data, World Bank Working Paper 2696
Emery, D. Finnerty, J. And Stowe J. (2004), Corporate Financial Management,
Pearson, Prentice Hall, New Jersey
Fukuda, S., Kasuya, M., and Akashi, K. (2006),The role of trade credit for small firms:
An implication from Japan's banking crisis, CIRJE Discussion Papers Series F-440.
Tokyo, Japan: The University of Tokyo.
Garcia-Teruel P.J. and Martinez-Solano, P.M. (2007),Effects of working capital
management on SME profitability, International Journal of Managerial Finance, 3, 164177.
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Gill, A., Biger, N. and Mathur, N. (2010),The Relationship Between Working Capital
Management And Profitability: Evidence From The United States, Business and
Economics Journal, Volume 2010: BEJ-10
Lazaridis, I. and Tryfonidis, D. (2006),Relationship Between Working Capital
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Love, I., Preve, A. P., and Sarria-Allende, V. (2007),Trade credit and bank credit:
Evidence from recent financial crises, Journal of Financial Economics, 83, 453–469.
Marotta, G. (1997),Does trade credit redistribution thwart monetary policy? Evidence
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Mathuva, D. (2010),The Influence of Working Capital Management Components on
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Petersen, M. A. and Rajan, R. G. (1997),Trade credit: theories and evidence, Review of
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Rajan, R. And Zingales, L. (1995),What do we know about capital structure? Some
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Samiloglu, F. and Demirgunes, K. (2008),The Effects of Working Capital Management
on Firm Profitability: Evidence from Turkey. The international Journal of Applied
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Sharma, A.K. and Kumar, S. (2011),Effect of Working Capital Management on Firm
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Yang, X.(2011), The role of trade credit in the recent subprime financial crisis, Journal of
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Author: Dencic mihajov
Title: IMPACT OF ACCOUNTS RECEIVABLE MANAGEMENT ON THE
PROFITABILITY DURING THE FINANCIAL CRISIS: EVIDENCE FROM SERBIA
URL: http://www.asecu.gr/files/9th_conf_files/dencic-mihajlov.pdf
LMSB-04-0606-004
Internal Revenue Service
Factoring of Receivables
Audit Technique Guide (ATG)
Accounts Payable and Receivable
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Service Management System
NOTE: This guide is current through the publication date. Since changes may have
occurred after the publication date that would affect the accuracy of this document, no
guarantees are made concerning the technical accuracy after the publication date.
This material was designed specifically for training purposes only. Under no
circumstances should the contents be used or cited as sustaining a technical position.
Internal Revenue Services
Large and Mid-Size
Business Division
(LMSB)
www.irs.gov
Publication Date (June 2006)
Factoring of Receivables Audit Techniques Guide
June 2006
NOTE: This guide is current through the publication date. Since changes may have
occurred after the publication date that would affect the accuracy of this document, no
guarantees are made concerning the technical accuracy after the publication date.
Accounts Payable and Receivable
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Overview
Companies generate accounts receivable by selling goods or services to their
customers on credit. Many companies who extend credit to their customers sell their
accounts receivable to a factor. A factor is a specialized financial intermediary who
purchases accounts receivable at a discount. Under a factoring agreement a company
sells or assigns its accounts receivable to a factor in exchange for a cash advance. The
factor typically charges interest on the advance plus a commission. The price paid for
the receivables is discounted from their face amount to take into account the likelihood
of un collectability of some of the receivables.
Factoring is a technique used by companies to manage their accounts receivable
and provide financing. Typically companies that have access to sources of
financing that is less expensive than factoring would not use factoring as source of
credit.
A factor may provide any of the following services:
•
Investigation of the credit risk of customers of the client;
•
Assumption of the credit risk of customers;
•
Collection of the client’s accounts receivable from customers;
•
Bookkeeping and reporting services related to accounts receivable;
•
Provision of expertise related to disputes, returns and adjustments;
•
Advancing or financing.
There are numerous types of factoring arrangements. Some of the basic types vary the
treatment of credit risk assumption and customer or debtor notification.
When the factoring agreement involves the purchase of accounts receivable where
the factor bears the risk of a customer or debtor failing to pay the client for reason of
financial inability it is a non-recourse or without-recourse agreement. In the situation
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where the client must bear the risk of non payment due to financial inability, the
agreement is a recourse agreement. In many instances, factoring agreements provide
for accounts to be purchased on both a recourse and non-recourse basis depending
on the credit worthiness of the customers or the debtors.
Compliance Focus
A strategy has been identified in which multinational corporations use the factoring of
accounts receivable among related parties. The goal of this strategy is to avoid U.S.
taxation by shifting income offshore and to significantly reduce remaining U.S. income
by deducting expenses related to the same income.
Typical Fact Pattern:
A U.S. subsidiary (“Taxpayer”) of a foreign parent earns sales income and books
accounts receivable. The Taxpayer then factors (sells at a discount) the accounts
receivable to a brother-sister foreign affiliate. The Taxpayer pays the foreign factor the
following fees: a discount; administration fees; commissions; and interest.
The Taxpayer deducts these fees or may net them against gross receipts. However,
the foreign factor does not perform any of the typical services of a factor, including
collection of the Taxpayer’s accounts receivable. Instead, the
Taxpayer agrees to continue doing all or most of its own collection work on its accounts
receivable. In some cases, factoring arrangements involve the use of a domestic (U.S.
based) factor instead of a factor located offshore. In cases involving a domestic factor,
some audit steps and issues discussed below may not apply. If the transaction is
between two domestic entities it may be structured for state tax purposes and has no
federal tax effect. In addition, in some cases, the Taxpayer and factor may be engaged
in a financing arrangement involving securitizing the accounts receivable.
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General Audit Steps
Although U.S. taxpayers are taxed on their worldwide income, the income of foreign
subsidiaries of U.S. taxpayers is generally deferred from taxation in the U.S.
Consequently, the existence of a factoring arrangement may not be readily identified on
the face of a return. Therefore, at a minimum the following audit steps should be
utilized:
•
Submit a specific IDR to determine if any accounts receivable were sold if yes,
were they sold to:
•
•
A related entity; and/or
•
Any entity located offshore.
Review the tax return balance sheet to determine if the accounts receivable
reflected thereon are reasonable for the size and type of business.
•
Perform a comparative analysis of the balance sheets for the current and at
least 5 prior tax years, noting any significant reduction in accounts receivable.
•
Review the tax preparation work papers for large debits to income.
•
Review and analyze Form 5472 and the audited financial statements of both the
domestic entity and the related foreign entity for any footnotes reflecting the sales
and/or securitization of the accounts receivable. Request that the foreign entity
provide this information in English. Note whether this analysis demonstrates
income shifting from the domestic entity to the foreign entity. Also note whether
there is evidence that the foreign entity was conducting a trade or business within
the United States.
The following facts should be determined during the audit through IDRs or
functional analysis and by requesting documentary substantiation where
appropriate.
The Factor
Name and location of the factor;
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•
Relationship of the factor to the taxpayer;
•
The name and location of a common parent of the factor and the taxpayer;
•
Whether the taxpayer and the factor are part of a consolidated group;
•
Whether the factor is a Controlled Foreign Corporation (CFC);
•
The name of any promoter/advisor or accounting firm involved in structuring the
taxpayer’s factoring arrangement.
The Factoring Arrangement
The factoring arrangement is usually set forth in a Factoring Agreement between the
factor and the taxpayer. Obtain a description of the terms of the factoring
arrangement including if applicable the following:
The names of the parties that entered into the Factoring Agreement;
•
The date the Factoring Agreement was signed;
•
The services the factor agreed to provide;
•
The services the factor contracted back to the taxpayer;
•
The fees the taxpayer charged the factor for performing the services
contracted back to the taxpayer;
•
The discount and fees charged by the factor for:
•
discount on accounts receivable;
•
administrative fees;
•
commission fees;
•
interest charges.
The date the taxpayer was required to transfer accounts receivable to the factor;
•
The date the factor had until to accept or deny the factored accounts
receivable;
•
Whether the sale of the receivables to the factor was recourse or nonrecourse;
•
The reasons the taxpayer provided for entering into the factoring
arrangement;
•
Whether the taxpayer ever entered a factoring arrangement before;
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•
Whether it is a common practice in the taxpayer’s industry to factor
receivables;
•
If a related entity is utilized to perform factoring, explain the source of the
funding used by this entity to acquire the accounts receivable.
