Corporate Accounting and Financial Management · Working Capital Management

Receivables Management and Credit Policy Explained

Updated 11 October 2026 · Fact-checked

Receivables management is the control of credit sales so that the extra sales earn more than the cost of funds locked in debtors and the bad debts. You solve numericals by comparing incremental contribution with extra carrying cost, bad debts, collection cost and discounts. Accept the policy if the net benefit is positive.

Understand Receivables Management

When you sell on credit, you do not get cash today. The amount owed to you is a receivable (trade debtors). Until it is collected, your money is tied up. That money has a cost, because you must fund it from your own funds or from borrowing.

Receivables management is about balancing two things. A liberal credit policy raises sales and contribution. It also raises the investment in debtors, the collection cost and the bad debts. A tight policy does the opposite. The aim is the policy where the extra profit is greater than the extra cost.

A credit policy has three parts: credit standards (how good a customer must be to get credit), credit terms (credit period and cash discount) and collection policy (how you follow up late payers). A term such as 2/10 net 45 means a 2% discount if the customer pays within 10 days, otherwise the full amount is due in 45 days.

To judge a change in policy, use incremental analysis. List the changes in contribution, investment in receivables, bad debts, collection cost and discount. Convert the investment into a carrying cost using the required rate of return. If the net change is positive, the change is worth making.

Factoring is another tool. You sell your receivables to a factor, who advances most of the amount at once, manages the sales ledger and collects from customers. Under recourse factoring, you bear the loss if the customer does not pay. Under non-recourse factoring, the factor bears it and charges more. Factoring in India is governed by the Factoring Regulation Act, 2011.

Key rules to remember

Receivables turnover and average collection period: Receivables turnover = Credit sales ÷ Average receivables Average collection period (ACP) = Days in year ÷ Receivables turnover; Use the number of days (360 or 365) that the question specifies. If it says nothing, state your assumption and stay consistent.
Average receivables: Average receivables = (Credit sales ÷ Days in year) × ACP; This is the amount of receivables at selling price.
Investment in receivables: Investment = Average receivables × (Variable cost ÷ Sales); Use variable cost when fixed costs do not change. Use total cost only if the question says so. Never use the selling price unless told.
Carrying cost of receivables: Carrying cost = Investment in receivables × Required rate of return; The required rate is the cost of funds or the opportunity cost given in the question.
Bad debts: Bad debts = Bad debt % × Credit sales; Apply the percentage to the sales of that policy, then take the difference between policies.
Net benefit of a credit policy: Net benefit = Contribution − Carrying cost − Bad debts − Collection cost − Cash discount; Compute for each policy and compare. Or compute only the incremental items. Both give the same answer.
Annualised cost of cash discount: Cost = [Discount % ÷ (100 − Discount %)] × [Days in year ÷ (Credit period − Discount period)]; For 2/10 net 30 this is (2 ÷ 98) × (365 ÷ 20) ≈ 37.24%. Compare with the cost of bank borrowing.
Factoring advance and cost: Advance = Invoice value − Reserve − Commission − Interest on advance Effective cost = Annual factoring charges ÷ Net funds received; Reserve is the part held back by the factor. Commission is usually charged on the invoice value. Interest is on the advance for the period. Read the question for the order of deductions.

How to solve Receivables Management questions

Use the same incremental method for any credit policy question. It keeps the working tidy and earns step marks.

1Read the question and note the days in a year, the required rate of return, whether fixed costs change and whether the investment is at variable cost or total cost.
2Write the existing policy and the proposed policy side by side: sales, credit period (ACP), bad debt %, collection cost and discount.
3Compute contribution for each policy, as sales × contribution margin (1 − variable cost ratio).
4Compute average receivables for each policy, then the investment in receivables at cost, then the carrying cost at the required rate.
5Compute bad debts, collection cost and any cash discount for each policy.
6Compute net benefit for each policy, or the incremental net benefit, and compare.
7If a cash discount is offered, compute its annualised cost and compare with the cost of funds or the benefit of lower receivables.
8State a clear conclusion: accept the proposal if the incremental net benefit is positive, otherwise reject it.

Quickest way: Incremental table method

When to use it: Use it when the question asks you to evaluate a change in credit policy and you have little time. Skip the full statement for each policy.

Draw one column for incremental items only.
Incremental contribution = Increase in sales × contribution margin.
Incremental investment = (New average receivables × cost ratio) − (Old average receivables × cost ratio).
Incremental carrying cost = Incremental investment × required rate.
Incremental bad debts = New bad debts − Old bad debts. Add any extra collection cost and discount.
Net incremental benefit = Incremental contribution − all incremental costs. Write accept or reject.

Common mistakes in Receivables Management

Computing the investment in receivables at selling price and charging interest on it.
Students see receivables on the balance sheet at sales value and forget that the money actually tied up is the cost.
Fix: Multiply average receivables by the variable cost ratio (or total cost ratio if the question says so) before applying the required return.
Using 2 ÷ 100 instead of 2 ÷ 98 in the cost of cash discount.
The discount feels like a percentage of the invoice, so the denominator looks like 100.
Fix: The customer pays 98 to get use of 98 for the extra days. Use Discount ÷ (100 − Discount).
Using the whole credit period instead of credit period minus discount period in the annualising factor.
Students confuse the length of the credit period with the number of days the customer gains by skipping the discount.
Fix: For 2/10 net 45, the extra days of credit are 45 − 10 = 35. Use 365 ÷ 35.
Treating fixed costs as incremental.
Students deduct total cost from extra sales without checking whether fixed costs change.
Fix: If the question says fixed costs are unchanged, use only the contribution margin on extra sales.
Applying the new bad debt percentage only to the extra sales.
Students assume that only new customers become risky.
Fix: Unless told otherwise, apply the bad debt % of each policy to total sales under that policy, then take the difference.
Mixing 360 and 365 days within one answer.
Students use 365 for one calculation and 360 for another from habit.
Fix: Pick the figure the question gives. If none is given, say 'assuming 360 days' (or 365) and use it throughout.

