Question

2 For the current year, the average settlement period for trade receivables at Sisi Company was 60 days. This figure is much higher than in previous years. What factors might have contributed to             this change in the ratio?                                                                                                                 (6)

Answer 1

• Account receivable collection period or settlement period measures the average number of days that credit customers usually make the payment to the company.
• The short period of days identified the good performance of collection or credit assessment, and the long period of days represents the long outstanding.

Accounts Receivable Collection Period or Settlement period= Average Receivables / (Net Credit Sales / 365 days)

or

Accounts Receivable Collection Period =365/ Account receivable turnover ratio

• if current year settlement period of trade receivable is more than previous year then the company must improve the ratio.
• Folowing are the factors that will help in favourable change in the ratio-

DEFINED CREDIT POLICIES

Design and document clear credit policies and encourage adherence of the same to reduced instances of delays in collection. A frequent revisit and modification of the policies will help adjust to the new environment.

COLLECTION EFFICIENCY

Increase the efficiency of the collections from debtors; some of it can be done by a dedicated team force. Insisting for a post-dated cheque, timely reminders, etc. can help in aiding faster collection.

OFFER DISCOUNTS FOR EARLY PAYMENTS

Designing discount structure for debtors who pay earlier than the credit period sanctioned will motivate some debtor’s payments to clear faster. The discounts can be designed keeping in mind the business’ return on investment or cost of short-term liability.

REWARD TIMELY PAYMENTS

rewarding debtors who have a history of timely payments will ensure timely or earlier payments by those debtors going forward.

DISCOURAGE LATE PAYMENTS

Charging interest to debtors who make payments beyond the sanctioned credit period can limit the number of debtors paying late. A stricter action could be to reduce/prohibit further sales to debtors who have a history of delay in payments.

NET OFF WHEREVER POSSIBLE

If there are credit purchases and credit sales with the same company; advising a net off payment at a defined interval can help reduce the debtors’ amount.

ANALYSIS REPORT

Generate a report on the aging profile of the debtors; which will highlight weekly collection due. Such analysis can help focus on the weeks where higher payments are due and aid in better working capital management.