Inefficiency receivable management case of hight account receivable in THMC

Days sales outstanding of THM, Nam Phong and the industry Figure 2.6 Aging of THM’s accounts receivable in 2014 Figure 2.7.. In reality, the company offer 45 days of credit period for al

International School of Business

NGUYEN THI THU THUY

INEFFICIENCY RECEIVABLE MANAGEMENT CASE OF HIGH ACCOUNT RECEIVABLE IN THMC

ID: 22130077

SUPERVISOR: PhD PHAM PHU QUOC

Ho Chi Minh City – Year 2016

Special thanks to members of THM Company for cooperating, supporting and

providing necessary information regarding this thesis

My thanks and appreciations also go to my group mates who have cooperated with me

to complete this thesis and classmates who have willingly helped me out with their abilities

Last but not least, warmest thanks to my family and my fiancé who always support and encourage me in completion of this thesis

TABLE OF CONTENT

ACKNOWLEDGEMENT 1

TABLE OF CONTENT 2

CHAPTER 1 – EXECUTIVE SUMMARY 5

CHAPTER 2 - PROBLEM IDENTIFICATION 6

2.1 Company Background 6

2.2 Situational analysis 7

2.3 The first tentative problem: Trade credit policy 16

2.4 The second tentative problem: Ineffective coordination 18

2.5 The third tentative problem: External effects 20

2.6 The real core problem: Trace credit policy 21

CHAPTER 3 – SOLUTIONS 23

3.1 Alternative 1 - Change trade credit policy 24

3.2 Alternative 2 - Bank guarantee 28

3.3 Alternative 3 - Factoring accounts receivable 29

3.4 Selection of solutions 31

CHAPTER 4 - IMPLEMENTATION 33

CHAPTER 5 - CONCLUSION 39

CHAPTER 6 – SUPPORTING INFORMATION 40

6.1 Methodology 40

6.2 Definition of theoretical frameworks 41

6.3 Consequences of ineffective accounts receivable management 45

6.4 Transcript 50

REFERENCES 57

APPENDIX 63

List of figures

Figure 2.1 Return on assets of THM, Nam Phong and the industry

Figure 2.2 Return on equity of THM, Nam Phong and the industry

Figure 2.3 Decrease in sales and accounts receivable

Figure 2.4 Receivable turnover ratio of THM, Nam Phong and the industry

Figure 2.5 Days sales outstanding of THM, Nam Phong and the industry

Figure 2.6 Aging of THM’s accounts receivable in 2014

Figure 2.7 Factors cause the inefficiency in accounts receivable

Figure 6.1 Cash conversion cycle

Figure 6.2 Consequences of high accounts receivable

List of tables

Table 2.1 Revenue and profit after tax of THM

Table 2.2 Percentage of accounts receivable on credit sales

Table 2.3 Receivables’ ratios of THMC

CHAPTER 1 – EXECUTIVE SUMMARY

Working capital management is paramount for an enterprise, especially for

manufacturing, trading and distribution firms, because of its significant effects on the profitability and liquidity of the firm (Lazaridis & Tryfonidis, 2006) As one of three primary elements of working capital, accounts receivable also have impact on the operating result of the firm It is the most important source of external finance of

enterprises (Petersen & Rajan, 1997) and also a supporting source for buyers (Cheng & Pike, 2003) Thus, the managers can use accounts receivable as a tool to increase

company’s revenue, profit as well as the relationship with customers Too high amount

of receivables, though, can lead to many consequences that make decreases on

company’s performance (Gill, Biger & Mathur, 2010) Thus, keeping accounts

receivable at an optimal amount is an important financial issue

The thesis is about the problem of inefficient receivable management of THM It

causes the inefficient in cash conversion cycle and working capital management which have bad influence on the profitability of the company The study will point out the factors that make this inefficiency as well as its financial outcomes After considering all the aspects leading to the problem, the thesis then aims at finding and advising the possible alternatives and practices for improving the efficiency of company’s

receivables management

CHAPTER 2 - PROBLEM IDENTIFICATION

2.1 Company Background

THM trading and construction limited company is the 1st level agency of Akzo Nobel Vietnam They distribute the painting products to the construction projects and the 2ndlevel agencies in Vietnam