Securitization
If the factoring arrangement involves the securitization of factored accounts
receivable then obtain a description of the securitization process including:
The purpose for securitizing the accounts receivable;
•
The names and location of all entities involved in the securitization process;
•
The relationship between the parties involved in the securitization
arrangement;
•
Whether any of the entities involved in securitizing the accounts receivable were a
Special Purpose Vehicle (SPV);
•
The fees charged by the parties involved in securitizing the accounts
receivable;
•
A description of how the accounts receivable were securitized, including the flow of
funds;
•
Whether the sale of the receivables to the factor was recourse or nonrecourse;
•
Whether the taxpayer ever securitized its accounts receivable before;
•
Whether it is a common practice in the taxpayer’s industry to securitize
accounts receivable;
•
If a related entity is utilized to perform securitization, explain the source of the
funding used by this entity to acquire the accounts receivable.
Tax Return
•
Indicate where on the tax return the expenses from the factoring
arrangements are deducted. Identify if the factoring fees are netted
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against other items such as sales. Also, indicate if the factoring
deductions are reflected as book/tax difference on Schedule M.
•
Provide all tax preparation work papers related to the factoring/securitization
arrangement.
Financial Statements
Indicate if and how the factoring arrangements are presented on the taxpayer’s
financial statements. Compare the treatment of how the factoring arrangements are
presented on the financial statements with the presentation on the tax returns.
Transfer Pricing Studies
Taxpayers engaged in transactions with related parties are required to establish an
appropriate transfer price in accordance with prescribed methodologies. Analysis and
evaluation of the appropriate price is what is known as a Transfer
Pricing Study.
To obtain a copy of any and all Transfer Pricing Studies, prepare a separate IDR
consisting of the following two paragraphs:
Please provide within 30 days of this request any principal documentation outlined in
Treas. Reg. Section 1.6662-6(d) (2) (iii) (B) that has been prepared to support your
transfer pricing methodologies for all years under examination. This information would
generally be provided in the form of a study; however all principal documentation
outlined under the Code and associated Treasury
Regulation which was prepared for the years under examination, regardless of form, is
requested. This documentation should include all internal and/or external studies.
It should be so noted that any documentation prepared by the taxpayer pursuant to
Section 6662(e) must be in existence when the return was filed in order to meet the
documentation requirement. In addition, if this documentation is not provided within 30
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days of this request, and if there are significant adjustments to your transfer price as
determined under IRC Section 482, a penalty may be applicable under IRC Section
6662(e) or (h).
Functional Analysis
When determining the appropriate amount of factoring fee charged between related
parties, it may be necessary to perform a functional analysis to determine the actual
services performed; the entity which performed the services; and, any compensation
charged for these services.
A functional analysis prepared with respect to factoring arrangements should include,
but not be limited to, the following:
Identity of the factor and its geographic location.
•
Identity of the legal form (partnership, corporation, LLC, etc) of the factor
•
Identity of the tax form (partnership, corporation, disregarded entity) of the factor.
•
Identity of the functions performed by the factor; and, if appropriate, the
functions which the factor contracts to be performed on its behalf.
•
Identity of the number, names and location of any employees of the factor.
•
Identity of duties specifically performed by each employee.
•
Identity of who performs the factoring functions.
•
Explanation, in detail, of any transfer pricing methodology used in determining
how a related entity reimbursed the taxpayer for services provided (i.e.
servicing rights).
•
Explanation, in detail, of any risks assumed with regard to the factored
receivables and the entity assuming such risks.
•
Analysis, in detail, of the amounts attributable to these risks, to be supported
by appropriate work papers.
Bad Debt History
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Determine the bad debt history of the taxpayer’s accounts receivable for the years
under exam and if possible the past 3 to 5 years. Calculate the percentage of
receivables written off as bad debts for each of the years. Identify the first time that the
taxpayer entered into a factoring arrangement and indicate the reasons the taxpayer
provided for entering into such an arrangement.
Dates the Receivables Were Collected and Transferred
The legal analysis of factoring arrangements may require identifying the dates and
amounts of receivables transferred to the factor. Accordingly, for all the factored
receivables determine:
The dates and the amounts of the accounts receivable the taxpayer transferred to the
factor.
The dates the taxpayer received collection on the accounts receivable; and
The dates the factor had until to accept or deny the transferred accounts
receivable.
Prior History on Sale of Accounts Receivable/Repeal of Mark-To-Market
Treatment under Section 475/Tax Avoidance
Obtain answers to the following questions:
•
Prior to July 1998, did the taxpayer utilize Section 475 to mark-to-market its
accounts receivable?
•
Did the taxpayer start or complete setting up transactions involving the
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“sale” of its accounts receivable to related corporations after July, 1998?
•
Were any of these corporations created or acquired around or after July,
1998 to carry out this sale of accounts receivable?
•
Were any of these types of transactions set up and promoted/marketed by any
of the accounting firms or other promoters/advisors?
•
Were any of the valuation services (for the accounts receivable) provided by
the same accounting firm which marketed the transaction? Who provided the
valuation services?
Other
Obtain a copy of the Accounting Manual; Standard Operating Procedures and/or Flow
Charts which describe the corporate factoring/securitization policies and/or procedures.
•
Obtain all legal, accounting, financial, and economic opinions and memoranda
secured by or on behalf of the taxpayer in connection with this transaction.
•
Determine whether a Tax Contingency reserve was established for any
transactions.
•
Obtain copies of any communications, brochures, memoranda or other
materials received from or sent to the Taxpayer or its representatives
describing the factoring arrangement.
Treas. Reg. section 6050P
Treas. Reg. section 6050P contains final regulations to the information reporting
requirement under section 6050P of the Internal Revenue Code for discharges of
indebtedness. The preamble of the Treas. Reg. section 6050P regulations, describe
typical unrelated party pricing of factoring transactions and provide an example
demonstrating how a bona fide unrelated party factoring transaction is often priced.
The preamble states that factoring between unrelated parties ordinarily involves a
factor who performs the following functions:
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Initial credit investigation;
•
Selective assumption of the risk of loss (sometimes referred to as
guaranteeing credit);
•
On-going credit monitoring of the client’s customers, collection and
bookkeeping.
The preamble states that for typical transactions with unrelated parties factoring fees
range between 0.35 percent of the face value of the accounts receivable (if the client
retains the collection function) and 0.70 percent of the face value (if the factor
undertakes the collection function).
Accordingly, it may be indicative that a factoring arrangement between related parties
is abusive if the factoring fees are much higher than the typical factoring fees charged
for unrelated parties. This type of analysis should be made in determining whether a
section 482 adjustment is warranted.
Typical Issues:
Potential issues include, but are not limited to:
Were there deemed dividends from the U.S. taxpayer to its foreign parent in the amount
of collected accounts receivable transferred to the foreign factor; and, were withholding
taxes due on the dividends paid to a foreign recipient?
Have the arm’s-length principles under section 482 been applied with respect to the
sale of accounts receivable to a related party?
•
Did the foreign factor’s factoring activities generate income from a trade or
business within the United States?
•
Should losses between the related parties in the factoring transaction be
adjusted under Section 267?
•
Was the factor a controlled foreign corporation (“CFC”) conducting intercompany
transactions with the Taxpayer pursuant to Treas. Reg. 1502?
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•
Should losses from the factoring transaction be disallowed under Section 269
because the factor was acquired or created to evade or avoid income tax?
Author:
Title: Internal Revenue Service Factoring of Receivables Audit Technique Guide (ATG)
URL: www.lrs.gov/pub/lrs-utl/tactoring of receivables atg final.pdf
Date Published: June 2006
JYRKI NISKANEN & MERVI NISKANEN
Accounts Receivable and
Accounts Payable in Large Finnish
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Firms’ Balance Sheets: What
Determines Their Levels?
ABSTRACT
This study empirically examines the determinants of Finnish listed firms’
accounts receivable and accounts payable. The results show that accounts
receivable are most likely to be affected by the firms’ incentive to use trade
credit as a means of price discrimination. Increases in the interest rate level
also increases the amount of accounts receivable through increased demand
for trade credit. The most important determinants for the level of accounts
payable appear to be the supply of trade credit, firm size, interest rate level, the
ratio of current assets to total assets, and insufficient internal financing.
1 . INTRODUCTION
Official statistics show that Finnish manufacturing companies’ accounts
receivable are on aver-age 9.7% and accounts payable 6.1% of total asset
(firms with more than 20 employees). For retail firms the respective percentages
are 8.1% and 16.0% and for wholesale firms the numbers are as high as 24.1%
and 23%, respectively.1 The importance of trade credit varies by country, and is
likely to be highest in industrialized countries, although there is substantial
variation across them (Marotta, 1997). Rajan and Zingales (1995) investigate
non-financial firms in the G7 countries, and find that the proportional share of
accounts receivable varies between 13% (Canada) and 29% (Italy), whereas
the range for accounts payable is between 11.5% (Germany) and 17%
(France). It is thus apparent that accounts receivable may form a substantial
fraction of a firm’s assets, and accounts payable may be an important source of
outside funding. Several theories have been developed to explain trade credit
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use. However, firm level empirical evidence is scarce and it is all on U.S. data.
This paper tests the available theories using data on Finnish listed firms.
