Chapter 7: Solutions to enhance receivable management in
7.2 Solutions to enhance receivable management
To achieve goals, Agrexport needs some solutions for its receivable management.
In the following part, I will mention some solutions for receivable management in Agrexport:
7.2.1 Applying cash discount to encourage early payment
Cash discount is an incentive that a seller offers to a buyer in return for paying a bill owed before the scheduled due date. The seller will usually reduce the amount owed by the buyer by a small percentage or a set dollar amount. If used properly, cash discounts improve the average-collection-period aspect of a business's cash conversion cycle.
At the present, Agrexport do not grant cash discount for all types of customers.
Because client firms do not have advantage of early payment, they do not pay receivable earlier. It is one of most important reason resulting in the long average collection period and high bad debts.
In fact, granting cash discount brings threes benefits. Firstly, cash will be collected sooner, thus decreasing the need for cash to invest or use in operating activities. Secondly, cash discount will stimulate sale because a discount is a price reduction. Thirdly, that customers pay debt early will reduce the occurrence of bad debts. In conclusion, applying a cash discount will reduce the cost of maintaining account receivable. However, cash discount may bring the loss in sale for firms due to the deduction in revenue. Therefore, firms need to weigh the change in collecting indicators and the ratio of bad debts and the loss in revenue.
7.2.2 Building up customer’s credit rating
As stated above, Agrexport classify customers into new customers and traditional customers. Traditional customers also categorized into 2 kinds based on their credit history. This type of classification just reflects the customers’ situation in the past, and skips its current situation. In fact, even owners of client firms with good credit history in the past may not pay their debt in the future due to its financial difficulty and unwillingness to pay. Thuy Anh is a typical case.
To avoid that situation, Agrexport must build a system of classifying customers based on its credit rating. Firstly, firms need to collect information of customers. Such information includes firms’ customer data, its financial statement, bank assessment and especially recent customers’ activities which may influence much on firms’ financial situation. In the second stage, customers’ financial status are analyzed and graded based on its ability to pay debt from A-F. The first two A, B are the ones who receive best assessment due to good current financial status and good credit history, thus firms believe most in their ability to pay debt. These customers are also the ones who have longtime relationship with firms, and account for substantial part in firms’ revenue.
Therefore, firm should grant the most relaxed credit policy for such type of customers.
The two following C, D are the one owned less ability to pay debt and the two last ones have highest probability to occur bad debts. It may include firms who only have good credit history but currently facing with financial difficulties and vice versa.
New customers who receive good assessment from firms may be classified in these categories. For this type of customers, firms may grant more rigid credit policy than ones in categories A and B but less strict than ones in E and F categories. In addition, firms should regularly update about its operating activities to have suitable reminding approaches and collection methods to reduce the occurrence of bad debts.
If customers do not satisfy the requirement about credit history or current financial status, they will be graded as E and F categories. For these customers, request of cash payment is necessary.
To select suitable credit policy, firms should frequently follow up customers’
financial status and thus give exact assessment about its ability to pay debt. Customers who face difficulties and do not satisfy the requirement in A or B categories should be moved into the lower ones. Conversely, new customers who create credit history after several transactions should be upgraded in the higher categories, and grant the better credit policy. This activity will not only limit the risk of bad debts due to wrong assessment but also build up the relationship with new customers.
I recommend the process of building customers’ credit rating is described through the following figure:
Figure 8: Process of building customer’ credit rating
(Source: http://www.encyclopediaofcredit.com) 7.2.3 Improve employees’ competence
Employees are the one who directly assess clients, and exercises credit sale, therefore employees’ abilities to analyze customers’ financial status will take considerable account for efficiency in receivable management. To ensure the quality in assessing customers’ financial situation, Agrexport need to pay attention to employees’
competence and set a suitable reward and penalty regime.