Established in 1996, THM was a retail store supplying construction materials like brick, iron, steel, paint, roller… THM has developed strongly and steadily In 2002, the

THM retail store was developed into THM trading and construction limited company with the business focus being painting products

Until now, their supply chain covers almost all provinces in the South of Vietnam They achieve the highest revenue in Southern Vietnam for many years In 2011, the company reached the highest revenue in both projects and agencies segments in the whole Vietnam market Below is some basic information of the company

 Company name: Công ty trách nhiệm hữu hạn thương mại và xây dựng Thế Hệ Mới

 English name: The He Moi trading and construction limited company (THMC)

 Office: 299 Tan Ky Tan Quy Street, Tan Son Nhi Ward, Tan Phu District, HCMC

 Warehouse: 259 Tan Ky Tan Quy Street, Tan Son Nhi Ward, Tan Phu District,

Directorate

Sales department Warehouse department

Accounting department

Accountants Warehouse staffs Salesman

Table 2.1 Revenue and profit after tax of THM

Revenue 83,873,256,871 50,348,740,377 34,229,467,210 26,441,898,754 Profit after tax 1,185,546,709 26,389,069 - 45,377,948 - 252,311,429

(THM’s Income statement, 2011-2014)

In 2011, the return rates of THMC were very high in comparison to the rates of

construction materials industry Especially, return on equity (ROE) was over 45%

However, in the next 3 years, ROA and ROE of the firm was decreased dramatically

In 2014, although the industry ROA and ROE ratio recovered and increased to 3% and 10%, respectively, THM’s ratios continued falling

In comparison to Nam Phong Company which is another supplier of Akzo Nobel’s

products, the data also indicates the poor outcome from THM During the period of 3

years from 2012 to 2014, Nam Phong’s return rates increased to the very high point

The comparisons with the industry and Nam Phong, it can be easily noticed point out

the ineffective in working of THM in the last 4 years The figures below will show the details

Figure 2.1 Return on assets of THM, Nam Phong and the industry

Figure 2.2 Return on equity of THM, Nam Phong and the industry

Conducting interviews with members of THM, they reveal many issues which have influences on the company’s performance and accounts receivable is one of the most

challenging troubles in recent years According to Mrs Nguyet, the director of THM,

“there is too much capital tied up in the account receivables”

Through the financial statement, it can be noticed that there were considerable drops in accounts receivable amount during the period from 2011 to 2014 However, this

decreases were not due to the efficient accounts receivable management but the large reduction of revenue The decrease speed of accounts receivable is even lower than sales which indicates that the credit terms are more lenient (Cheng & Pike, 2003) In 4 years, the sales felt down over 68% while amount of accounts receivable only

decreases less than a half

Figure 2.3 Decrease in sales and accounts receivable

There are many factors affecting the level of receivable, but the amount of credit sales have direct influence on this accounts (Subramanyam & Wild, 2009) The table below shows the volume of credit sales and percentage of accounts receivable on the credit sales

Table 2.2 Percentage of accounts receivable on credit sales

Sale on credit 47,074,803,226 29,150,598,951 20,840,975,616 15,691,555,213

(THM’s Income statement, 2011-2014)

During 4 years, although the volume of sales on credit decrease sharply, the percentage

of accounts receivable on total sales on credit climbed up from 23% and remain at a significant high level of 47% in 2014 The decrease speed of accounts receivable is also slower than credit sales

Based on data from financial reports, accounts receivable ratios are computed and

indicated in the following table

Table 2.3 Receivables’ ratios of THMC

THM Receivable Turnover ratio 4.32 2.73 2.33 2.10

Over 4 years, both two accounts receivable ratios tended to deteriorate Receivables

turnover ratio decreased substantially from 4.32 to 2.1 and the number of days sales

outstanding increased to over 5 months in 2014 The meaning of receivables turnover ratio is measure the number of times accounts receivable were collected during the year and how efficiently a company uses the working capital (Subramanyam & Wild, 2011) The decrease in account receivable turnover shows that the company was not

successful in managing the account and it took more time to turn account receivable into cash This is a signal of the fact that the company is having difficulties in

collecting sales made on credit The number confirms the perspective of Ms Nhi, who

works in Finance – accounting department She said that “the speed of collecting

receivables in THM kept declining”; “customers delayed their debts for longer time”

and it makes “an amount of working capital locked up in this account for long time” In

other words, there were more delinquent customers and also the costs of holding receivables for a longer period of time