2 . THEORIES AND SOME EMPIRICAL EVIDENCE ON TRADE CREDIT
Several theoretical studies attempt to explain why suppliers provide financial
intermediary services to their clients, and why these are willing to use trade credit
instead of, e.g., bank debt even if trade credit is well known to be a more expensive
source of funds.
Transaction costs have been stated to be one reason to maintain credit sales. Ferris
(1981) argues that the existence of trade credit allows flexibility in payments and makes
it possible to cumulate the payments of several successive shipments to be paid at
once thus leading to savings of transaction costs. Furthermore, trade credit allows the
buyers to hold smaller cash balances and save money accordingly. Other versions of
the transaction costs theories relate to seasonalities in the consumption pattern of the
selling firm’s products (for a detailed de-scription, see Petersen and Rajan, 1997).
Financial models are based on capital market imperfections relating to information
asymmetries. Schwartz (1974) suggests that firms with better access to the
institutionalized capital market and with lower cost of financing will offer trade credit to
firms with high costs when borrowing from financial intermediaries. As Schwartz points
out, the institutional arrangement of trade credit enables established firms to help
finance the growth of their customers. It may also be argued that trade credit can serve
to mitigate credit rationing while trade credit provides a signal on the buyer’s good
quality to the financial intermediary (Frank and Maksimovic, 1998; Biais and Gollier,
1997).2
Other financial models suggest that the seller has an advantage over financial
intermediaries in information acquisition and controlling the buyer. In the AngloSaxon countries, all these advantages relate to the closer and more ’physical’
relationship between the seller and the buyer than between the buyer and
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financial intermediaries. E.g., if the buyer does not pay in time, the supplier can
threaten to cut off future supplies. A financial intermediary may not have such
powerful tools in use, since the threat to withdraw future finance may not have
an immediate effect on the buyer’s behavior (Petersen and Rajan, 1997).
Trade credit may serve as a means of price discrimination when law (e.g.,
the Robinson-Patman Act in the U.S.) prohibits companies from directly using
different prices for different customers. This is possible when credit terms
contain an early payment discount. Firms with market power are more likely to
offer such terms (Brennan et al., 1988; Mian and Smith, 1992). Such firms are
operating with a high contribution margin, and have a strong incentive to gather
additional sales but without cutting the price to existing customers. Therefore,
they offer trade credit that creditworthy customers will avoid because of its high
price. On the other hand, risky customers will take the credit because it may still
be cheaper than to borrow from other sources (Brennan et al., 1988; Petersen
and Rajan, 1997).
Trade credit can be considered an implicit guarantee for the seller’s
products. The idea is that the buyer is given time to become convinced on the
quality of the product before he pays for it (Lee and Stowe, 1993). Frank and
Maksimovic (1998) argue that trade credit as a guarantee is likely to be of
particular importance for small and less well established sellers.
Some studies discuss the effect of changing macroeconomic conditions on
the use and terms of trade credit. Schwartz (1974) argues that trade credit
reduces the efficacy of any given amount of monetary control, but also mitigates
the discriminatory effects generated by restrictive monetary policy. When loan
supply is constrained, larger firms with easier access to institutionalized capital
markets can extend trade credit to smaller firms (Kashyap et al., 1993). Under
those circumstances it can be expected that smaller firms are willing to extend
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the term of the offered trade credit because rising interest rates make trade
credit a more competitive form of short-term financing.
As Petersen and Rajan (1997) point out, there is little empirical evidence on
the above theories in addition to their own study. They use firm level data from
the National Survey of Small Business Finances that was conducted in 1988–
89, and find that firms use trade credit more when credit from financial
institutions is not available. Their evidence also shows that well established
suppliers might act as financial intermediaries by lending to firms with no access
to the financial markets. The study further finds some evidence to support the
theory that trade credit is used as a means of price discrimination.
There are several differences between our data set and Petersen and Rajan’s
(1997) data. One important difference is that between the Finnish and U.S. capital
markets. The Finnish capital markets are bank-based and highly concentrated. A
number of studies on relationship lending suggest that close bank-borrower
relationships enhance credit availability. These studies also suggest that firms operating
in concentrated as opposed to competitive markets have easier access to funds
(Petersen and Rajan, 1995; Boot and Thakor, 1999). One distinguishing feature of the
bank-based systems is that banks monitor the performance of firms more closely than in
the market-based systems such as that of the U.S., play an active part in the
administration of many large corporations, and may even own substantial amounts of
their share capital. Under the Finnish circumstances, this fact may provide banks a
relative advantage over suppliers as opposed to the financial intermediaries in the U.S.,
and thus have an effect on the firms’ patterns of using trade credit in their short and
intermediate term funding.
Second, we use time series data that allow us to test the determinants of trade
credit over time, whereas Petersen and Rajan (1997) used a cross-sectional one-year
sample. We include explanatory variables such as the interest rate level and yeardummies that cannot be used when the data are available for only one year. A third
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difference is that our data consist of firms that are among the largest in Finland,
whereas Petersen and Rajan’s sample mainly consisted of small firms.
The study proceeds as follows. Section 3 describes the data sample used.
Section 4 presents the results on the determinants of accounts receivable and
accounts payable. Section 5 concludes the study.
3 . DATA DESCRIPTION
The data sample consists of financial accounting data on firms that were listed on
the Helsinki Stock Exchange either in the main list or in the OTC list during the research
period 1989– 1997. For some firms data are available for shorter periods. The entire
sample size is 1018 observations from 121 firms.
Table 1 shows the time-series behaviour of median accounts receivable (divided
by as-sets) in firm size quartiles during the research period. Table 2 reports the
respective results for accounts payable. The data have been classified into firm size
quartiles based on annual sales.
The relative amounts of trade credit offered and used remain quite stable during
the research period, and neither accounts receivable nor accounts payable display a
trend in time in any quartile of sales. However, there are certain differences in trade
credit policies between the different quartiles. Especially, firms in the smallest sales
quartile clearly have the smallest accounts receivable and accounts payable relative to
assets, while differences between the three larger quartiles are smaller and less
consistent. The relative difference between the lowest sales quartile firms and other
firms is much larger for accounts payable. The lowest sales quartile firms borrow from
suppliers on average only 50% compared to the
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TABLE 1. Median accounts receivable to total assets: time-series
behaviour in different firm size quartiles. The smallest firms are in quartile
< 0.25 and the largest firms in quartile > 0.75.
Years
Quartile of sales
1989
1990
1991
1992
1993
1994
1995
1996
1997 All years
< 0.25
0.108
0.101
0.102
0.068
0.099
0.106
0.102
0.091
0.119
0.102
0.25 – 0.50
0.133
0.151
0.129
0.151
0.142
0.177
0.170
0.164
0.148
0.149
0.50 – 0.75
0.162
0.146
0.125
0.117
0.130
0.133
0.148
0.147
0.128
0.138
> 0.75
0.135
0.134
0.125
0.128
0.129
0.130
0.147
0.141
0.162
0.136
All firms
0.138
0.134
0.119
0.123
0.131
0.132
0.144
0.140
0.143
0.133
TABLE 2. Median accounts payable to total assets: time-series behaviour in
different sales quartiles.
The smallest firms are in quartile < 0.25 and the largest firms in quartile > 0.75.
Years
Quartile of sales
1989
1990
1991
1992
1993
1994
1995
1996
1997 All years
< 0.25
0.035
0.045
0.025
0.020
0.030
0.027
0.034
0.033
0.039
0.031
0.25 – 0.50
0.062
0.057
0.045
0.052
0.053
0.071
0.072
0.073
0.080
0.082
0.50 – 0.75
0.069
0.059
0.054
0.066
0.055
0.069
0.058
0.055
0.058
0.059
> 0.75
0.081
0.075
0.061
0.067
0.070
0.085
0.082
0.079
0.086
0.078
All firms
0.068
0.059
0.050
0.051
0.053
0.071
0.062
0.060
0.071
0.060
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median firm of the total sample, whereas the respective ratio when lending to
customers is about 75%.
The result concerning the differences between large and small firms may
not be quite generalisable because there in fact are only large firms in our
sample in the context of the entire population of Finnish firms. However, also
Petersen and Rajan (1997) found that larger firms tend to offer more trade
credit to their customers and they also hold larger balances of accounts
payable. Their results were similar for a sample of large COMPUSTAT firms as
well as for their primary sample consisting of small and medium sized firms.
Table 3 shows the median percentages of accounts receivable and
accounts payable classified by industry. The data are divided into four industry
categories (classification codes used by Statistics Finland since 1995 are in
parentheses): manufacturing and mining (C, D), energy
supply and construction (E, F), retail and wholesale firms (G, H) and other services (I, J,
K, O).
Firms in wholesale and retail industries have the largest accounts receivable
and accounts payable (16.6% and 13.3%, respectively). Accounts receivable
are an important part of assets (14.7%) also in manufacturing and mining firms,
whereas the level of accounts payable in
TABLE 3. Accounts receivable and accounts payable by industry.