Firstly, employees must be educated about the effect of assessing customers’
financial status on receivable management and analyzing skills to give exact measures about customers’ conditions. Agrexport need to have a recruitment process to discover
Customers’ data Financial statement Bank assessment
Current financial activities Collecting data
Analyzing and grading customers
Selecting suitable credit policy
YES NO
and attract talents. In addition, Agrexport should organize technique- courses to improve employees’ financial analyzing skills. For employees in export-import businesses and financial and accounting department, such courses are very essential.
Courses should be taken place monthly, and teachers may be Agrexport’s AR-AP manager or specialists in receivable management. In case Agrexport is unable to organize such courses, Agrexport may encourage employees to take part in extra- courses by sponsoring tuition fees.
Secondly, it is necessary for Agrexport to develop a system of penalty for employees who arise overdue debts. For example, after 15 days overdue, the correspondent employee carries a penalty of bank interest rate of the overdue debt. At the end of the month, the punishment amount will be deducted from his salary. Such penalty regime will restrict employees’ irresponsibility in assessing customers’
financial health, thus reduce the risk of bad debts.
7.2.4 Organize a specialized department for debt management
Besides, there must be a specialized department for debt management. As stated above, just 2 accountants in Finance and Accounting Department followed receivable and this amount of workload becomes overloaded with 2 employees.
The specialized department for debt management may be integrated to follow up firms’ payable. It includes 1 AR-AP manager and accountants specialized for tracking receivable and payable. The AR-AP manager assists chairman in monitoring receivable and payable. He is charged with the proper invoicing within standard polices reflective of the customers requirements. He or she shall work with any and all personnel to assure timely and accurate invoicing and rating occurs. He will at times be required to interface with operational manager and occasionally with the Supervisor.
AR-AP manager has main following responsibilities:
Assure timely collection of monies due to corporation.
Monitor and report on deviations from credit standards.
Assure timely and accurate invoicing.
Manage cash application making sure all cash receipts are applied properly
Assure that the companies standard template regarding invoice sample is in place for every customer
Conduct credit checks on all customer, establish and manage limits
Make recommendations to improve quality of invoicing and collection procedures.
Weekly reporting of invoicing totals/aging totals/cash receipts/invoice adjustments
7.2.5 Building debt controlling system
Agrexport is a big firm and has many customers. As a result, Agrexport’s receivable also takes a considerable account. It is very essential for Agrexport’s board of directors to build a debt controlling system with professional techniques. The most characteristics of this system is the debt classifying.
In debt classifying system, debt are rated based on the level of risk, which is determined based on clients’ current financial situation as well as factors influencing on payment. The debt with lowest risk, or highest-quality debt, is ranked as A, followed by A- and B. The overdue debt is ranked as D, while the uncollectible debt is ranked as E. Most of Agrexport’s debts belong to A and B catergory. However, due to fluctuation in 2011, the amount of doubtful debt increase. Thus, classifying debt becomes very neccessary to Agrexport. In addition, classification of debt will also help Agrexport manage receivable more effectively, and have more effective collection solutions.
7.2.6 Factoring bad debts
Factoring bad debts is selling bad debts for factors who are specialized in collecting debts. Factoring occured when firms need cash immediately or do not want to waste time, effort and cost as well to collect debt. Thus, firms can solve their bad debts, improve its receivable management indicators and can focus on operating
activities.
Making decision of whether factoring or not is conducted after companies comparing the cost of factoring and the cost of maintaining debt. Firms should use factoring when they have substantial amount of bad debts for a long time. For Agrexport, due to the fluctuation in operating activities, the bad debts increased considerably in 2010 and 2011 with 3.5 billlion VND and 6.5 billion VND, respectively. If this amount is really uncollectible and Agrexport do not want to spend time and personnel in collecting debts, Agrexport may factor this debt. It will not only bring for Agrexport an amount of cash immediately to continuously invest and operate but also avoiding ruining the relationship between Agrexport and its customers.