The figures below indicate the ratio comparison of THM with Nam Phong and

industry

Figure 2.4 Receivable turnover ratio of THM, Nam Phong and the industry

Figure 2.5 Days sales outstanding of THM, Nam Phong and the industry

Receivable Turnover ratio

THM Nam Phong Industry

Days sales outstanding

THM Nam Phong Industry

In comparison to the industry of construction materials and a competitor – Nam Phong, THM’s ratios are worst While Nam Phong had ratios being near by the industry, there was a significant gap between THM’s turnover and the others That is a signal of the

ineffective accounts receivable management That means the company is having

troubles in collecting accounts receivable and the customers hold a large number of working capital in too long period The liquidity of THM accounts receivable and the speed that receivables are converted into cash is low

In the interview, Miss Nhi, who works in financial – accounting department, revealed

that “many customers delay their payment for long time It is about 4-6 months, even 1

year Moreover, some of them default in payment” From the provided accounts

receivable legers at the end of 2014, the accounts receivable of THM can be divided in

to 6 levels The pie chart below indicates percentage of each element in accounts

receivable in 2014

Figure 2.6 Aging of THM’s accounts receivable in 2014

It can be easily see that data from accounting documents reflects properly the results of direct interviews At the end of 2014, the most percentage of total receivables

concentrates in 3 to 6 months accounts receivable which is overdue for 1.5-4.5 months There is even 8% of debt is over 2 years and the company considers it as uncollectable debt In reality, the company offer 45 days of credit period for all customers, account receivables lasted more than 45 days are overdue debts In 2014, there is only 18% of receivable being in maturity and overdue debt occupied 82% of accounts receivable

amount This large number indicates that accounts receivable management of THM is not effective

3 months - 6months

6 months - 12 months

1 year - 2 years over 2 year - consider as default

From the symptom of “high accounts receivable”, literature as well as the evidence

from the in-depth interview, there are some tentative problems that the company is facing

2.3 The first tentative problem: Trade credit policy

One of serious reasons for ineffective accounts receivable management in THM comes from the company trade credit policy Trade credit is considered as a replacement to offering an interest-free loan to customer when comparing with borrowing money from

a financial institution to make the purchase (Cheng & Pike, 2003) As recommended by Brigham and Ehrhardt (2013), a credit policy should include the credit standards, the credit period, the discount for early payment and the collection policy The decrease speed of accounts receivable is lower than sales which indicates that the credit policy

of THM is too lenient (Cheng & Pike, 2003) The advantages of this approach are the attraction for customers and the increase in sales due to high accounts receivables However, it has several drawbacks, which are higher costs and risk of default payment due to using large amount of trade credit (Garcia-Ternuel and Martinez-Solano, 2008)

According to Mrs Nguyet, “most of customers of THM are contractors of construction

projects Therefore, the value of purchasing contracts are usually large and various Thus, THM grants different credit sales amount for different customer” Without a

credit standard or checking on their financial capacity, “the company mainly based on

the design plans of the projects that the customers provide to offer the limit of sales on credit The limit is about 10% of the total amount that customers are going to spend for painting products in the whole projects” The company will stop supplying to the

customer who have not pay their on due debts or when their debts exceeds the credit limit In THM credit policy, there is no credit term to assess the customers They offer credit limit mainly based on the information of project This lenient credit policy can attract customer but also leads to the delinquency in payments due to the weak finance

of customers

Ms Nhi said that “THM applies the credit period of 45 days for all customers and does

not differentiate the size of contracts” When all products in the contract are delivered

to customers, they will have 45 to pay entire contract It is obvious an inflexible credit period The length of credit period is equivalent to the product price (Cheng & Pike, 2003) That also means the longer customers holding their payment, the lower price of product is Therefore, a customer who has ability to pay their debt soon often has

tendency to wait until the last day of credit period Moreover, it is risky when company allows all customers to hold the payment in a long time Financial capability of the customer may change during that period, especially who own a big amount of credit sales may not afford the debt (Teng & Lou, 2012)