Industry (classification codes
used by Statistics Finland
are in parentheses)
Manufacturing and mining (C, D)
Accounts Payable and Receivable
Median
Median
Median
Median
Accounts
collection
accounts
payment
Receivable
period
payable
period
to total assets
(days)
to total assets
(days)
.147
56
.067
59
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Energy supply and construction (E,
F)
.079
55
.041
57
Trade (G, H)
.166
44
.133
53
Other services (I, J, K, O)
.095
42
.042
74
Total
.133
51
.060
60
these firms’ balance sheets is only 6.7% of total liabilities. In general, it is true for all
industries that firms hold more accounts receivable than accounts payable. The
medians for the whole sample are 13.3% and 6%, respectively.
4. RESULTS
We regress accounts receivable and accounts payable on variables that can be argued
to be their determinants based on the theories discussed earlier. We shortly discuss the
theoretical relevance of each variable while presenting the empirical results from the
estimations. Table 4 first summarises the variables of primary interest and presents
correlations between them.3
4.1. Accounts receivable
Table 5 presents the results from regressing accounts receivable (scaled by
assets) on the different explanatory variables.4 Model I in table 5 is estimated
using the variables listed in table 4 above. Since it seems possible that the
relationship of accounts receivable with sales growth and cash flow is not
linear, we estimate model II. The sales growth and cash flow variable are now
both separated into two variables by multiplying them with (0,1) dummies
indicating whether a particular observation has been positive or negative.
Demand for trade credit. It is convenient to think that the level of a firm’s
accounts receivable depends on how much it decides to lend to its customers.
However, as Petersen and Rajan (1997) point out, there is most probably also a
demand factor that affects the amount of The number of observations varies
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slightly across the different regressions because of listwise deletion of
observations with missing data on some variable(s).As it is the common
practice in related literature, assets is used as the scaling variable for both the
dependent variable and independent variables when scaling is needed.
Potential problems related to this practice are dis-cussed in Kasanen and Lukka
(1993).
TABLE 5. The determinants of accounts receivable.
Dependent variable: accounts
receivable/assets
Model I (N = 896)
Variable
Coefficient Significance
Model II (N = 894)
Coefficient Significance
level
LN(book value of assets)
level
. 002
. 094
. 002
. 289
LN(1 + firm age)
–. 002
. 493
–. 002
. 279
% sales growth
–. 0002
. 566
% sales growth if positive, 0
–. 008
. 078
% sales growth if negative, 0
. 078
. 001
Cash flow when positive, 0
–. 082
. 067
Cash flow when negative, 0
–. 007
. 992
Operating cash flow
Contribution margin
–. 046
. 227
. 091
. 000
. 087
. 000
Market interest rate
1 . 198
. 080
1 . 111
. 099
Year - dummy 1989
–. 094
. 141
–. 088
. 159
Year - dummy 1990
–. 120
. 101
–. 113
. 119
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Year - dummy 1991
–. 122
. 069
–. 111
. 096
Year - dummy 1992
–. 126
. 066
–. 118
. 081
Year - dummy 1993
–. 059
. 059
–. 054
. 080
Year - dummy 1994
–. 025
. 138
–. 022
. 189
Year - dummy 1995
–. 031
. 106
–. 029
. 123
Year - dummy 1996
–. 009
. 356
–. 008
. 371
Manufacturing and mining
. 049
. 000
. 049
. 000
Wholesale and retail trade
. 041
. 000
. 042
. 000
–. 015
. 133
–. 012
. 203
Constant
. 009
. 790
. 035
. 298
Adjusted R - squared
. 238
. 000
. 248
. 000
Other services
trade credit a firm is able to extend. This demand is practically impossible to measure
directly. Most firms have many customers whose individual attitudes towards trade
credit differ from each other. For instance, a retail firm may have thousands of credit
customers who may be either individuals or other firms. On the contrary, the accounts
payable of a given firm may be more homogenous since they usually are payables to
other firms whose number at least in certain industries may be relatively small.
Since we don’t know the demand curve for trade credit, this issue must be
taken into
account when interpreting the estimated coefficients. Petersen and Rajan (1997)
illustrate the alternative interpretations of the result that large firms have higher
accounts receivable. First, this result may mean that larger firms are less capital
constrained because they have better access to capital markets. An alternative
interpretation is that a part of large firms’ customers may be credit rationed for one
reason or another, and the larger than average accounts receiv-able of large firms may
be explained by the demand factor. However, we believe that the use of industry
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dummies in our regression partly mitigates this problem since they divide the customers
of the sample firms into more homogenous groups.
Creditworthiness and access to capital markets. A firm’s creditworthiness and
access to capital markets are most commonly measured by firm size and age. We use
the natural log of the firm’s total assets (Ln (Assets)) and the natural log of firm age
(Ln(1 + Firm Age)) to proxy for the supplier’s access to external capital.5
The results in table 5 show that asset size is significant in model I (p = 0.094), but
insignificant in model II. Firm age remains insignificant in both models, even when the
square of the log of firm age is added in the model (the coefficient of the squared age
variable is not reported in table 5). We added the squared age variable, because
Petersen and Rajan’s (1997) results show that after 19 years of operation a firm’s level
of accounts receivable peaks and starts to decrease.
The result that a firm’s creditworthiness and access to capital markets does not
affect the level of trade credit it extends is theoretically unexpected, and it also differs
from previous empirical findings by Petersen and Rajan (1997). Table 4 shows that firm
size and age are correlated by factor 0.4. Although the correlation is not very large, it
may be one reason be-hind the insignificance of firm size and age as predictors for
trade credit extended.
Growth. Firms may have trade credit policies that are in connection with their target
growth rates. Traditionally, credit terms such as trade credit discounts and time of
payment are believed to be used as competitive tools. A firm willing to grow may choose
a strategy of extending trade credit with longer due periods than its competitors. This
suggests that growth should be positively related to the level of accounts receivable.
However, also firms whose sales have developed inadequately, may use trade credit to
enhance their sales. Especially, a firm whose sales are declining may extend more
trade credit than the average firm in its industry (Petersen and Rajan, 1997). In this
study, we measure growth by the annual sales growth percentage.
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Empirically, it appears that neither of the above theories holds. When negative and
positive observations are in the same variable, the regression coefficient is insignificant.
However, when the variable is partitioned on the basis of the signs of the observations,
it appears that the coefficient of the variable with negative sales growth numbers has a
significant positive coefficient. When interpreted, this result means that the more
negative a firm’s sales growth, the less trade credit it extends. On the other hand, the
coefficient of the variable including positive growth observations is significantly negative
(p = 0.078), indicating that firms with high growth rates extend less trade credit than
lower-growth firms. The results are exactly the mirror image to Petersen and Rajan’s
(1997) results, who found that firms with high growth rates extend more credit than firms
with lower growth rates. Additionally, their results showed that the more a firm’s sales
declined the more it used trade credit to finance its customers’ purchases, and thus
support both the above mentioned theories.
Internal financing. We use operating cash flow (earnings before depreciation and
interest minus taxes) divided by assets to measure the firm’s ability to generate cash
from internal sources to finance the trade credit that it offers to its customers. The
results in Table 5 are mixed and difficult to interpret. When the initial cash flow variable
is used, the coefficient is insignificant. However, when positive and negative
observations are separated into two variables, the variable with positive observations
has a negative coefficient (significant at the 6.7% level), while the variable with negative
observations is insignificant. This result means that the larger positive cash flow the
supplier has, the less trade credit it is willing to extend to its customers. Petersen and
Rajan (1997) find that the firm’s ability to generate cash internally from operations is
statistically significant but its sign is unexpectedly negative. However, when they
elaborate their analysis, they find that only losses are significantly negatively correlated
with accounts receivable, and conclude that firms in trouble extend more credit to
maintain sales. Our results may be considered exactly the opposite to theirs.
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Price discrimination. Price discrimination is a practice whereby different buyers are
charged different prices for the same product for reasons other than any differences
which exist in the costs of supplying them. Monopolists will often enjoy the power to
discriminate in this way. Our measure for price discrimination is the monopoly power of
the firm measured by the ratio of contribution margin (sales minus variable costs) to
assets. (See, e.g., Ferguson et al., 1993, for formal derivation and discussion).
In our sample of large Finnish firms, it appears that price discrimination is by far the
most important variable explaining accounts receivable management policies. Its
coefficient is positive and statistically very significant in both models I and II in table 5.
Cost of alternative capital. We use the annual average three-month HELIBOR rate
to measure the underlying cost of capital. We expect to find a positive association
between accounts receivable and the interest rate level, because the demand for trade
credit can be expected to be highest when the cost of alternative sources of funds is
high. Table 5 shows that the interest rate has a significant positive coefficient in both
models I and II (p = 0.099).
