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Collection Policy

It would be nice if all customers paid their bills by the due date. But they don`t, and, since you may also ¬stretch ­ your payables, you can`t altogether blame them. Slow payers impose two costs on the firm. First, they require the firm to spend more resources in collecting payments. They also force the firm to invest more in working capital. Recall that accounts receivable are proportional to the average collection period

(also known as days` sales in receivables): Accounts receivable = daily sales average collection period When your customers stretch payables, you end up with a longer collection period and a greater investment in accounts receivable. Thus you must establish a collection policy.

The credit manager keeps a record of payment experiences with each customer. In addition, the manager monitors overdue payments by drawing up a schedule of the aging of receivables. The aging schedule classifies accounts receivable by the length of time they are outstanding. This may look roughly like Table 2.11. The table shows that customer A, for example, is fully current: there are no bills outstanding for more than a month. Customer Z, however, might present problems, as there are $15,000 in bills that have been outstanding for more than 3 months.

When a customer is in arrears, the usual procedure is to send a statement of account and to follow this at intervals with increasingly insistent letters, telephone calls, or fax messages. If none of these has any effect, most companies turn the debt over to a collection agency or an attorney.

There is always a potential conflict of interest between the collection department and the sales department. Sales representatives commonly complain that they no sooner win new customers than the collection department frightens them off with threatening letters. The collection manager, on the other hand, bemoans the fact that the sales force is concerned only with winning orders and does not care whether the goods are subsequently paid for. This conflict is another example of the agency problem introduced earlier.

Good collection policy balances conflicting goals. The company wants cordial relations with its customers. It also wants them to pay their bills on time.

There are instances of cooperation between sales managers and the financial managers who worry about collections. For example, the specialty chemicals division of a major pharmaceutical company actually made a business loan to an important customer that had been suddenly cut off by its bank. The pharmaceutical company bet that it knew its customer better than the customer`s bank did and the pharmaceutical company was right. The customer arranged alternative bank financing, paid back the pharmaceutical company, and became an even more loyal customer. It was a nice example of financial management supporting sales.

COLLECTION POLICY

Procedures to collect and monitor receivables.

AGING SCHEDULE

Classification of accounts receivable by time outstanding.