Worked examples

Example 1

Asha Textiles Ltd has annual credit sales of ₹60,00,000. Variable cost is 70% of sales. The average collection period is 30 days and bad debts are 1% of sales. The company plans to relax credit. Sales will rise to ₹72,00,000, the average collection period will become 45 days and bad debts will become 2% of sales. Fixed costs will not change. The required return on investment is 15%. Assume 360 days in a year. Should the company change its policy?

Show the solution

Contribution margin = 100% − 70% = 30%.
Present policy: contribution = 30% × ₹60,00,000 = ₹18,00,000.
Present average receivables = 60,00,000 × 30 ÷ 360 = ₹5,00,000. Investment at variable cost = 70% × 5,00,000 = ₹3,50,000. Carrying cost = 15% × 3,50,000 = ₹52,500.
Present bad debts = 1% × 60,00,000 = ₹60,000.
Present net benefit = 18,00,000 − 52,500 − 60,000 = ₹16,87,500.
Proposed policy: contribution = 30% × ₹72,00,000 = ₹21,60,000.
Proposed average receivables = 72,00,000 × 45 ÷ 360 = ₹9,00,000. Investment = 70% × 9,00,000 = ₹6,30,000. Carrying cost = 15% × 6,30,000 = ₹94,500.
Proposed bad debts = 2% × 72,00,000 = ₹1,44,000.
Proposed net benefit = 21,60,000 − 94,500 − 1,44,000 = ₹19,21,500.
Incremental net benefit = 19,21,500 − 16,87,500 = ₹2,34,000. Check: extra contribution 3,60,000 − extra carrying cost 42,000 − extra bad debts 84,000 = 2,34,000.

Answer: The proposed policy gives a higher net benefit by ₹2,34,000. The company should relax its credit policy.

Example 2

Ravi Traders sells on terms of 2/10 net 45. A customer buys goods worth ₹10,00,000. The customer can borrow from a bank at 18% per annum. Assume 365 days in a year. Find the annualised cost of not taking the discount and advise whether the customer should take it.

Show the solution

Discount if paid within 10 days = 2% × 10,00,000 = ₹20,000. The customer pays ₹9,80,000 on day 10.
If the customer does not take the discount, it pays ₹10,00,000 on day 45. The extra cost of ₹20,000 buys credit for 45 − 10 = 35 more days on ₹9,80,000.
Cost = [2 ÷ (100 − 2)] × [365 ÷ 35].
2 ÷ 98 = 0.020408. 365 ÷ 35 = 10.4286.
Cost = 0.020408 × 10.4286 = 0.2128, or about 21.28% per annum.
Compare: the cost of skipping the discount is 21.28%. The bank loan costs 18%, which is cheaper.

Answer: The cost of not taking the discount is about 21.28% per annum. As bank borrowing at 18% is cheaper, the customer should pay on day 10, take the discount and borrow from the bank to do so.

Exam tips

In credit policy problems, always show contribution, investment in receivables, carrying cost and bad debts as separate lines. Step marks depend on them.
State your assumption about 360 or 365 days and the cost basis (variable or total) in one line at the start.
Close with a one-line conclusion such as 'Accept the proposal, as the incremental net benefit is ₹2,34,000'. A numerical answer without a decision loses marks.
For theory questions, write short points on credit standards, credit terms and collection policy, then add the cost and benefit of each. For factoring, cover recourse and non-recourse, and the services and cost.
Practise the cash discount formula until you can do 2/10 net 30 and 2/10 net 45 without looking at notes. Examiners often vary the terms.

Practice questions from Working Capital Management

Receivables Management in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Receivables Management: frequently asked questions

How do I evaluate a change in credit policy in a numerical?

Compute contribution, average receivables, investment in receivables at cost, carrying cost and bad debts for both policies. Subtract the costs from contribution to get net benefit. Accept the new policy if its net benefit is higher.

What is the difference between factoring and forfaiting?

Factoring deals mainly with short-term trade receivables, and the factor often also keeps the sales ledger and collects the debts. It can be with or without recourse. Forfaiting is the without-recourse purchase of export receivables, usually medium-term and often backed by a bank guarantee or aval, at a discount fixed in advance.

What is the formula for the cost of a cash discount?

Annualised cost = [Discount % ÷ (100 − Discount %)] × [Days in year ÷ (Credit period − Discount period)]. For 2/10 net 30 this is about 37.24% on a 365-day year. A customer should take the discount if this cost is higher than its cost of borrowing.

Should I use selling price or cost for investment in receivables?

Use cost, because that is the money actually tied up. Use variable cost if fixed costs do not change, and total cost if the question tells you to. Use selling price only if the question specifically says so.