Time. Our model includes eight year-dummies to control for annual changes
with 1997 serving as the control year. All coefficients of the year-dummies are
negative indicating that the level of trade credit was highest in 1997.
Interestingly, the negative coefficients are statistically significant during the
period 1991–1993, when the economic conditions in Finland were weak. Thus,
it seems that the deep economic recession reduced the amount of trade credit
extended.
Industry. The coefficients of the industry dummies for manufacturing and
mining firms and for retail and wholesale firms are both positive and very
significant. This indicates that firms in these industries extend more trade credit
than in the two other industries (electricity supply and construction; other
services).
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4.2. Accounts payable
Table 6 presents the results from regressing accounts payable on their
suggested determinants. The variables (including control variables) are for the
most part the same as above in the model estimated for accounts receivable.
Additionally, there are two new variables: purchases (scaled by assets)
describing the supply of trade credit and the ratio of current assets (financial
assets and inventories) to total assets measuring asset maturity.
Model III in table 6 is estimated using the ’original’ explanatory variables,
whereas in model IV the sales growth and cash flow variables are both
separated into two variables one containing positive observations and the other
negative observations.
Supply of trade credit. Petersen and Rajan (1997) use the fraction of the
firm’s annual purchases made on account as a proxy for the quantity of trade
credit offered to the firm. Their sample consists of small firms some of which
may be credit rationed by suppliers. Since our sample firms are larger firms we
make an assumption that all purchases are on credit and use their annual
purchases as a proxy for the supply of trade credit. We believe that this
assumption is not very restrictive, since large firms typically don’t pay their
purchases in cash. In measuring the supply of trade credit we have an
advantage over previous research since we know the exact amounts of the
sample firms’ annual purchases. Petersen and Rajan had to estimate the
amount of purchases to measure supply of trade credit since U.S. firms do not
provide information on the division of cost of goods sold into different cost
categories such as wages and purchases.
Because we use a proxy for the supply of trade credit, we can be more
confident in interpreting the coefficients of the other variables in the model. The
regressions for accounts receivable and accounts payable differ in this respect,
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since the coefficients of the former regression are reduced form coefficients that
include both demand and supply side. (Petersen and Rajan, 1997).
The result concerning the supply of trade credit is clear and expected:
purchases are statistically significantly associated with accounts payable, and
their coefficient is positive. That is, an increase in the supply of trade credit
enhances the level of its use.
TABLE 6. The determinants of accounts payable.
Dependent variable: accounts
payable/assets
Model III (N = 911)
Variable
Coefficient Significance
Model IV (N = 909)
Coefficient Significance
level
level
Purchases
. 018
. 000
. 019
. 000
LN(book value of assets)
. 005
. 000
. 004
. 000
LN(1 + firm age)
–. 001
. 402
–. 002
. 134
% sales growth
–. 0006
. 006
% sales growth if positive, 0
–. 012
. 000
% sales growth if negative, 0
. 082
. 000
Cash flow when positive, 0
. 083
. 001
Cash flow when negative, 0
–. 128
. 062
Operating cash flow
. 085
. 000
Current assets % total assets
. 041
. 000
. 043
. 000
Market interest rate
. 825
. 037
. 795
. 037
Year - dummy 1989
–. 076
. 040
–. 074
. 039
Year - dummy 1990
–. 091
. 020
–. 085
. 038
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Year - dummy 1991
–. 091
. 020
–. 082
. 029
Year - dummy 1992
–. 088
. 027
–. 085
. 026
Year - dummy 1993
–. 044
. 016
–. 041
. 019
Year - dummy 1994
–. 019
. 049
–. 016
. 083
Year - dummy 1995
–. 027
. 014
–. 026
. 014
Year - dummy 1996
–. 007
. 163
–. 007
. 194
Manufacturing and mining
. 023
. 000
. 023
. 000
Wholesale and retail trade
. 047
. 000
. 049
. 000
Other services
. 004
. 528
. 006
. 299
–. 062
. 001
–. 053
. 005
. 241
. 000
. 281
. 000
Constant
Adjusted R - squared
Creditworthiness and access to capital markets. The results in table 6 show that
asset size is a very significant explanatory variable for accounts payable in both models
III and IV. How-ever, firm age remains insignificant in both models, even when the
square of age is added in the model (coefficient not reported). We add the squared age
variable, because previous re-search provides evidence that older firms have less
investment opportunities than younger firms, and therefore they need less external
funding.
The results concerning size and age contradict the notion that larger and older
firms would use less trade credit than smaller and younger firms. The positive
sign of the size variable indicates that large firms which even otherwise have
easier access to the capital market use more trade credit in their financing. Also
Petersen and Rajan (1997) find that there is a weak positive correlation
between the level of accounts payable and firm size.
Growth. Theoretically, it may be argued that rapidly growing firms have
better investment opportunities than other firms and would thus be willing to use
more trade credit as a partial source of financing for new investments. However,
the empirical results show just the opposite. As a whole, sales growth is
negatively associated with accounts payable (model III). When this variable is
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separated into two variables one containing the positive values (negative values
are set to be zeros) and another containing the negative observations (positive
values set to be zeros), both variables are very significant. On one hand, the
coefficient of positive growth is negative indicating that the faster a firm is
growing the less it uses trade credit in its financing. On the other hand, the
larger the sales decrease, the less trade credit a firm will use. Therefore, the
maximum amount of trade credit is used by firms who grow slowly or not at all.
Consistently with the theory explained above, Petersen and Rajan (1997)
observe the mirror image of our results while they find that the more a firm’s
sales is growing or decreasing the more it uses trade credit. One explanation to
the different results is that Finland is traditionally a bank-dominated
environment, and firms may rather turn to financial intermediaries (banks) than
to extend the use of trade credit when their level of growth deviates from normal
growth in one direction or another.
Internal financing. The results show that operating cash flow is a significant
explanatory variable for accounts payable with an initially positive coefficient
(model III). However, when it is separated into two variables (model IV), it
appears that the coefficient of positive cash flows is positive and the coefficient
of negative cash flows is negative. This result means that the most liquid firms
use more trade credit than the average firm and the same holds for firms with
negative internal financing. The latter part of this result is consistent with the
notion that firms in trouble use more trade credit, and it is also in line with
Petersen and Rajan’s (1997) results.
Asset maturity. The proportional share of current assets (current assets/total
assets) is a (very) significant explanatory variable for the level of accounts
payable. This is in line with the theories stating that firms attempt to finance
assets of certain maturity with funds having the same maturity. This is done to
schedule repayments of the financial capital to correspond with the decline in
value in the firm’s assets (Myers, 1977; Diamond, 1991; Hart and Moore, 1991).
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Therefore, short-term (current) assets are financed using short-term debt such
as accounts pay-able, while long-term assets are financed using long-term debt
or equity.
Cost of alternative capital. Market interest rate is a significant explanatory
variable for accounts payable. It may be noted that it is statistically more
significant than in the model(s) estimated for accounts receivable. This result
may support the notion that movements of the market rate affect in particular
the demand side of trade credit.
Time. The results concerning the year-dummies indicate that the level of accounts
payable was highest during the control year 1997. All dummies except that of the year
1996 have statistically significant negative coefficients.
Industry. Industry effects are similar to the regressions for accounts receivable. The
coefficients of the manufacturing and mining industries and the retail and wholesale
industries are both positive and very significant indicating that firms in these industries
use more trade credit in their financing than in the two other industry groups.
5. CONCLUSION
This study empirically examined the determinants of Finnish listed firms’ accounts
receivable and accounts payable management policies. The results show that accounts
receivable are strongly affected by the firms’ incentive to use trade credit as a means of
price discrimination. Market cost of capital also has an effect on their level. The latter
result may be largely explained by increasing demand of trade credit when market
interest rates rise.
All the variables that were used to explain the level of accounts payable were
statistically significant although their signs were not always expected. The results show
that the most important variables behind accounts payable policies are supply of trade
credit, firm size, level of interest rates, asset maturity, and internal (insufficient)
financing.
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The results of this study differ in many aspects from previous results obtained using
U.S. data. These differences may largely be due to differences between the Finnish and
U.S. capital markets, since Finland has a bank-based system much like those of
Germany and Japan. Corporate bond markets are basically non existent, and banks
form the major source of capital even for most large firms. One obvious line of further
research would be to examine the role of bank-borrower relationships, as financial
intermediaries are an alternative source of capital for trade credit. However, data on
relationships between firms and banks is private, and data samples containing such
information are not publicly available
REFERENCES
BIAIS, B. and C. GOLLIER, 1997, Trade credit and credit rationing, Review of Financial
Studies 10, 903– 937.
BOOT, A. and A. THAKOR, 1999, Can relationship banking survive competition?
Working paper, University of Amsterdam.
