Handbook of Finance: Investment Management and Financial Management

Chapter 84. Management of Accounts Receivable

PAMELA P. DRAKE, PhD, CFA

J. Gray Ferguson Professor of Finance and Department Head of Finance and Business Law, James Madison University

FRANK J. FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

Abstract: The majority of a company's investment in current assets, however, is tied up in accounts receivable and inventory. Both the accounts receivable and inventory represent investments that are necessary for day-to-day operations of the business. A company extends credit, and thus has accounts receivable, to encourage customers to purchase its goods or services. Because accounts receivable are a use of funds, tying up funds in this asset has an associated cost. This cost must be considered alongside the benefits from the enhanced sales of goods and services.

Keywords: accounts receivable, trade credit, merchandise credit, dealer credit, implicit cost of trade credit, credit policies, collection policies, credit terms, number of days of credit, credit sales per day, average collection period, days sales outstanding (DSO), captive finance subsidiary, securitization of accounts receivable

When a company allows customers to pay for goods and services at a later date, it creates accounts receivable. By allowing customers to pay some time after they receive the goods or services, a company is granting credit, which is referred to as trade credit, merchandise credit, or dealer credit. Trade credit is an informal ...