CHAPTER 2

LITERATURE REVIEW
 CHAPTER 2

LITERATURE REVIEW

Mamo, David, (1994), Receivables financing as a source of working capital, Nursing

Homes, 8, vol.43, 28

Financing through a securitization of receivables does not create a liability. An asset

—the receivables --is sold for cash; no loan has been granted.

Banks and finance companies are the most obvious source of receivables financing.
Their lending decision is generally driven by an analysis of a borrower's financial statements.
Consequently it is common for a company's line of credit to be limited by how its debt
compares to its equity base (the ratio of debt-to-worth) or for the lender to set minimum
levels of solvency for the company (the current ratio or acid-test ratio).

Under these covenants, a lender limits his willingness to lend funds beyond a
predetermined point at which the company would be deemed either excessively indebted or
too short of cash for the payments it must meet. The receivables function as part of the total
collateral that the company pledges in order to strengthen its corporate commitment to
eventually repay the loan. In support of this, the company usually must periodically produce a
report (the borrowing base report) showing how much in receivables it carries on its balance
sheet.

Strischek, Dev, (2001), Looking for a vital sign in contractor accounts: The receivables
ratio, The RMA Journal, 10,vol. 83, 62-66

A contractor's receivables represent two significant elements of contractor cash flow

and working capital. Receivables constitute the major source of cash inflow, and payables
absorb a big share of cash outflow. A construction company's ability to extend credit to its
customers depends on its own trade creditors' willingness to wait for their payments from the
contractor's collection of its progress billing receivables. The delicate balance of receivables
and payables is key to the financial success of the contractor. Contract receivables take longer
to collect, and the trade creditors expect prompt payment. The receivables ratio is a quick-
and-easy test of contractor viability.

Colabella, Patrick; Fitzsimons, Adrian P; Shoaf, Victoria,(2009), FASB Proposes

Disclosures About the Credit Quality of Financing Receivables and the Allowance for
Credit Losses, Commercial Lending Review, 5,vol. 24, 35-40

Specifically, the proposed FAS would require a creditor to disclose information that
would allow credit analysts and other financial statement users to understand the following:

* The nature of credit risk inherent in the creditor's portfolio of financing receivables

* How that risk is analyzed and assessed in arriving at the allowance for credit losses

* The changes and reasons for those changes in both the receivables and the allowance for
credit losses

The proposed FAS would apply to all financing receivables held by creditors,
including all public and nonpublic entities that prepare financial statements.

The FASB states that the term "financing receivables" would include loans defined as
a contractual right to receive money on demand or on fixed or determinable dates that are
recognized as an asset in the creditor's statement of financial position, whether originated or
acquired.

Black, Tom, (1998), Using receivables purchasing to improve cash flow for small
businesses, Commercial Lending Review, 4, vol.13, 70-74

Within the last decade, a growing number of bankers have begun supplementing their
commercial product line with receivables purchasing programs, boasting both exceptional
yields and stable, satisfied customers.

By adhering to these 4 risk-management principles, bankers can significantly mitigate

risk in receivables purchasing: 1. Making a prudent initial credit decision, 2. maintaining
accurate and timely account information, 3. controlling the cash, 4. Implementing effective
monitoring procedures, and 5.providing protection against changing credit circumstances.
 Receivables purchasing has great potential for community banks. For bankers willing
to dig every day into invoices, payment terms, and billing statements, receivables purchasing
is a way to create profits.

Because receivables are the fastest-moving noncash asset a business has, effective and
consistent monitoring is the backbone of any credit facility based on accounts receivable.

Paul, Salima Y, (2007), Organizing the credit management function, Credit Management,
26-28, 30-31

If accounts receivable constitute one of the biggest but riskiest assets the company is
likely to have, one would expect special attention to be given to its management. The way the
credit function is organized has an effect on credit management. So the management of this
function should be part of the overall objectives and should fit into the strategy of the
business

It is widely accepted in credit management literature that factors such as the nature of
the product, the channels of distribution and whether companies can benefit from economies
of scale can affect the management of the credit function

Other factors affecting the credit management function is that it is widely accepted
that investment in the credit function and the time spent on each activity of the credit
management process have an impact on corporate performance.

The integration of the credit function within another department may be desirable.
Nevertheless, there may be a conflict of interest between credit objectives and others. There
may be incentives for the sales department, for instance, to maximise the turnover and thus
sales staff may offer more generous credit terms than the industry norm or offer credit to
risky customers. Consequently, more time and resources are spent on back-end activities such
as chasing unpaid bills, and the role of credit mangers/controllers shifts to one of
retrospective credit collection rather than credit management and cannot be used proactively
to contribute to the enhancement of the company's performance.

