Financial controls (Part 2)

I received an email from a reader asking me this question..." what kind of "financial controls" can we use to determine the effectiveness of our credit and collection department in managing our company's accounts receivables?"

Well, lets face it, whether you know it or not, you are directly or indirectly capitalizing your debtor by financing its business through your credit line and if ever this debtor of yours failed to pay you back in the agreed credit term, you are going to need more capital to further finance your accounts receivables. So it is a good practice to institute some financial controls to determine the effectiveness and efficiency of your credit and collection department.

There are many ratios that can be used, among these measures are;

Accounts Receivable Turnover.

This can be arrived by using this formula: Total Credit Sales ÷ Average Receivables Outstanding = Receivable Turn over rate. The receivables outstanding at the end of the accounting period is generally used rather than upon an average figure for the computation of the rate.

Unless, the business ending receivables may not affect materially the result. If the turnover rate is higher than the average in its industry its indicative that collections are promptly and effectively made; or, that with a given amount of funds invested in the receivables a bigger amount of credit business was made possible. Whether an opposite condition of the rate was attributable to either inefficient collection efforts or inefficient sales efforts must be determined by analysis of the collection index and the credit sales index.

Activity of the Investments in receivables may be as a rate or in terms of number of days needed for one revolution of the accounts receivables. Thus, it is arrive at by dividing 360 days by the receivable rate turnover as follows;

360days ÷ Receivables Turnover Rate =No. of day of credit sales outstanding (days of one revolution of accounts receivable)

Another way of availing at the number of days of credit sales carried in the accounts receivables is computed as follows; Accounts & Notes Receivables ÷ Average Daily Credit Sales = No. of days of credit Sales Outstanding. This measure in terms of days must not be confused with the number of days in the average collection period.

It might be also prudent for you to determine your Delinquency Index.

The objective here is to determine the proportion of all accounts receivable in number and in amount that is delinquent. Formula: Total Delinquent Accounts ÷ Total Accounts Receivable =Delinquency Index.

Successive computation by period of this index may serve as thermometer of the trend of delinquency whether it is improving or deteriorating. If the index or percentage increases faster than it should at any given period, proper task force collection efforts must be undertaken to stop the trend and bring back to normal the delinquency.

Editor's Note: Mr. Ed F. Limtingco, is the VisMin Manager of CIBI Information, Inc., a business information and receivables management company. He can be reached at 0917-7220521 or at [email protected]