BRENNAN M., V. MAKSIMOVIC, and J. ZECHNER, 1988, Vendor financing, Journal of
Finance 43, 1127– 1141.
DIAMOND, D., 1991, Monitoring and reputation: The choice between bank loans and
directly placed debt, Journal of Political Economy 99, 689–721.
FERGUSON, P.R., G.J. FERGUSON and R. ROTSCHILD, 1993, Business Economics
(Macmillan).
FERRIS, J. S., 1981, A transactions theory of trade credit use, Quarterly
Journal of Economics 94, 243– 270.
FRANK, M. and V. MAKSIMOVIC, 1998, Trade credit, collateral and adverse
selection, Working paper, University of Maryland.
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HARHOFF, D. and T. KÖRTING, 1998, Lending relationships in Germany –
empirical evidence from survey data, Journal of Banking and Finance 22,
1317–1353.
HART, O. and J. MOORE, 1991, A theory of debt based on the inalienability of
human capital, Working paper, MIT.
KASANEN E. and K. LUKKA, 1993, Yleistettävyyden ongelma
liiketaloustieteessä, Liiketaloudellinen Aikakauskirja 41, 348–379.
KASHYAP A.K., J.C. STEIN and D.W. WILCOX, 1993, Monetary policy and
credit conditions: evidence from the composition of external finance,
American Economic Review 83, 78–98.
La PORTA, R., LOPEZ-DE-SILANES, F., SHLEIFER, A., and R. VISHNY,
1997, Legal determinants of external finance, Journal of Finance 52, 1131–
1150.
LEE Y.W. and S.D. STOWE, 1993, Product risk, asymmetric information and
trade credit, Journal of Financial and Quantitative Analysis 28, 285–300.
MAROTTA, G., 1998, Does Trade Credit Redistribution Thwart Monetary
Policy? Evidence From Italy, Working paper, University of Modena.
MYERS, S.C., 1977, Determinants of Corporate Borrowing, Journal of Financial
Economics 5, 147–175.
MIAN, S. and C. SMITH, 1992, Accounts receivable management policy:
Theory and evidence, Journal of Finance 47, 169–200.
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PETERSEN, M. and R. RAJAN, 1994, The benefits of lending relationships:
Evidence from small business data, Journal of Finance 49, 3–37.
PETERSEN, M. and R. RAJAN, 1995, The effect of credit market competition
on lending relationships, Quarterly Journal of Economics, 407–433.
PETERSEN, M. and R. RAJAN, 1997, Trade credit: Theories and Evidence,
Review of Financial Studies 10, 661–691.
RAJAN, R. and ZINGALES, 1995, What do we know about capital structure?
Some evidence from international data, Journal of Finance 50, 1421–1460.
SCHWARTZ, R.A., 1974, An economic model of trade credit, Journal of
Financial and Quantitative Analysis 9, 643–657.
SMITH, J., 1987, Trade credit and information asymmetry, Journal of Finance 4, 863–
869.
Author: J NISKANEN
Title: Accounts Receivable and Accounts Payable in Large Finnish Firms’ Balance
Sheets: What Determines Their Levels?
URL: http://www.htmlpublish.com/convert-pdf-to
html/success.aspx?zip=DocStorage/da1132e3bdaf4baab53963a75cda2442/lta_2000_0
4_a2.zip&app=pdf2word#
Management of Accounts Receivable
December 1997
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----------------------------------------------------------------------------------------------------------
Contents
Preface
Introduction
The Accounts Receivable Process
Re-Engineering Accounts Receivable
Risk Management
Use of Advanced Technology
Debt Collection Processes
Performance Measurement
Appendix
Preface
This guide accompanies the Auditor-General’s Audit Report No. 29, Management of
Accounts Receivable in the Commonwealth. It is intended to provide an overview of the
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current trends and "better practice" approaches that are being adopted by organisations
in managing accounts receivable.
In the commercial world the way in which organisations manage their accounts
receivable has significant implications for the financial health of those organisations.
This creates an imperative to ensure the management of receivables is both efficient
and effective. The practices used in common business processes such as accounts
receivable management have universal application and are not industry specific. In this
regard there are lessons to be learned by others from the practices followed by
organizations for whom accounts receivable is a core business process. The better
practices discussed in this guide are therefore recommended for consideration by
Commonwealth government agencies.
Not all of the practices outlined in this guide will suit each agency’s circumstances,
however, it is considered that most agencies, which derive revenue on sale of goods
and services on credit terms, will benefit from benchmarking their current practices
against those detailed in the guide.
Introduction
Effective management of accounts receivable presents important opportunities for
agencies to achieve strategic advantage through improvements in customer service,
cash management and reductions in costs.
The primary objective of accounts receivable in the Commonwealth public sector is to
collect monies due and to assist in meeting cash flow requirements. An effective
accounts receivable function can assist in achieving the desired cash flow outcome
through the timely collection of outstanding debts.
All agencies also have an objective of continually improving customer service. A large
number of agencies which operate as businesses are required to perform public
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services under a full or partial cost recovery arrangement. Effective accounts receivable
management can assist agencies improve customer service through providing timely
information on customer requirements and by making dealing with the agency as easy
as possible.
All government agencies, including those operating in a monopoly, are required to
demonstrate contestability - that is delivery of a high quality standard of service at a cost
that is comparable to providers of similar services operating in similar environments.
Improvements in accounts receivable management which reduce the cost of collecting
monies can improve an agency’s ability to demonstrate contestability and accountability.
Importance of Organizational Culture
An international receivables management benchmarking study commissioned by the
Australian Taxation Office has highlighted the importance that organizational culture has
in the successful management of accounts receivable. The study, which involved the
survey of five international taxation agencies and eight domestic organizations for which
accounts receivable is a strategic issue, indicated that management attitudes need to
support practices for minimization of debt.
All agencies should adopt a culture whereby staff are encouraged to obtain payment,
where required, and not just focus on program or service delivery.
The Accounts Receivable Process
A typical accounts receivable process is mapped below.
The process commences with a receipt of a customer order and ends with the collection
or write off of a debt.
Financial management functions such as accounts receivable have been traditionally
viewed as transaction processing activities. An international benchmarking study
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referred to in the Paying Accounts Better Practice Guide issued by the ANAO in
November 1996 indicated that up to 65 per cent of time was spent on non-value added
activities across all government and industry sectors. The study suggested that the
elimination or reduction of non-value tasks can be effected through better work
practices and automation of
processes. This can be achieved by analysing current processes and redesigning them
to remove as much manual intervention as possible, reducing rekeying and appraisal
activities and minimizing operator error. An important part of this analysis is a formal,
structured risk assessment which identifies and measures exposures associated with
the accounts receivable process.
The following diagram highlights the opportunities available for improvement through
better practices.
Significant advances in accounts receivable performance and process efficiency are
available to agencies through the following five complementary key management
initiatives:
•
Re-engineering accounts receivable
•
Risk assessment
•
Use of advanced technology
•
Debt collection processes
•
Performance Measurement
These matters are addressed in the following chapter.
Re-engineering accounts receivable
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Some large private sector organizations have achieved real cost reductions and
performance improvements by re-engineering the accounts receivable process. Reengineering is a fundamental rethink and re-design of business processes which
incorporates modern business approaches.
The nature of accounts receivable is such that decisions made elsewhere in the
organization are likely to effect the level of resources that are expended on the
management of accounts receivable. An illustration of this point is the extra effort that
must be put into debt collection where credit policy is poorly administered or too freely
given. The strong linkages between different processes means that true improvements
cannot be achieved without focusing on all aspects of the management of accounts
receivable.
The following better practices present opportunities to improve the accounts receivable
function.
Centralized Processing
A better practice for the delivery of finance services is the adoption of centralized
processing for finance functions such as accounts payable and accounts receivable.
Centralized processing groups are typically high volume transaction processing centers
servicing multiple operating groups. Their establishment achieves a number of benefits
for the organization. These include the achievement of a high degree of specialist
expertise in the function supported, the establishment of centers of excellence that
develop and enforce common practices and standards and the achievement of cost
efficiencies
through the co-locating of systems and staff. The establishment of these centres also
frees up other staff for more value adding work.
One private sector firm reduced its total finance staff numbers by 12 per cent through
centralized processing.
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Standing Payments
Research into better practice indicates that repayment rates are significantly enhanced
by providing customers and debtors with alternative payment approaches. In addition to
there being alternative payment methods there are also alternatives to issuing invoices
in the traditional accounts receivable processing approach. These alternative payment
strategies result in efficiencies in the management of accounts receivable.
An approach that is available to agencies which deliver services on a regular basis
resulting in recurring invoicing and receipting cycles is to arrange for the provision by
customers of standing payments. An annual or bi-annual settlement can be undertaken
to reconcile payments to services provided. The process can be facilitated by providing
customers with regular updates of fees charged.