Ms Nhi also reveal that to enhance revenue on cash, the company “offers 2% discount

for immediate payment purchases” However, “there is no discount for early payment

for sales on credit” The discount not only attracts customers who consider it to be a

price deduction but also lures them to repay sooner to get price deduction (Brigham & Ehrhardt, 2013) Therefore, no discount means there is no encouragement for

customers to repay early so they often delay the payment until the last day of credit period

In reality, THM has poor collection efforts When there is a mature debt, the company

“often makes calls and sends request payment letters to customers The debts are

frequently paid partly and less than my expectation”, Mrs Nguyet said Those methods

are not enough pressure to obligate the debtors to repay immediately so that the

receivable are often delayed Although the collection policy by law and the penalty interest rate for late-payment is written in purchasing contracts, the company does not

frequently use this method Mrs Nguyet supposes that “it will affect the relationship

and the pleasure of the customers So that we just apply the law collection policy to the customers who are unwilling to pay or companies delay the payment in too long time”

The lenient in collection policy encourages customers to delay their payment which makes long days sales outstanding

2.4 The second tentative problem: ineffective coordination

Ms Nhi who currently works at finance – accounting department said that “there is a

conflict between finance department and sales department The salesmen’s do not

bother the customer’s creditworthy when selling products At the end, we – the finance – accounting department have to deal with the large amount of bad debt” Mr Hai also

revealed that in THMC, “the main income of salesmen is come from the commission of

their revenue sold in that month Therefore we often are motivated to sell as many products as possible” Generally speaking, the conflict in communication and working

perspective between sales department and finance department is one of the reasons for ineffective accounts receivable management

Theoretically, Burez and Vandenpoel (2008) indicated that the credit and finance department consider customer’s creditworthy as the most important condition when offer credit contract They do not want the company’s working capital tied up in the

overdue debts or loose money for uncollectable debts In contrast, the sales department wants the total revenue being as high as possible whether the customer is creditworthy

or not In THMC, this problem was happening during the period of 4 recent years Moreover, the total revenue of the company was drop considerably which put more pressure on the sales department In order to meet the goals of sales, the salespeople tried to sign more contracts and sell more products without carefully considering

customer’s information or creditworthy Consequently, the finance department has to

deal with the high amount of delinquency and bad debts

Actually, the sales department has to follow a trade credit policy when finding

customer (Burez &Vandenpoel, 2008) However, because of the ineffective credit

policy of the company, salesmen primarily focus on increasing revenue and accomplish their tasks Therefore, the sales department might meet their goals, the risk and costs also increased and the accounts receivable ratio was deteriorating during the period

2.5 The third tentative problem: External effects

According to Mrs Nguyet, since the beginning of 2012, “Akzo Nobel Vietnam oriented

THM as the specialized project distributer Thus, they required THM to stop supply for

2 nd level agencies to concentrate on construction projects That explains for the sharp drop in the revenue and the profit in the next 3 years” Because of the limitation in

market segments, from 2012, the company focused only on construction projects

“THM stopped supplying for 2 nd agencies and those customers were not willing to pay

for the previous orders”, Ms Nhi said Large amount of accounts receivable became

doubtful debts due to this reason

Level of accounts receivable is also affected by the economic situation (García-Teruel

& Martínez-Solano, 2008) Under deteriorating economic conditions, firms’ capacity

of generate cash from their operations reduce There may raise an alternative in

debtors’ financial position after credit is granted Consequently, some customers were

unable to repay their debts on time and they delayed their payment makes the number

of days receivable of the company increase Besides, there is more risky in selling for construction projects They often hold their payable amount longer because their cash

flows depend on the market and economic situation “They only pay their debt when

they have already sold their property”, Mrs Nguyet said

2.6 The real core problem: Trace credit policy

From the above analysis, literature reviews and the interview result, the core problem for the inefficiency in accounts receivable comes from the trade credit policy The trade credit policy is a guideline for company to grant or reject credit to a customer It affects directly on the accounts receivable management in company (Gupta & Gupta, 2015) Thus, an ineffective policy brings many mistakes in making decision in granting credit

