The third area involved in the accounts receivable management is collection policies. They refer to the procedures followed to collect accounts receivable when, after the expiry of the credit period, they become due. These policies cover two aspects. (j) degree of effort to collect the over dues, and (ii) type of collection efforts.
Degree of Collection Effort
To illustrate the effect of the collection effort, the credit policies of a firm may be catcgorised into. (j) strict/light, and (ii) lenient. The collection policy would be tight if very rigorous procedures are followed. A tight collection policy has implications which involve benefits as well costs. The management has to consider a trade-off between them. likewise. a lenient collection effort also affects the cost-benefit trade-off. The effect of tightening the collection is discussed. below. In the flrst place, the bad debt expenses (default cost) would decline. Moreover. the average collection period will be reduced. As a result of these two effects. the firm will benefit and its profits will increase. But. there would be a negative effects also. A very rigorous collection strategy would involve increased collection costs. Yet another negative effect may be in the form of a decline in the volume of sales. This may be because some customers may not like the pressure and intense efforts initiated by the firm•.and may switch to other firms.
A f1nn is contemplating stricter collection policies. the following details are available:
1. At present, the firm is selling 36,000 units on credit at a price of Rs 32 each; the variable cost per unit is Rs 25 while the average cost per unit is Rs 29; average collection period is 11 days; and collection expenses al11?unt to Rs 10.000; bat! debts are 3 per cent. 2. If the collection procedures retightened, additional collection charges amounting to Rs 20,000 would be required, bad debts will be J per cent; the collection period will be 40 days; sales volume is likely .to decline by 500 Assuming a 20 per cent rate of return on investments, what would be your recommendation?.