The benefits of this approach to the service providers is the reduction of costs through
the removal of the need for an invoicing and debt collection function and the more timely
receipt of revenues. There is also benefit to the customer through the streamlining of
payment processes. The approach is most effective if adopted in conjunction with
payment by direct debit of customer bank accounts.
Alternative payment options
Private sector organizations and public authorities are finding that payment of accounts
outstanding is likely to be quicker where a number of payment alternatives are made
available to customers. They also find that the availability of convenient payment
methods is a marketing tool that is of benefit in attracting and retaining customers.
The following modern payment methods are available and provide the benefits of added
customer service, reducing remittance processing costs and improving cash flow
through faster debtor turnover.
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Direct debit - involves authorization for the transfer of funds from the purchaser’s bank
account; this approach has the advantage of reduced processing costs, however it can
present security exposures.
Integrated Voice Response - a system which combines use of human operators and a
computer based system to allow customers to make payments over the phone,
generally by credit card; this system has been proved highly successful in organizations
which process a large number of payments regularly.
Outsourced Agency Collection - payments are collected by an external agency under a
contractual arrangement (e.g. Australia Post). The payment method
under this approach can be either cash, check, credit card or EFTPOS. This method
increases flexibility and convenience to the customer which may lead to improvements
in the rate of payment. A variant on this approach is BPAY, a system whereby banks act
as outsourcing partners by collecting payments from suppliers’ customers and directly
crediting supplier accounts.
Lock Box processing - an outsourced partner captures check and invoice data and
transmits the file to the client agency for processing in that agency’s systems. This
approach transfers the cost of data collection to service provider.
Other payment methods such as use of data kiosks by customers in public use areas
and payment for goods and services via the Internet are likely to become readily
available in the near future.
Each of the above payment types have advantages and disadvantages which are likely
to be peculiar to the environment that particular agencies operate in. Agencies need to
balance the benefits in both the payment and receipting processes against the costs
that some payment options may present to the agencies themselves.
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Marketing and educational activities can be used to promote timely payment.
Agencies should provide information on the nature of products or services available, the
required payment cycle, payment options available and the consequences of non
payment.
Customers should be aware of their liability at all times. A practical way of achieving this
objective is the issue of monthly customer statements.
Use of Payment Incentives
Private sector practice has been to, over time, reduce the level of reliance on
discounting as an incentive for prompt payment. However, the practice is still used in
government instrumentalities in Australia and should be considered by agencies which
have problems with debtor turnover. Discounting can be used as an incentive for
customers to pay upon receipt of services, thereby avoiding the use of credit terms.
Whilst discounting has the advantage of potentially shortening the average collection
period it also reduces net revenue. Before deciding to offer discounts agencies should
conduct an analysis of the effect that the utilisation of discounting will have on net
revenue. This estimate should be balanced against the costs of continuing to hold
receivables at their existing levels, which is effectively the market interest rate applied to
the annual carrying cost of receivables. Another issue for consideration is the alternative
uses to which the funds tied up in receivables could be put.
In addition to developing a range of incentives for early payment agencies should
consider the imposition of penalties on late payment. In designing penalties agencies
should be aware of legislative and policy considerations which may reduce the potential
for major penalties such as removal of service.
Case management approach
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Where individual customers have strategic importance to the agency a case
management approach may be adopted to the management of the agency-customer
relationship. Under this approach all aspects of the relationship are drawn together
including debt management. The increased knowledge of the customer that derives
from the adoption of a case management approach can assist in the design of
strategies for the prompt repayment of debt.
Risk assessment
Risk assessment is a major component in the establishment of an effective control
structure. Once risks have been properly identified, controls can be introduced to either
reduce risks to an acceptable level or to eliminate them entirely. A proper risk
assessment also creates opportunities for freeing processes from inefficient practices.
In managing accounts receivable the key areas that management should focus on for
the purpose of conducting a risk assessment are:
•
debt management processes, and
•
outstanding debts and debtors.
Debt management processes
The risk analysis involves a re-think of processes and questioning the way that tasks
are performed. A risk assessment opens the way for efficiency and effectiveness
benefits in the management of accounts receivable. In particular, processes can be redesigned to achieve the following benefits:
•
the establishment of clear and concise policies for issuing credit and for
recovery of debt;
•
the removal of non value adding tasks and clarification of roles and
responsibilities, by, for example, streamlining delegations;
•
the establishment of controls where exposures are noted;
•
allowing staff to apply more initiative and ingenuity to every day tasks and;
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•
the identification of new and more effective ways of delivering services.
A credit policy document is a key component of the accounts receivable control
environment and needs to cover all aspects of revenue and debt collection practices. It
needs to be:
•
written in plain English so that it is understandable by staff and customers;
•
accessible to all staff who are required to administer it; and
•
made available to customers in summary form. In addition, it should
•
establish a financial threshold under which it is uneconomical to pursue
recovery action;
•
set down criteria against which a debt might be considered for waiver;
•
be kept up to date. This means it should be reviewed at regular intervals so
that consideration can be given to incorporating new practices or initiatives,
and
•
be endorsed by executive management
Agencies should be aware that the credit term set in a credit policy will have a direct
impact on their terms of trade.
A checklist of features which should exist within a good policy document is included as
an appendix to this Guide.
Outstanding debts and debtors
The application of a credit policy will not be fully effective unless there has been a
comprehensive risk analysis of the customer population performed. This can be
achieved by having detailed information on the characteristics of customers (and
potential customers) and through the establishment of criteria against which to assess
the credit worthiness of individual customers.
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The criteria needs to be laid out in the credit policy. Sufficient information on customers
will need to be held on a comprehensive customer database. Key components of the
database are:
•
billing name and address;
•
credit information;
•
place of purchase;
•
date of purchase;
•
special service requirements (will vary with the nature of the service);
•
method of payment;
•
payment history; and
•
customer type.
This database will need to be regularly maintained and updated.
Use of Advanced Technology
Advances in technology present an opportunity for improvement in accounts receivable
processes. The principal innovations available are the integration of systems used in the
management of accounts receivable, the automation of debt collection processes and
the use of electronic commerce.
Systems Integration
Improvements are available from the integration of the revenue and accounts receivable
systems. This integration results in remittances being automatically credited against a
customer account with a simultaneous update of the general ledger. This process
avoids the downloading of data and re keying.
A fully integrated system could exhibit some or all of the following features:
•
electronic invoice; which extracts details from database of approved
customers, credit terms and which is authorised electronically;
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•
quantity, price and account code for sales entered once only, on invoice;
•
electronic notification of delivery of goods/services;
•
customer and account code details extracted automatically from
customer order for payment;
•
automation of reminder letters, and
•
automatic triggering of write-off or waiver action.
Electronic Commerce
Electronic commerce is a term applied to the use of computer and telecommunications
technologies, particularly on an inter organisational basis, to support trading in goods
and services. It uses technologies such as electronic data interchange (EDI), electronic
mail, electronic funds transfer
(EFT) and electronic catalogue systems to allow the buyer and supplier to transact
business by exchanging information between computer applications systems. This
achieves cost savings by removing the need for direct negotiation between the parties.
The Commonwealth government has required departments, through its
Commonwealth Electronic Commerce Service, to ensure that all suppliers and potential
suppliers of goods and services are given the opportunity to transact their business
electronically. In its Statement of Direction on electronic commerce issued in July 1996
the government noted:
"There is, in addition, an unrealized potential for the wider application of other electronic
commerce technologies."
The Statement indicated that individual departments should:
"take account of the opportunities offered by electronic commerce in their business
planning processes, and include in their information technology and telecommunications
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strategic plans relevant provisions covering the use or intended use of electronic data
interchange both for core functions and in support applications."
The objective of the Commonwealth Electronic Commerce Service to date has been to
promote the use of electronic commerce by government agencies in purchasing. It is
proposed to extend the system to payment of accounts in the near future. In situations
where the government service recipients are other government agencies or non
government organizations which operate IT systems which have electronic commerce
capabilities the potential exists for use of electronic commerce in accounts receivable.
This potential is likely to increase in the future.
Debt Collection processes
Debt collection processes should be undertaken with the objective of reducing
outstanding accounts while keeping sight of the need to maintain customer goodwill, in
an environment of cost restraint.
Better practice in debt collection includes the following:
•
assessment of debts against a financial threshold before proceeding with
recovery action;
•
review of the accuracy of invoices following failure by debtors to respond to a
letter of demand;
•
categorize debtors in accordance with their ability and willingness to pay.
•
Tailor debt collection processes in accordance with results of this analysis;
•
prioritize debt on the basis of risk indicators. The indicators could include the
payment history of the customer, debt level, demographics, etc;
•
communicate directly with debtors most probably by phone and obtain
personal commitment as to repayment schedule;
•
staff have the authority to negotiate payment options within guidelines,
without further approval from management;
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•
treat debt collection as a specialist function. Recruit specialists as required
and provide appropriate training; and
•
consider outsourcing all or part of the debt collection process to a private
collection agency. Where debt collection is outsourced agencies should
ensure that the Information Privacy Principles as laid down in the Privacy Act
1988 are complied with.
