By CPA Robert Mwangi
Firms sell on credit to stimulate sales. Credit sales create accounts receivables (trade debtors). In most manufacturing and merchandising firms in Kenya, after inventory, receivables form a major component of current assets. A firm’s credit policy typically depends on the credit standards, credit terms, and collection period set by the firm.
A firm must determine the optimal credit policy. Receivables represent an investment tied up, and therefore, firms must make a decision between the optimal amount of credit and the opportunity cost of the investment in credit sales compared to other investments.
Credit Sales
Having worked as an accounts clerk, accounts assistant, and as an accountant for more than eight continuous years and now as Finance manager at a debt collection firm, I have realized that the key reason why accounts receivables remain unpaid over a long period in most organizations is because of the following factors;
- Businesses typically only consider sales as receivables after the credit period has expired.
- Inconsistencies & discrepancies in sales invoices and goods sold or services offered.
- Lack of proper credit scoring
Business looking at sales as receivables only after the expiry of the credit period.
Most businesses tend to view sales as receivables only after the expiry of the credit period, which is typically 30 days, 45 days, or some other specified period. After the credit period expires, they’ll likely offer the customer a grace period before initiating the process of following up on the payment. By the time they write or call to enquire about the payment status, the customer will probably have misplaced the invoice, committed funds to pay some other bills, realized that the invoice has some issues or errors, maybe overcharged or undercharged and they need a credit note or debit note and many more factors and then they’ll have to start the process again & wait for another 30- or 45-days credit period and then a back and forth will start. Before the payment is done, it could be maybe a month/(s) or so, and this will affect the firm’s cash flow, and they will not be able to service their short-term liabilities.
This should not be the case; businesses should treat sales as receivables as soon as the customer receives the invoice or the goods/services, whichever is earlier. The two traditional methods of monitoring the management of receivables should be employed: the average collection period and the debtors’ aging schedule.
Allow me to explain. By recognizing sales as receivables as soon as the customer receives the invoice or the goods/services whichever is earlier does not mean that they start asking for payment before expiry of the credit period, rather, immediately after the invoice have been dispatched, either by email or courier, they should start by calling or writing to the customer asking if they received the invoice and if everything is in order. This way, after the expiry of the credit period, the customer will have no excuse but to pay, unless maybe there are some unavoidable circumstances. After adopting the above method for treating receivables, our receivable turnover ratio improved from an average of 1.5 to less than 1.
Reconciliation problems
In my experience, another reason why receivables remain unpaid for a long time is due to inconsistencies in the debtor’s account that need to be reconciled, which could come as a result of;
- Account overcharge – A Credit note should be issued to correct such
- Account undercharge – A Debit note should be issued to correct such.
- Withheld tax – Withholding certificate.
- A problem with goods delivered or services offered.
The inconsistency needs to be noticed early and addressed immediately. If a credit note or debit note needs to be issued, it should be done promptly. Laise with the customer and iron out any issues. liase
As far as withholding tax is concerned, there are many cases where clients withhold the tax but fail to remit it to KRA or remit it late. It is important that the withholding tax be treated as a normal receivable, as it’s an asset that is claimed or netted off against tax liabilities.
Lack of proper credit scoring.
One of the most effective ways to ensure a robust credit risk assessment is by utilizing Credit Reference Bureaus for credit scoring before extending credit to customers. Kenya has three licensed CRBs, which are Metropol, TransUnion & Credit Info. They maintain credit histories for individuals and businesses in the country. By using their services, companies can determine if customers have a history of bounced cheques and/or delayed payments, which will enable them to set informed credit limits, deny credit to risky customers, and employ strategic receivables management techniques for customers with different credit histories. This will result in reduced default risk and efficient receivables management.
If, after following the above steps, the debtor still does not pay, then it is time to employ other methods to recover the money owed, which include;
- Invoking the ‘goods remain property of seller until fully paid’ clause, if applicable, in case of sale of goods.
- Employing the services of a Debt Collection Agency. Debt collection agencies charge a commission on the amount of debt recovered.
- Taking legal action – The Small Claims Court Acts of 2016 provides mechanisms for creditors owed less than Kes 1 million to litigate on their debt.
Factoring
Banks have a policy of financing receivables at a fee, often referred to as ‘invoice discounting’. A company can also assign management of its receivables to factoring organizations. In recent years, credit management organizations have begun offering factoring services to firms, including banks, to assist them in managing loan defaults. In this case, the factor pays for the receivables/loans at a discounted price, providing immediate cash to the banks or any other firm and assuming the responsibility of collecting the receivables.
There are different types of factoring, including full-service non-recourse, where the factor assumes 100% of the risk in the event of default. Full-service recourse factoring where the client is not protected against the risk of bad debts. The non-notification factoring involves the factor managing the ledger account in the name of the sales company.
Financial standards related to receivables, IFRS 9 – Financial instruments, expected credit loss application
The standard allows for the classification of financial assets at either amortized cost or at fair value. The standard introduced a clearer and forward-looking approach to the impairment of receivables, among other financial assets, in that, instead of recognizing credit losses when they are incurred, the standard requires companies to report Expected Credit Loss (ECL) at the time the receivables are first recognized. This approach ensures that the financial statements reflect the true credit risk earlier.
IFRS 9 allows entities to recognize a lifetime ECL from the time they recognize the receivable, using historical data, current macroeconomic factors, and future forecasts to estimate the probability of credit loss, in this case, the possibility of non-payment.
Emerging Trends in Trade Receivables Management
Artificial Intelligence (AI)
In recent years, AI has become a crucial tool in receivables management, enabling entities to transition from manual and reactive strategies to predictive and proactive approaches. By utilizing algorithms and advanced data analytics, AI can transform how firms manage receivables by predicting customer payment behavior, providing real-time credit scoring, issuing automated and customized reminders based on customer behavior, detecting fraud, and enhancing customer insights. This will result in reduced Day Sales Outstanding (DSO), lower credit loss, strong customer relations, and improved compliance with IFRS 9 requirements.
In today’s dynamic and changing environment, the role of accountants and finance managers must evolve and adapt beyond traditional reporting and compliance. Accountants have a unique viewpoint and are well-positioned to provide leadership in credit management. By applying risk assessment and strategic foresight, they can help develop and implement effective credit policies and integrate forward-looking techniques to manage receivables, thereby protecting firms‘ liquidity while supporting growth.
Robert Mwangi, CPA-K, is the Group Finance Manager at Collection Africa Ltd. He holds an MSc in Finance and over eight years of experience in finance, accounting, and credit management, with a focus on receivables and financial strategy.