Investing in the credit function is very important and may help trade credit not just to
remain a collectable asset but also to become one that is converted into cash within the terms

Stevenson, Paul, (2005), Credit management policy, Credit Management, 8-18

 The function of credit management is to maximize profitable sales, through the
prudent extension of credit, the balancing of financial risk and the efficient collection of sales
income within a framework of customer care. The primary objectives of credit management
include:

1. To ensure that all amounts due are collected according to the agreed payment terms and
that the most efficient methods of payment are used.

2. To identify high risk or marginal customers at an early stage, especially those likely to get
into financial difficulties and to take whatever action is thought necessary to safeguard
further sales to those customers.

3. Ensure that the cost of providing the goods/services on credit terms is at a level that
maximizes turnover with the minimum of risk.

4. Ensure that monthly cash collection targets are achieved.

5. Maintain a high quality of accounts receivable.

6. Develop a compatible working relationship with Sales, so that the needs of all departments
involved are satisfied to the benefit of the company as a whole.

Byl, Calvin D, (1994), Reporting accounts receivable to management, Business Credit, 9,

vol.96, 43

Managers need to have timely, accurate, and useful information to understand and
respond to the impact that the usually sizeable investment in accounts receivable has on the
cash flow and profitability of their operating units.

To determine what criteria for reporting on accounts receivable portfolios are

requested by management or used by credit departments in other companies in the industry, a
survey of credit managers from 34 agricultural companies was conducted

The survey participants were asked, "What do you consider to be the two primary
criteria for reporting the status of your accounts receivable to management?" Their responses,
though varied in detail, generally could be classified into five broad categories:

1. Accounts Receivable Aging

2. Exception Reports

3. Days Sales Outstanding

4. Ratio Analysis

5. Trends Analysis Reports.

The responses from the seven survey participants using one criterion for their reports
fell into three different categories. Two used the Accounts Receivable Aging. Two more used
similar Ratio reports regarding the percentage of sales collected. The other three used
Exception Reports, but they were each a little different.

One of the participants reviewed only those accounts that were over their credit lines
as established by the credit department. Another participant reviewed all accounts over 30
days past due. The other participant reviewed a watch list of accounts that are of particular
concern. The parameters for getting on this list were not given.

Kerwin, Richard J, (1992), Field Examinations of Accounts Receivable, The Secured

Lender, 2, vol.48, 28

The best way to determine whether accounts receivables are fairly stated is through a
field examination. Risks involved in financing accounts receivable that increase the lender's
exposure for loss include: 1. the client may bill and hold. 2. The client may pre-bill. 3.
Returns, allowances, or other credits may dilute the value of receivables. 4. The client may
produce fictitious receivables. The auditor must ensure that the receivables are valid and
collectible.

Although each client employs different accounting methods and controls, some
general standards exist that can be adjusted as circumstances require.

The scope of the field examination includes:

* Reconciling the accounts receivable aging to the general ledger and the financial statement.

* Reconciling the accounts receivable aging to reports produced by the client to the lender.

* Verifying the aging.

* Verifying shipment of the goods.

* Reviewing the timeliness of the posting of payments and credit memos.

* Determining the concentration of customers.

* Determining if any pre billing or bill and holding exists.

* Reviewing credit approval procedures.

* Reviewing collection procedures.

Sims, C Paul, Jr; True, Patrick, (1997), Five keys to relying on accounts receivable as a
repayment source, The Journal of Lending & Credit Risk Management, 1, vol.80, 40-44

Accounts receivable can represent a very sound repayment source because they will
typically convert to cash faster than any other asset on the balance sheet. For the same reason,
accounts receivable also can represent additional risks.

There are 5 keys to relying on accounts receivable as a repayment source: 1. making a

prudent initial credit decision, 2. maintaining accurate and timely information, 3. ensuring
control of the cash, 4. establishing effective monitoring procedures, and 5. protecting against
changing credit circumstances.

The 5 C's of credit - character, capacity, conditions, capital, and collateral - play a
vital role in any prudent initial credit decision. The need for businesses to free cash from their
receivables is not going to disappear. The banks most successful at capitalizing on this
market opportunity will be those that recognize and control their receivables risk.

Kontus, Eleonora, (2013), Management of Accounts Receivable in a Company,

Ekonomska Misao i Praksa, 1, vol. 22, 21-38

Accounts receivable is the money owed to a company as a result of having sold its
products to customers on credit. The primary determinants of the company's investment in
accounts receivable are the industry, the level of total sales along with the company's credit
and the collection policies.

The major decision regarding accounts receivable is the determination of the amount
and terms of credit to extend to customers. The total amount of accounts receivable
outstanding at any given time is determined by two factors: the volume of credit sales and the
average length of time between sales and collections.

The purpose of this study is to determine ways of finding an optimal accounts

receivable level along with making optimum use of different credit policies in order to
achieve a maximum return at an acceptable level of risk.

We hypothesize that by applying scientifically-based accounts receivable management and by

establishing a credit policy that results in the highest net earnings, companies can earn a
satisfactory profit as well as a return on investment.