Accounting For Credit and Collections - Part 5
This is the 5th article in a series about Credit and Collections. This material is adapted from The Automated Accounting Systems and Procedures Handbook (John Wiley, New York 1991) Chapter 4.
4.3 COLLECTIONS
Collections procedures identify and follow-up on late-paying customer accounts. They are a necessary side-effect of extending trade credit to customers. From a management standpoint, collections procedures are necessary to help minimize the bad debts expense and help manage marginal account situations. From an accounting standpoint, these procedures are necessary to cull out the uncollectible accounts from the accounts receivable, giving a truer picture of accounts receivable.
In smaller organizations one person may be responsible for both collection, follow-up, and credit research, leaving a higher authority, such as the controller, to review and approve the recommended actions (write-off, place account on COD, etc.). In larger organizations these staff-level collections responsibilities are split among different individuals in the credit department. Many businesses use collectors to make account adjustments and write-offs. Usually write-offs are approved in advance or reviewed after the fact by a responsible accounting manager, possibly a controller in a smaller organization or a credit manager in a larger one.
Regardless of the organization’s size or its industry, collection procedures usually have the following fundamental characteristics :
- Accurate and current customer account records.
- Routine and inexpensive methods of issuing casual reminders.
- Procedures for identifying and following up on accounts that become seriously late in payment.
- Written record of special collection follow-up.
- Provision for classifying and recording the extent and stages of delinquency.
Automation has significantly eased the collector’s responsibility. In a modern environment, the accounts receivable system has features for assisting collectors with each of these five characteristics.
Figure 4-7 Distribution of Customer Accounts Receivable.
| | Rank | Customer | Amount | % Total | Cum % |
“A” Accounts:
10% of accounts
70% of receivables
| 1 | Shane Holdings | 400,293 | 5.64 | 5.64 |
| 2 | Compten Group | 310,276 | 4.37 | 10.01 |
| 3 | W. W. Williams Company | 260,245 | 3.67 | 13.68 |
| 4 | Holly Stores | 219,030 | 3.09 | 16.76 |
| 5 | Woolton’s | 205,497 | 2.90 | 19.66 |
| 6 | Sake Importing | 204,350 | 2.88 | 22.54 |
| 7 | International Devices | 191,843 | 2.70 | 25.24 |
| 8 | The Jamestown Company | 182,054 | 2.56 | 27.80 |
| 9 | Brewer’s Central | 161,058 | 2.27 | 30.07 |
| 10 | The Digest | 155,479 | 2.19 | 32.26 |
.
.
. | | | | |
| 100 | Brook’s Importers | 45,021 | 0.63 | 69.09 |
“B” Accounts:
20% of accounts
20% of receivables | 101 | Trade Industries | 44,094 | 0.62 | 69.71 |
.
.
.
| | | | |
| 300 | Wellahey’s | 6,550 | 0.09 | 91.00 |
“C” Accounts:
70% of accounts
10% of receivables | 301 | Demsey Center | 6,098 | 0.09 | 91.16 |
.
.
.
| | | | |
| 1,000 | Corner Stores, Inc. | 340 | 0.00 | 100.00 |
| | | | 7,098.251 | | 100.00 |
ACCOUNT STRATIFICATION
Practical collections procedures consider the strength of each individual customer account. Those accounts that make up the largest portion of the receivables (and sales) will receive a special amount of attention from the credit analysts. Those accounts that make up the vast number of low-dollar receivables will be dunned repeatedly by the system and shipments will be curtailed at the first sign of trouble (e.g., an invoice becomes 30 days past due).
To determine which accounts receive these different levels of treatment, credit management must stratify the accounts receivable, sorting the accounts according to receivable amount or total sales. In a three-tiered system, the accounts are sorted into three different groups (Figure 4-7):
- “A” accounts constitute 10% of the largest accounts and comprise about 70% of the total accounts receivable.
- “B” accounts also constitute that next 20% of accounts but only comprise about 20% of the total accounts receivable dollars.
- “C” accounts comprise the remaining (70%) of the customer account population yet make up only about 10% of the total accounts receivable dollar amount.
Credit management applies different collections procedures to each tier; each procedure involves a level of effort appropriate for that stratum of accounts. Some businesses may choose a two-tiered approach—treating accounts with either one of two different approaches for collections. In either a two-tiered or a three-tiered approach, the stratification of customer accounts (Figure 4-7) is the best means of showing where to split the accounts to apply such different collections procedures. Note that each collection procedure is progressively less expensive to carry out.
PAST DUE ACCOUNT PROCEDURES
Using a three-tiered stratification of the customer accounts, collections procedures generally are as follows:
- “A” Accounts Procedures. Have a credit analyst or customer service representative contact (or visit) the customer to resolve late payment. Do not stop shipments to the customer unless the situation (total amount due) becomes progressively worse.
- “B” Accounts Procedures. Have a collector call the customer to extract verbal commitments for payment. Hold customer shipments as soon as an invoice is more than 30 days late. Remind the customer using dunning letters.
- “C” Accounts Procedures. Dun the customer using the automated system features and stop all shipments to the customer as soon as the payment becomes late. Do not bother to contact the customer.
Good accounts receivable systems can have a set of features that assists this approach, including features for
- Collections.
- Customer notification.
| About this article and the author: |
Doug Potter is the owner of The Newport Consulting Group a professional management consulting organization that provides clients with information systems planning, selection, and implementation services. He can be reached at dpotter@newportconsulting.com or through his Web site, http://www.newportconsulting.com.
Note: The contents of this article were excerpted from Mr. Potters book "Automated Accounting Systems and Procedures Handbook" Copyright 1991 by Douglas A. Potter, published by John Wiley & Sons, Inc. New York
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