Auditing accounts receivable credit management and collection procedures is an essential aspect of examining an organization’s financial records to ensure accuracy and reliability.
Here are key steps and considerations for auditing accounts receivable, specifically focusing on credit management and collection procedures:
Understanding Accounts Receivable & Credit Management
Accounts Receivable (AR) is the money a business expects from customers for sales made on credit.
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.
Credit management is the process of assessing, granting, and monitoring credit to customers. It involves setting credit policies, evaluating customer creditworthiness, and implementing strategies for debt collection.
Credit management ensures customers pay on time by setting credit limits, assessing risks, and tracking payments.
It helps maintain cash flow and reduces bad debts for a healthy financial balance.
Effective AR and credit management ensure business stability. Companies must balance extending credit and timely collections using strong policies and technology-driven solutions.
Key Aspects of Auditing Accounts Receivables 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:
- A trusted audit firm like PKC will review the organization’s credit policy and procedures to ensure they are clearly defined and documented.
- They 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.
Potential Risk and Responses in Auditing Accounts Receivable 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.
PKC’s Checklist for Auditing 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?
Author
Mohamad Zhakeer