Of vital importance in the design of debt collection procedures is the need to be
proactive about the recovery process. Credit industry advice is that the more a debt
ages, the greater is the risk of non recovery. Estimates are that allowing a debt to age
more than 90 days increases the risk of non recovery by at least 20 per cent.
Performance Measurement
An integral part of the re-engineering of any finance function is to develop a suite of
indicators which will measure progress over time.
The following tables may be used by agencies both to establish performance indicators
and to measure improvements which result from re-engineering the accounts receivable
process. Each list should be modelled and adapted as necessary to suit the
requirements of individual agencies.
Table 1 is an example of a type of value analysis. Under this approach the data on time
spent on each part of the process would most likely be based on estimates. The benefit
of this approach is that it makes clear to managers the proportion of time that is spent
on non value adding activities in the accounts receivable cycle. This type of analysis is
not an absolute indicator of cost effectiveness of processing as it takes no account of
costs, however, it does demonstrate the interrelationship between the various steps in
the process and therefore opportunities to reduce non value added activities.
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Table 2 provides examples of the types of performance indicators that agencies can
use to measure themselves against both standard and best practice, at a point in time
and over time.
Following is an outline of the possible uses of some of the measures of effectiveness
in accounts receivable management:
Debtors turnover - This ratio measures the average period for which sales revenue will
be held in accounts receivable. This measures the efficiency and effectiveness of
receivables collection.
Accounts Receivable to Revenue ratio - This ratio can be used to highlight trends in
the level of investment in accounts receivable. Where accounts receivable as a
proportion of monthly revenue exceeds an established bench mark, thereby indicating
the possibility of interest foregone, the matter can be highlighted for management
attention.
Receivables Aging Schedule - This schedule is a listing of debtors by aging category.
Analysing this schedule allows Accounts Receivable management to spot problems in
accounts receivable early enough to protect the agency from major revenue problems.
It may also assist in highlighting individual delinquent accounts.
In addition to measuring the effectiveness of the accounts receivable process as a
whole specific debt collection techniques and their effectiveness should be monitored.
This information can be used when assessing alternative debt collection strategies. It
is of assistance when conducting assessments of this type to be cognisant of the costs
of the relative collection strategies.
An important consideration in this process is the cost of measuring and analysing
performance data. Where possible agencies should seek to have performance
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information on activities such as accounts receivable part of their Financial
Management Information Systems. The current move of
Commonwealth agencies from cash based accounting systems to accrual systems
presents an opportunity for agencies to include the production of performance
information as a feature of any new systems.
It is also critical that reports be timely, present information in a readily digestible
fashion and that they are directed to the appropriate levels of management. Reports
presented to higher levels of management are more effective when they are presented
in summary form, often with table or chart form presentations. Reports containing too
much data are unlikely to be effective. Better practice would be to obtain management
input into the design of reports to ensure that the reports are used as intended. A good
starting point in designing management reports is to carry out a survey of users to
establish what they like and dislike about the current suite of reports.
Table 1 - Example of Value Analysis of Accounts Receivable Activities
Activity
Value
Hours
Set price
VA
Grant credit
BR
Make sale
VA
Issue Invoice
BR
Update receivables ledger
BR
Accounts Payable and Receivable
Current
Current Target
% Time
Hours
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Deal with customer inquiry
NVA
Receipt payment
VA
Issue monthly statement
NVA
Issue letter of demand
NVA
Determine repayment schedule with NVA
debtor
Match payment to invoice BR
Code: VA - value adding; NVA - non value adding; BR - business
requirement
Table 2 - Suggested performance indicators
Indicator
Current
Target
Common
Best
Benchmark
Practice
Bench
mark
Efficiency Measures
Invoices processed per
Time Equivalent
Full
1000
5000
2000
8000
(FTE) staff
member per month
Remittances processed
per
FTE per month
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Debtors contacted per FTE
per month
Direct
labour
cost
per
*
invoice/remittance/debt
collection action
Cost of accounts
receivable
0.3%
0.15%
as a percentage of revenue
from credit sales
Cost of accounts
receivable
as a proportion of total administrative costs
Effectiveness Measures
Accounts Receivable as a percentage of total revenue
Debtors turnover i.e average time to collect
Debt written off as a percentage of total debt
Doubtful debts as a percentage of total debt
Percentage of debts collected within terms of trade
Debtors by age group as a percentage of total debt
-aged 30 to 60 days
-aged 60 to 90 days -aged > 90 days
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Proportion of debts settled by electronic means, i.e EFT
#
30 days
23 days
10%
1%
f
50%
90%
30%
15%
20%
10%
15%
5%
10%
100%
costs will vary with the nature of invoice production and issue, the nature of
remittance and the type of debt collection action
dependent on nature of business
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a relatively low figure will indicate better practice, however, the level of doubtful
debts will be influenced by factors outside accounts receivable management
such as accounting policy
Appendix
The following is a checklist of features which should exist within a good policy or
procedure document.
The policy is endorsed by an Executive Officer
The policy is based on a risk assessment of the agency and it’s customers. This is
recognized in the document by stating the risk factors.
The policy:
•
Explains the nature of debts and debtors
•
Outlines the agency’s rights and duties with debtors; and legal
consequences.
•
Details the terms of trade and circumstances when a delegate may
change the terms of trade
•
Identifies other related procedure manuals, legislation which can guide
processing of debts.
•
Outlines mode of payment accepted and under what conditions (eg any
transaction less than $1,000 must be by credit card)
•
Identifies mechanisms for reviewing requests from debtors
•
Outlines general procedures for handling unusual requests or events
•
Outlines who is responsible for debt collection
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•
States how and when to communicate with a debtor regarding an
overdue amount
•
States procedures to recover debts from employees
•
Lists options for recovering an overdue debt (eg allow instalments)
•
Describes the use of commercial debt collection agencies
•
Identifies whom has the authority for determining the mode of collecting
an overdue debt (eg instalments) and identifies circumstances to guide
the decision.
•
Identifies when to record a debt as overdue (including whether a period
of grace applies).
•
Details procedures for imposing charges
•
Details the preparation of and requirement for certain report production
•
Identifies means of monitoring debts
•
Outlines the process of managing dishonored checks
•
Lists circumstance when debts no longer need to be pursued and whom
has the authority to decide not to pursue a debt
•
States clear and comprehensive standards of performance (including the
desired relationship with the customer) and targets for the timing of debt
collection (eg 80% within 30 days from date of invoice).
•
Details the requirement to review the policy and procedures - when, whom by
Author:
Title: Management of Accounts Receivable
URL: www.ahao.gov.au/uploads/.../Management of Accounts Receivable.pdf
Date Published: December 1997
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ANALYSIS/SYNTHESIS:
We notice the complexicity of the AR and AP in different firms, from household AP/AR
to a commercial and business organizations. They have different Payables components.
Same is true in what they receive. But one thing in common that matters most is the
generation of a specifically detailed report that an accountant can rely on. Though it
differs from time-to-time updates (weekly, monthly, quarterly, annually, etc.), they still
spread out the clear details of where the company's budget is allocated. They also have
a good communication along with the governing bodies of law that constitutes their
economical process. Of course, each company mentioned above has a unique set of
computations of their accounting process. We observed how relevant the AR/AP
process in accounting. It serves as a "balancer" in accounting core group. But due to
economic differences, some AP/AR structural figures are differently defined along with
other accounting subsystems.
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BESTLINK COLLEGE OF THE PHILIPPINES
College of Information Technology
#1044 Brgy Sta. Monica, Quirino Hi-way Novaliches, Quezon City
Questionnaires :
1. Can we have the origins of the previous system being used?
2. What is the difference between AR and AP? (Accounts
Payable/Receivables) in your system?
3. What particular accounts do you handled difficult?
4. Can we know how you compute the AP/AR in your existing system?
5. What specific reports do you issue?
6. Who is/are the personnel using the system?
7. In your case, as a Security Agency, what particular payables and
receivables do you have?
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8. Do you use Purchase Order? How?
9. Do you use Receiving Reports? How it goes along with the system?
10. How about the Vendors invoice.
11. Can we have a sample of your forms/reports?
12. How do you update your account payables and receivables? Is it weekly,
monthly, quarterly, etc?
13. Do you encountered problems while using the system?
14. Can we know the System’s scope?
15. When using the system, do you have in mind that you must have an
assistant? Why or why not?
16. How the Manager/Head monitors the transaction process?
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17. What database management you use?
18. How can you describe its connection with your treasury system? Can we
view them?
19. Just in case, what particular perspective do you want to your existing
system to change?
20. Is this system can be operated only by accountants, or it is an easy-to-use
to other assigned personnel?
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