Because of the less stringent policy, there was no clear rule for all departments to follow in granting and solving trade credit This is also the cause for the inconsistency among departments Besides, the external factors cannot be controlled by the company Therefore, the most important issue for receivables management is the trade credit policy

Figure 2.7 Factors cause the inefficiency in accounts receivable

Economic fluctuation

Unclear credit standard

Inflexible credit period

Collecting policy

Policy change

of Akzo Nobel

External factors

Inefficiency accounts receivable

Ineffective coordination Credit

policy

CHAPTER 3 – SOLUTIONS

Accounts receivable are assets that have to be financed at some capital costs There are also existed some risk and costs for the form of credit and collection efforts From that point of view, reducing volume of accounts receivable and days sales outstanding make the deduction in these costs As strong significant relationship between working capital and profitability, the company can improve their performance by focusing on reducing investment in working capital and improving working capital efficiency THMC can create positive profit by tighten management of accounts receivable and reducing the number of days sales outstanding and amount of accounts receivables (Knauer &

Wöhrmann, 2013)

It should be noted, however, that minimizing this account is not always the most

rational option; instead it should be actively optimized and managed according to contextual factors The optimal amount of account receivables is the point at the trade-off between the securing of sales and profits and the amount of al the costs of the

increasing account receivables (Berry & Jarvis, 2006, Nazir & Afza, 2009; Hill, Wayne

& Highfield, 2010) When determine accounts receivable management, company has to consider both sides and try to find the right balance between risk and return However, because of the limited of information and data, finding the accurate optimal level for THM case is required a further deep research The reasonable level of working capital

may also depend on the ratios of construction material industry in which the company operates Therefore, THM should keep the receivable turnover ratio and the days sales outstanding at the same level with the industry

3.1 Alternative 1 - Change trade credit policy

The trade credit policy is a guideline for company to grant or reject credit to a

customer A trade credit put a direct effect on the accounts receivable management in company (Gupta & Gupta, 2015) Therefore, a change of credit policy influences the amount of credit sales which is invested in receivables (Omolumo, 2003) In the case

of THM, the core problem in accounts receivable management comes from the lenient, relaxed and unclear trade credit policy For that reason, one of the needful alternatives

is changing the credit policy According to Ojeka (2011), there are some reasons for an enterprise to have a clear and efficient credit policy Firstly, it can limit the costs of bad debt and improve the cash flow of the company Secondly, a clear credit policy insures

a degree of consistent cooperating among departments This can also solve the second tentative problem of the THM Company By setting a clear policy, all the departments

of the company will have to follow it and there would not be any bias on offering trade credit to the customers Finally, it can bring the consistency in approaching customers and making decision is easier, based on a credit standard This also provides the

fairness among the customer that will improve customer relations Hence, it can be clearly seen that writing a clear trade credit policy is important issue for THM It is an

opportunity to improve the efficiency of accounts receivable management as well as the entire organization As recommended by Brigham and Ehrhardt (2013), a clear credit policy should include the credit standards, the credit period, the discount for early payment and the collection policy

Setting credit standard: The credit standard is a scale for company to categorize their customers to offer the credit limit and the credit term The limits of credit grant to customers directly relate to the amount of investment in receivables A generous credit standard can attract more buyers and push up sales However, investment in

receivables will be expanded along with many costs Contrary, the strict credit

standards can reduce investment in accounts receivable, save company from bad debt losses and the associated costs But it also results in depressing sales and profit

Therefore, setting clear and effective credit standards is essential for THMC It helps the company to categorize the customer and determine the appropriate credit limit Granting trade credit needs to depend on the creditworthiness of the customer and its financial capacity (Mian & Smith, 1992)

