Receivables management explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Every sale on credit is a loan to the customer, and the money stays out of the business until it is collected. A longer credit period wins orders but carries costs; a shorter one protects cash but may lose customers. This guide shows how a wholesale trader tests the choice with figures, reads an ageing schedule and judges factoring.
Receivables management weighs the extra profit from credit sales against the cost of the funds locked in debtors and the bad debts that follow. For a change in credit policy: incremental contribution - incremental carrying cost - incremental bad debts = net gain or loss. Investment in debtors is measured at variable cost, not at sales value. Adopt the change only if the net figure is positive and the bad-debt assumption survives a stress test.
What debtors cost and what you need
Carrying debtors costs money in four ways: the interest or opportunity cost of the funds tied up, the collection effort, bad debts and the risk that customers delay beyond terms. Data needed: credit sales, the variable cost ratio, the present and proposed credit period, expected change in sales, bad-debt rates, the cost of funds, and the ageing of current debtors. A firm that wants a collection process set up alongside its books can look at cash flow management support.
Credit policy: the elements
Credit standards decide who gets credit (judged on payment history, capacity and security). The credit period is the time allowed; a cash discount is a reduction for early payment; collection policy fixes how soon and how firmly reminders are sent. The incremental test compares what is gained with what is spent on funds and losses.
| Item | Formula in words |
|---|---|
| Incremental contribution | Extra sales x contribution ratio |
| Investment in debtors | Sales / 360 x credit days x variable cost ratio |
| Carrying cost | Increase in investment x cost of funds |
| Incremental bad debts | New bad debts - old bad debts |
| Net gain | Incremental contribution - carrying cost - incremental bad debts |
Worked example: Sethi Wholesale Traders
Sethi Wholesale Traders, an invented trader, sells ₹600 lakh a year on 30 days' credit. The variable cost is 80 per cent of sales, so contribution is 20 per cent. Proposal: allow 60 days. Sales are expected to rise 15 per cent to ₹690 lakh. Bad debts would rise from 0.5 per cent to 1.5 per cent of sales. Cost of funds is assumed at 12 per cent. A year is 360 days, and customers are assumed to pay exactly at the end of the credit period.
| ₹ lakh | Present (30 days) | Proposed (60 days) | Difference |
|---|---|---|---|
| Sales | 600 | 690 | +90 |
| Contribution at 20% | 120 | 138 | +18.00 |
| Investment in debtors: sales / 360 x days x 0.80 | 600 / 360 x 30 x 0.80 = 40.00 | 690 / 360 x 60 x 0.80 = 92.00 | +52.00 |
| Carrying cost at 12% | 52 x 0.12 = 6.24 | ||
| Bad debts | 0.5% x 600 = 3.00 | 1.5% x 690 = 10.35 | +7.35 |
| Net gain | 18.00 - 6.24 - 7.35 = +4.41 |
The extension adds ₹4.41 lakh a year. The result is sensitive to the bad-debt rate: break-even is where 690 x x - 3.00 equals 18.00 - 6.24 = 11.76, so x = 14.76 / 690 = 2.14 per cent. If the new customers turn bad at more than 2.14 per cent of sales, the change loses money. The owner therefore tries the longer period for chosen customers, with a credit limit, and monitors bad debts after three months.
Cash discount. An offer such as 2 per cent for payment within 10 days, otherwise 30 days, is another way to speed cash. Its annual cost to the seller is 2 / 98 x 360 / 20 = 0.0204 x 18 = 36.73 per cent. That is higher than the cost of bank funds assumed above, so for Sethi the discount is dear unless many customers take it and the saved bad debts are large. The same arithmetic applies on the other side: if a supplier offers 2 per cent for payment in 10 days against a 30-day term, skipping the discount costs the buyer 36.73 per cent a year. Cash taken from a bank at 12 per cent to pay early is cheaper than losing that discount. A buyer should also keep payments to micro and small suppliers within the statutory period; see MSME vendor status and the 45-day rule and buyer compliance on MSME payment. The guides state the rule; this article does not.
Ageing schedule and collection follow-up
An ageing schedule groups debtors by how long they have been outstanding: not yet due, 1 to 30 days overdue, 31 to 60, 61 to 90 and above. It shows where money is stuck, which customers pay late and how much may be doubtful. The schedule III format for ageing is covered in ageing schedules. Use it weekly: call at the first sign of delay, stop supply to accounts past a set age, and review the debtor's limit. The average collection period (debtors / sales x 360) and the proportion overdue tell you if the policy is working.
Factoring
Factoring sells the invoices, or borrows against them, with a factor who advances part of the amount and collects from the customer. Illustration with invented terms: invoices of ₹10 lakh due in 60 days; the factor advances 80 per cent (₹8 lakh), charges 14 per cent a year on the advance and a fee of 1 per cent of invoice value (₹0.10 lakh). Interest = 8 x 0.14 x 60 / 360 = ₹0.1867 lakh. Total cost = 0.1867 + 0.10 = ₹0.2867 lakh on an advance of ₹8 lakh, or 3.58 per cent for 60 days, about 21.5 per cent a year (3.58 x 6). Against that, the firm saves collection effort and may carry less bad-debt risk if the arrangement is without recourse. Forfaiting, a similar tool for export bills, is a topic of its own.
Common mistakes
- Measuring the investment in debtors at sales value instead of variable cost.
- Ignoring the extra bad debts and collection costs.
- Assuming customers pay exactly on the due date.
- Forgetting the effect on stock and creditors; see working capital cycle.
- Offering a discount without comparing its annual cost with the cost of funds.
- Never reading the ageing schedule.
Need help with collections and cash?
If overdue debtors are straining your cash, our cash flow management service helps you set credit limits, reminder cycles and a weekly ageing review. We use your own sales ledger so that the policy suits your customers and your cost of funds.
Key takeaways
- Each credit sale is a loan; test changes by incremental contribution against carrying cost and bad debts.
- Measure investment in debtors at variable cost.
- A cash discount can be dear: work out its annual rate.
- Read the ageing schedule regularly and act on overdue accounts.
- Compare the cost of factoring with your cost of funds, not just the convenience.
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Disclaimer: The methods described are standard cost accounting and financial management techniques. The worked example uses an invented business and invented figures, including any tax, interest or exchange rate, which are assumptions for illustration and not current rates. Where the article refers to a legal requirement, the linked guide and the official text should be checked. This article is general information, not legal advice; check the official text before acting.