Question

Question 1

Cash flow problems are a major cause of insolvency and it is often created by the delay in payments by customers. Cash flow planning involves making sure that a business generates enough cash at the right time to meet pressing liabilities.

For example, many manufacturing businesses have a cash cycle. They buy raw materials (parts) on credit and then manufacture goods, which they store as Inventory (stock). They then sell these goods on credit (funds, which may be due for payment from 1-3 months’ time). In the meantime, they have overheads and a workforce to pay. A problem for traders is that they expect credit customers to pay on time. This provides the cash to continue the credit cycle and to pay wages and other outstanding bills. Unfortunately, the cycle often breaks down because creditors are slow to pay. This leaves the firm with a cash flow problem.

a) Based on the information above, it has always been companies’ aim to have a favourable receivables turnover ratio. Discuss six strategies that can be implemented to reduce its receivable turnover in days.

b) You are a junior accountant in a Commercial Bank. Your senior accountant has asked you to prepare a report on whether to approve a loan of a well-established SME. Discuss five (5) factors you will be examining the SME before you decide whether to approve/decline a loan.                   

Answer 1

Six strategies that can be implemented to increase reduce accounts receivable turnover in days are as follows:

1. Building strong client relationships – It is not unknown that relationship with customers is of foremost importance when it comes to business. Therefore, small gestures like sending friendly emails, calling instead of emailing for following up for payments may speed up the process of collection.

2. Bill immediately – Immediately when a transaction happens, enterprises should raise their invoices on the customers. The faster that the customer receives the bill, faster would he release the payment against it.

3. Reduce the credit period – The credit policy of the enterprise may be visited. If customers are being allowed a credit period of 60 days, a lower credit period of 30 days or 45 days may be considered.

4. Frequent follow ups – An enterprise may also choose to regularly follow up with customers for their payment. For bigger organisations, a collections team may be set up to monitor when the last follow up was taken and when to follow up next.

5. Rewarding fast payments – An enterprise may consider offering rewards to its customers like discounts, free gifts etc. who make quick payment. This would motivate the customers in making fast payments.

6. Making payment system easy – By making available facilities like electronic transfer, cheque drop boxes, an enterprise may improve its collection of accounts receivable. One has to figure out the most convenient way in which the customer would be happy making payments and make the same available to him.

Five factors that may be examined while approving/declining a loan are as follows:

1. Working capital – The position of a company’s working capital has to be seen. A healthy working capital ensures that the company would be able to pay back the Bank easily.

2. Cash flows – The cash flows of a company should be thoroughly seen to understand that it generates sufficient cash to make regular payments to banks.

3. Accounts receivables and payables ageing – The lag in payments made by the customers of a company and the lag in making payments by a company to its creditors should be seen to understand if the company does not make/ receive payments on time.

4. Creditors and debtors – The list of creditors as on the date of applying for loan should be verified to see the existing liabilities that an enterprise has. Verifying the debtors is also very important to see if an enterprise has reasonable amount of debtors to cover the payment liabilities due to creditors.

5. Confirmation of creditors and debtors balances – Confirmation may be obtained from debtors and creditors to verify that the balances actually exist and are not fictitious.