Setting credit terms: The credit term includes the discount percentage on selling price

if the buyer pays early, the number of days that qualify for early payment and the credit period There are two ways for company discriminate the selling price The first is offering the credit period and second is by giving a discount in payment, which can be seen as a price reduction (Brennan, Maksimovic & Zechner, 1998) Granting discount

can induce customer to repay their debts earlier than the expired credit period It

provides benefit for buyer by premium on payment and the seller by prompt collecting debts The discount not only attracts customers who consider it to be a price deduction but also makes reduction in the days sale outstanding (Brigham & Ehrhardt, 2013) In order to get the deduction, the customers will repay in the discount term Hence,

instead of no discount, THM should offer a discount rate for early payment to the buyers These discount policies attract customers but it is faster in collection of money

In addition, varying the credit period can make the difference and the flexibility in the product price (Cheng & Pike, 2003) In the credit policy, THM only offer a period of

45 days for all customers It is not flexible and efficient Therefore THM should offer the period based on the size of the purchase contract

Setting penalties for late payment: The penalty is one of the pressures for the customer

to pay their debts on time With no late-payment penalty, the customers of THM are encouraged to delay their payment Thus, THMC should fix the penalty rate in

purchase contracts and also claim for that fine whenever the customer get late in

systematization in collection policy will have a psychological effect on the customers and make them remember their obligation

Other legal actions should be used when there is a debtor who delays the debt for too long period

However, changing policy also brings some impacts to the company If we choose to tighten the credit policy that we grant to the customers, at some point there will be decrease in sales and it may harm the customer relation (Molina & Preve, 2009)

- Tightening credit policy makes the

reduction in levels of account receivables,

along with the decrease in the related

costs The risks taken by a firm is also

low

- It can also improve the efficiency and

consistency in coordination among

departments

- It brings the consistency in approaching

customers and making decision is easier,

based on a credit standard

- Flexible credit period and discount rate

brings the price discrimination

- The disadvantages of this approach are mainly the reduction of sales, goodwill and profit due to the lack of trade extension to customers

- Tighten credit policy may harm the relationships with customers

3.2 Alternative 2 - Bank guarantee

To reduce the risk of default, THM should require the customers to sign bank

guarantee contracts It is a guarantee from a lending institution ensuring that the debt of

a customer will be met In other word, when the debtor is unable to pay their debt, the bank will cover the obligation Thus, using bank guarantee, the company can transfer default risk to the bank (Knezević & Lukić, 2012) According to Knezević and Lukić (2012), the bank guarantee is legally and economically more secure than other security instruments The bank will provide the full protection for the accounts receivable from the risk of failure to perform the contract As a supplier for construction projects, the value of purchasing contracts is often large, THM should apply bank guarantee as a possible solution Bank guarantees enables THM to manage the risk better than

conventional credit financing In addition, when offering the guarantee, the bank will also set the credit limit based on the information and creditworthy of the customer (Vlasák, 2013) It is convenient and save more time for THM in the process granting the trade credit

In reality, the bank guarantee is a formal legal activity and it is demonstrated in written form It includes the clear obligations and rights of the three parties The bank will require the buyer and seller to fulfill the form with all important elements agreed upon when concluding the primary contract (Knezević & Lukić, 2012) It can bring the

inconvenience to the customer and lead to the discomfort and displeasure They may think that they are not trusted and it can harm the customer relations

- It is convenient and save more time for

THM in the process granting the trade

credit

- Bank guarantee gives full protection for

accounts receivable, reduce risk of

delinquency and default

- Process of bank guarantee causes the inconvenient for buyers Thus it makes the customer feel uncomfortable and unpleasant

- Being required to sign bank guarantee contract, customer will feel not being trusted It will harm customer’s relation

3.3 Alternative 3 - Factoring accounts receivable

Factoring is a financial service enabling enterprises to raise short-term capital by

selling their accounts receivable to a factoring company in exchange for cash at a discount (James, 1989) When company faces with a distress in finance, it may seek financing from a third party, for instance a bank Factoring can bring suitable solution for short term financing in cash flow and also decrease the amount of accounts

receivable (Summers & Wilson, 2000)

