Synopsis
- Introduction
- How does an account receivable Work?
- Why are accounts receivable important
- Evaluating Credit Management
- 5 C’s of Credit Management
- PKC Checklist for credit management and collection Procedure
- Potential Risk and Responses
- Conclusion
Introduction:
- Auditing accounts receivable involves examining an organization’s financial records to ensure accuracy and reliability.
- Evaluating credit management and collection procedures is an essential aspect of this process, as it helps identify potential risks and weaknesses in the organization’s cash flow management.
- Here are key steps and considerations for auditing accounts receivable, specifically focusing on credit management and collection procedures:
How does an account receivable work?
- The most common form of an account receivable is a sale made on credit, via an invoice, to a customer. The customer subsequently pays the debt within agreed credit terms, which may differ from customer to customer.
- Some companies offer discounts to incentivize early payment or privileges to customers permitting a direct debit to be set up.
Why PKC concerned on accounts receivable as important:
- The prompt and full collection of monies owed is vital to ensure the organization has the necessary cash flow to operate effectively and to remain a going concern.
Evaluating Credit Management:
- Evaluating credit management is a critical aspect of assessing an organization’s financial health and risk management practices.
- Here are key areas to focus on when evaluating credit management
Credit Policy and Procedure:
- PKC will Review the organization’s credit policy and procedures to ensure they are clearly defined and documented.
- PKC will assess the consistency of credit decisions with established policies.
Credit Risk Assessment:
- Examine the methods used to assess the creditworthiness of customers.
- Verify that the organization employs a systematic approach, considering financial statements, credit reports, and other relevant information.
Credit limits
- Evaluate the process for establishing and reviewing credit limits for customers.
- Confirm that credit limits are aligned with the customer’s ability to meet payment obligations.
Terms and conditions:
- Review the credit terms and conditions offered to customers.
- Ensure that these terms are communicated clearly and consistently.
Credit Approval Authority:
- Assess the segregation of duties in the credit approval process to prevent conflicts of interest.
- Verify that appropriate individuals have the authority to approve credit.
Customer Relationship Management:
- Assess how the organization manages relationships with customers, especially those with extended credit terms.
- Ensure that communication channels are open and proactive.
5 C’s Concept of Credit Management:
The 5 Cs of Credit analysis are:
Character
- Character, which refers to the customers’ reputation and credit history.
- Character is a critical factor because it helps organizations determine the level of risk involved in extending credit.
Capacity
- ‘Capacity’ means whether the customer’s organization has enough funds to repay the supplier team.
Capital
- Capital is important because it gives credit teams a measure of security. If a customer defaults on the credit owed, the supplier can seize their assets to recover the losses.
Collateral
- ‘Collaterals’ are similar to the concept of a mortgage.
Conditions
- Conditions play a crucial role as they impact the overall cost of credit.
- Conditions encompass the current financial condition of the customer, which can be measured by analyzing the company’s financial statements, cash flow, balance sheet, and income statement.
PKC’s Checklist for credit management and collection Procedure:
- Do formally documented policies and procedures exist for all accounts receivable and collection activities?
- Have credit limits been automatically increased?
- If/where a credit limit is breached has a review of the customer been undertaken?
- How many times have services been withheld because of a poor credit risk or limits being breached?
- Are reconciliations performed between the detailed accounts receivable ledger and the accounts receivable control account in the general ledger?
- Are payments terms clearly included on invoices
- Are accounts receivable balance statements issued and include customer account activity, outstanding unpaid invoices and recent payments?
- Are write-offs or other reductions in the receivable balances approved by a relevant member of senior management, for example the financial controller or finance director?
- Are accounts receivable recorded in a manner to permit an analysis of aged debtors (for example <30 days, 30-60 days etc.)
- Are all credit balances reviewed periodically?
- Is credit controllers/ those with the customer relationship provided with debtor information so that they can take informed decisions on continuing to provide services to a customer with significant aged debts?
Potential risk and responses in Credit management:
- Risk 1: Allowing customers high credit levels beyond their capacity or willingness to pay will ultimately damage our business performance.
Potential Impact:
- The debtor is slow to their debts.
- The amounts owed are disputed.
- Inability to recoup all debts.
- Financial loss to the organization.
- Reduction in profits.
- Cash flow issues
Potential response:
- Credit checks are undertaken prior to allowing credit being agreed.
- Credit limits set are based on the information from the credit check.
- Credit limits are regularly reviewed based on set indicators and not automatically increased.
- Indicators are set on the debtors file to flag up when they are reaching their credit limit.
Risk 2: Debts that are uncollectable (bad debts) will give a false impression of our performance.
Potential Impact:
- Reduction in profits.
- Cash flow Management
Potential response:
- team on a weekly basis and is formally reviewed and signed off by senior management.
- The allowance for doubtful debts is reviewed and formally signed off by management periodically.
Conclusion:
- Throughout the audit process, PKC consulting will document the findings, including any deficiencies or areas requiring management’s attention.
- PKC’s ultimate goal is to provide assurance on the reliability of the accounts receivable balances and the effectiveness of credit management and collection procedures.
Author
Mohamad Zhakeer
Zhakeer is a semi-qualified chartered accountant with a keen interest in direct taxes, international taxation, and statutory matters. Known for attention to detail, client communication, and strategic ideas.
