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What are the Techniques for Monitoring of Accounts Receivables?
For a business to continue running with granting credit, it must continuously monitor the accounts receivables so that there is no laxity in the process of credit collection. There are two traditional methods that are used to monitor accounts receivables. These are
Average Collection Period
Aging Schedule.
As these methods have some limitations, analysts now use the collection experience matrix method to judge the accounts receivables efficiency of a firm.
Average Collection Period (ACP)
The Average Collection Period Formula (ACP) is –
$$\mathrm{ACP \:= \:\frac{Debtors \:\times \:360}{Credit \: sales}}$$
The average collection period calculated with this formula is compared with the real collection period of the firm to adjudge the efficiency of the firm in the collection of the dues.
For example, if ACP calculated with the formula is 30 days and the firm collects the dues in 45 days in reality then there is a mismatch and thereby a lack of efficiency in the firm’s credit collection method.
An extended credit period consumes cash inflows, impairs the liquidity of the firm, and increases the possibilities of bad debts. That is why a lax system is inefficient in collecting the dues from the borrowing firms.
Limitations
The first limitation of the two that this method has is that it offers only an average picture of the collecting experience and it is based on aggregate data. For control, the age of outstanding variables is needed.
The second shortcoming is that it is susceptible to sales variables and the periods on which these variables are aggregated. Thus, ACP fails to provide a meaningful account of the effective collection of accounts receivables.
Aging Schedule
The aging schedule breaks down the data of receivables in sync with the outstanding period for which they have been outstanding. This helps one to get a more meaningful view of actual accounts receivable information related to a given firm.
For example, if the stated credit period of a firm is 30 days and accounts show that 50 percent of this remains outstanding beyond this period, a significant amount of credit remains uncollected beyond the actual credit period.
Thereby, an aging schedule helps to get a more meaningful insight into the collection experience and is better in determining whether the firm is lax in collecting the dues from the borrowers.
The aging schedule however faces the problem of aggregation like the ACP method.
Collection Experience Matrix
As mentioned above, the major two shortcomings of the methods of monitoring accounts receivables are that they are based on aggregates and they fail to relate to the period of outstanding receivables with the actual period of credits outstanding. Thus, two types of outcomes can be ascertained using the same variables and sales data differently.
Using disaggregated data for analyzing collection experiences can get rid of the problem stated above. The key here should be the linking of variables with the sales data of the same period. When the sales are shown horizontally and associated receivables vertically in a table, a certain matrix is obtained. This is known as the collection experience matrix and it can be used to a great extent to monitor the accounts receivables.
Conclusion
The three methods of monitoring accounts receivables can help lenders determine whether their collection efforts are bearing fruit or they are running in the wrong direction.
Among the three, the collection experience matrix is the best to adjudge the receivables. It removes the drawbacks that are found in the ACP and aging schedule methods to offer a complete and more meaningful insight into the process of monitoring the accounts receivables. Constructing a collection experience matrix should therefore be the aim to adjudge the monitoring of accounts receivables.
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