There are two type of factoring: recourse factoring and nonrecourse factoring The former provide short-term financing to company and use their accounts receivable as collateral It allows the factoring company to claim payment directly from the client if the customer defaults on payment (Soufani, 2002) On the other hand, the nonrecourse factoring provides full insurance of potential bad debts The factoring company will cover all the amount of receivable if the customer is unable to repay their debts

(Hartmann-Wendels & Stöter, n.d.) With this method, the company can not only

transfer risks and costs associated with receivables but it also increases free cash for the company to invest in other better assets

However, this solution also makes deduction in the profitability due to the costs of commissions or interest rate Factoring is a possible option to reduce amount of

accounts receivable However, before making decision to purchase an accounts

receivable, the bank will considers carefully all the elements which influence the

quality of accounts receivable such as company's size, type of product it offers,

financial statement, industry, age, type of customers, the management, collectability and credit notes (Soufani, 2002) Thus, only high quality accounts receivable amount can be factored by a bank and the low quality one is still exist in the account This solution can only solve the cash shortage

In reality, there are some factoring companies which allow buying low quality accounts receivables Even so, the fee for this service is quite high Mrs Nguyet reveals that

“they often take from 20% to 40% of the amount of accounts receivable” This option

can be expensive However, the company at least can reduce the amount of accounts receivable and especially minimize the outright losses (Brigham & Ehrhardt, 2013)

- Factoring can bring suitable solution for

short term financing in cash flow

- It decreases the amount of accounts

- Only high quality accounts receivable amount can be sold and the low quality one is still exist in the account

3.4 Selection of solutions

Based on theory and information collected in the interview, there are listed three possible alternatives All of them would affect the amount and ratio of accounts receivable However, not all of them can be apply and fit with the reality of the THM Company Those alternatives are:

Alternative 1: Change the trade credit policy; make it tighter and more flexible

Alternative 2: Using bank guarantee to secure the accounts receivable

Alternative 3: Factoring accounts receivable to reduce the amount of this balance

The alternative 1 is the most priority because the trade credit policy is the main core problem in accounts receivable management of THM Credit policy is the most

important instrument of managing and regulating receivables (Ojeka, 2011) Therefore setting an effective and reasonable credit policy can enhance the efficiency of accounts receivable as well as the entire company’s activities Working under a clear rule also improves the working effectiveness and the corporation among the department Besides setting a policy, the alternative 2 is a possible solution to secure the accounts

receivable It will give full protection for accounts receivable, reduce risk of

delinquency and default In fact, THM have used this method in this year and it brings

a significant improvement in the receivable management

For the alternative 3, the high quality accounts receivable amount can be factored easily but the low quality one is still exist in the account This solution can only solve the cash shortage and short-term financial issue Besides, in THM accounts receivable, only 18% of amount is high quality account If the company chose to sell low quality account, it will be really costly and harm the profitability and performance Therefore,

in the situation of THM, the alternative 1 and 2 is suitable and appropriate

CHAPTER 4 - IMPLEMENTATION

As the alternative 1, the credit policy of THM has to be made clearer and tighter

However, if we reduce receivables too much with an overly restrictive credit policy, the reduction adversely impacts sales and profitability Receivables must, therefore, be effectively managed As recommended by Brigham and Ehrhardt (2013), a clear credit policy should include the credit standards, the credit period, the discount for early payment and the collection policy

Setting credit standards

A credit standard helps the company to categorize the customer and determine the appropriate credit limit Granting trade credit needs to depend on the creditworthiness

of the customer and its financial capacity to establish limits in terms of amount and time (Mian and Smith, 1992) Somol, Baessens, Pudil and Vanthienen (2005) named credit history as one of the most important variables for classification of credit scoring The imperfect information leads to the uncertainty about the buyer default risk.THM can check the customer’s transactions with the company in the past and the aging

receivable of each customer to evaluate the creditworthiness For the new customer, THM should be more careful in collecting customers’ information Company can make

calls to some suppliers of that customer to get information and know how promptly the customer pays Moreover, evaluate customer’s financial reports and asking their banker