Monitoring the Debtors Techniques (DSO, Ageing Schedule)

10/06/2020 1 By indiafreenotes

1. Ratio Analysis for Control of Receivables:

The analysis of receivables can be done with the help of ratios given below for efficient management of debtors balances:

(a) Debtors Turnover Ratio:

Credit Sales / Average Debtors

(b) Average Credit Period (in days):

(Average Debtors / Credit Sales) * 365

(c) Debtors to Current Assets Debtors:

(Debtors / Current Assets) * 100

(d) Debtors to Total Assets Debtors:

(Debtors / Total Assets) * 100

(e) Bad Debts to Sales:

(Bad Debts / Sales) * 100

(f) Bad Debts to Debtors:

(Bad Debts / Debtors) * 100

The above formulae can be used to analyze the efficiency in management of receivables and to analyze the trend over a period of time.

Ageing Schedule:

The ageing schedule of debtors is prepared basing on the collection pattern. The total debtors balances are classified according to their age i.e. the outstanding period for which the amount is uncollected. The ageing schedule provides useful information for assessing the company’s liquidity position, efficiency of credit control department, efficiency in collection of receivables, comparison with previous ageing schedules etc.

The age analysis of debtors may be used to help decide what action to take about older debts. For better control on collection of receivables, ageing schedule is prepared and analyzed for identifying the overdue amounts. Ageing schedule of receivables is prepared according their period of outstanding, for example, less than 30 days, 31-45 days, 46 – 60 days, 61-75 days, 76-90 days, above 90 days etc.

The ageing schedule of debtors can be prepared manually or by computer. Preparation of the schedule requires to go back to the date on which invoice is raised. The schedule is used for identifying the quality accounts, overdue accounts and trouble some accounts. The age schedule can also incorporate the details of individual accounts, region wise accounts, industry sector wise accounts etc.

2. ABC Analysis of Receivables:

The ABC analysis technique mainly framed for effective control of inventory. The application of the same technique to manage the debtor’s balances will also give good results for the firm with huge number of accounts.

It is seen from the above table that only 20% of the total accounts represents the 70% of total debtors balance and a close scrutiny of these accounts and realization of dues in time will cost only moderately and improves the efficiency of debtors collection and also improve the liquidity of the firm and avoids unnecessary blockage of funds in debtors balances which can be invested elsewhere to obtain the opportunity cost of funds. To large extent it avoids the administration costs also.

Category B debtors balances needs moderate control and Category C balances, though large in number, but are very less in amount to the proportion of total debtors and the managerial attention should not be diverted to these balances. However, it also requires moderate attention for efficient management of debtors.

3. Discriminate Analysis and Credit Scoring:

Discriminate Analysis:

It is an important tool used for discriminating between good and bad accounts taking into account the readily available information from financial data relating to size of firm, acid test ratio, creditors payment period etc.

Credit Scoring:

It is a technique used in discriminating between good and bad accounts based on past repayment and default experience relating a particular customer. The credit scoring is given for each such customer and credit facility is extend if he exceeds the cut-off score.

4. Credit Utilization Report:

The total limit of credit offered to each customer and the extent to which it is utilized will be reviewed on periodical basis to observe the extent to which total limits being utilized. All this information is presented in a report form called ‘credit utilization report’.

An example of the report is given below:

This report will also contain the other information, such as day sales outstanding and so on. This report will reveal the following:

(a) The number of customers who might want more credit.

(b) The extent to which the company is exposed to debtors.

(c) The tightness of the credit policy.

(d) The degree of exposure to different customers.

5. Cost-Benefit Analysis of Collection Expenses:

A firm has to incur some routine costs like sending reminders, telephone expenses, expenses incurred for personal visits to customers’ places, commission and fees payable to collection agencies, legal expenses etc.

When the firm incurs more costs on collection of debts, there is likely to be less amount of debts turn into bad debts and vice versa. If the firm goes on increasing the cost of collection of debts, after- some point, there would not be further decrease of bad debts. The point is called ‘saturation point’ as shown in figure 16.1, if the firm incurs collection expenses beyond this point, cannot benefit the firm in reducing its bad-debt losses.

6. Measuring Day’s Sales in Terms of Debtors:

The total debtor represented by day’s sales is calculated in the following three ways:

Debtors Turnover Method:

The days sales in debtors ratio represents the length of the credit period taken by customers.

Count Back Method:

This method is based on the assumption that the debtors balance relating to the most current period sales.

Partial Month Period:

This method analyses each months sales and the unpaid portion. These are aggregated together to get days sales of debtors.

The partial month method not only provides the overall debtors ageing figure but also provides month-wise debtors outstanding.