Cash Collection Practices
Cash management is intimately connected with realization from debtors. Prompt collection from debtors is preferred for that involves less money being locked-up in accounts receivables, less bad debts, etc. How can collections be prompted? We can give cash discount to prompt collections. Besides a system of decentralized collection is suggested for prompt collections.
- Concentration Banking is a technique of decentralized or prompt collection. Concentration banking system works this way: (i) there is decentralized billing of customers, so that immediate dispatch of goods, invoices are made and dispatched, (ii) customers are directed to send the remittances to corresponding regional offices, (iii) regional offices on receipt of remittances send them to banks for collection, (iv) After collection is effected, after retaining a minimum sum, the regional office sends the balance on account to the head-office bank account. As all such cash balance remittances get concentrated in the head-office bank account, the method is known ‘concentration banking’. This system involves quick dispatch of invoices, quick receipt of remittances, quick posting of entries, quick forwarding of remittances to banks for collection, quick collection by banks and lump-sum transfer to the concentration bank of collections from debtors. As a result, collection float, that is, total time between mailing of a cheque by a consumer and the availability of cash to the receiving firm, is reduced.
- Lock-box System is another method of prompt collection. Here (i) the regional branch offices send invoices to credit customers in respective branch areas and direct them to send remittances to specified post-boxes hired from post-office under an arrangement (ii) the bankers of the company clear the post boxes several times a day and process for collection and also inform the firm’s branch office of the remittance (iii) after keeping a minimum balance, the rest of funds is remitted onward to the firm’s main bank account. Lock box system is an improvement over the concentration system. In lock-box system the bankers clear the remittances from post-boxes instead of remittances being sent to branch offices and branch offices sending the cheques and bills to the bankers for collection. Thus one more interim step is skipped to speedup the collection.
- Preauthorized debit is another method of prompt collection. He the transfer of funds from payer’s bank to payee’s bank is preauthorised triggered, by the payee with payer’s advance authorization.
- Now-a-days cash transfer is also done electronically. Electronic Fund Transfer (EFT) is used to instantly transfer funds from payer’s bank to the payee’s bank.
While collections are prompted through decentralization, payments may be centralized, so that the same are delayed to the net advantage of the firm. Suppliers are directed to send bill for payment to the Head-office. A transmission delay is quite possible to the advantage of the firm. This is also known as mailing float. A processing delay, due to centralized processing, is also imminent. Cheques are issued and posted to suppliers. Another transmission delay results. The supplier might cause a processing delay at his end before the cheque is sent for collection to its banker. The banker sends the instrument for collection, again involving a delay. Knowing that these delays are systematic, the firm may issue cheques without sufficient cash balance on the day of issue of the cheque. This practice is known as “playing the float’.
Payable through Drafts only, Zero Balance Account, remote disbursement, controlled disbursement, etc are other alternatives of delayed payment tactics.
Are prompt collection and delayed payment possible?
If one firm wants to speed up collection, others may also do so. So, prompt collection and prompt payment are likely to go together in practice. One firm may ask its customers to send remittances to regional branch offices. Similarly, the firm’s suppliers may also go for decentralised collection. The firm must adjust to the collection practices of its suppliers. Lest, suppliers might stop supplying. Of course, everything depends on the firm’s equation with customers and with suppliers. If the firm’s market for its output is of the sellers’ market type, prompt collection may be resorted to and if it is of the buyers’ market type this system of collection may not be possibly. Similarly, if the firm’s input market is of the sellers’ market type delayed payment cannot be adopted and if it is of the buyers’ market type delayed payment can be adopted. Collection efforts and payment practices are generally governed by general trade practices. But in any case, every customer and every supplier are individual cases and that the treatment meted out to them should help establishing long-run relationship.
Credit: Financial Management Concepts-MGU MBA