CHAPTER 1 1. Introduction 1.1.

Background of the study There are different kinds of current assets found in almost all business such as cash, securities accounts receivable and inventories. The amount of investment in each type of current asset may vary from day-to-day. If the amount of cash on hand exceeds immediate cash requirements, the excess cash might be invested in securities until needed. These securities are accounted for as temporary investments. (Fess, 1984)Therefore the average amount invested is frequently used in deciding how large the investment should be, decisions regarding investment in one type of current asset are frequently not independent of decisions regarding other current assets. For example a change in credit policies that affect account receivable may also affect sales and therefore affect the desirable level of inventory. The result is that there are very large number of alternative levels of investment in each type of current asset.

Accounts receivable is one of the current assets and it represents the extension of credit given by the firm to its customers. The extension of credit to customers by most businesses is a cost of doing business. By keeping its money fed up in accounts receivable the firm losses for incurring these costs. While the availability of credit facilitates many business transactions, it is also costly. The firm can be competitive, attract and retain customers and improve and sales and profits. Merchants frequently note that the availability of credit entices customers to make a purchase decision. (Walther,2008)

1|Page

For most companies account receivable is very important investment with the concern for return on assets expressed by many companies in recent years. As it constitutes large amount of asset value. Some researches show as a percentage of total assets, accounts receivable has been estimated
to constitute 20% for large organizations and 30% in small/medium sized organizations. Up to 80% of business transactions between corporations are conducted on credit. (Leitch, 2009) There has

come ever-increasing focus on the funds committed to receivables. Whether this current asset is managed efficiently influence very strongly the amount of fund invested. The optimal investment is determined by comparing benefits to be derived from a particular level of investment with the costs of that level.

Generally, the firms accounts receivable is directly controlled through involvements in the establishment and management of credit policy which includes determining credit selection credit standards, and credit terms and collection policy the firm's approach to managing each of this aspect of account receivable is heavily influenced by competitive conditions. Among the major controllable determinants of demand the firms credit policy is a tool for managing and monitoring accounts receivable. (FM,27-2)

The length of time granted by the seller to the buyer before which the account is settled differs from time to time and industry to industry. Within a firm different credit periods may be allowed to customers depending on their credit worthiness and other factors such as trade discount allowed. If the account is not settled at the specific period it will be turned into uncollectible account.

2|Page

The Ethio telecom is the sole telecom operator and provides its service on credit basis to corporate customers. The telecom operator has credit policy which comprise credit selection credit standards, and credit terms and collection policies.

1.2. Statement of the Problem The term receivable includes all money claims against people organization or other debtors. Receivables are acquired by a business enterprise in various kinds of transactions. It is anessential marketing tool acting as a bridge for the movement of services to customers. A firm grants trade credit to protect its sales and to attract the potential customers to buy its services at favorable terms but it involves an element of risk which should be carefully analyzed. Management of receivables is the main determinant factor for the existence and efficient performance of every business organization The main revenue of Ethio Telecom is resulted from credit bill of services, as the 20% of the total customers are credit service customers from whom 80% is almost earned.(Tele Negarit,2009) This is likely to be significant asset for the firms but it has its own cost to the firm such as cost of managing receivables & bad debt losses etc. Because differentiated products and services tend to have more quality variation, making buyers more reluctant to pay before having had time to inspect the merchandise or ascertained the quality of services.(Gianetti, 2008) To minimize the uncollectible accounts and the consequent additional cost burdens the organization should have monitor its accounts receivable in appropriate ways and policies.

3|Page

1.3. Objective of the study 1.3.2 General Objective The general objective of the study is to diagnose, assess and evaluate accounts receivable management in Ethio Telecom northern region. 1.3.2 Specific Objectives The specific objectives of the study are stated as follows Assess various accounts receivable management procedures in the organization, and its relationship with principles and theories in the management of account receivable. Assess the implementation of the accounts receivable procedures and policies. Evaluate the status of uncollectible accounts. Assess efforts made to protect uncollectible accounts. Assess selected customer eligibility with the selection procedures to have credit from the company.

1.4. Significance of the study This project focuses in the management of accounts receivable in the case of Ethio telecom northern region. This shows that the case will definitely touch many stakeholders. The main focus of this project is to understand whether the northern region Ethio telecom follows proper receivable management system or not and to help the organization feed with factual details for possible remedial action. As the customers are corporate customers they will be in need of this project to see the performance of their service provider in order to strengthen their relationship. The other stakeholder is government as the organization state owned sole operator company. 4|Page

This project enables the government to evaluate the performance of the company and may initiate the need to assess the other regions or the company as a whole. Similarly, this paper would be important to serve as a base for further study on similar problems.

1.5. Methodology 1.5.1 Data sources and type Combination of primary and secondary data will be used. The secondary data will help in assessing & comparing relevant theories & practices of managing accounts receivable. This will be collected from previous research reports, books and journals. These secondary data enable to see the theories and the pattern of practice in managing accounts receivable. The companys credit policies as well as the periodical reports are the main sources. There are different type of customers namely government offices, non government offices and business companies in which their proportion is stated below. The company credit policy and the primary data will depict the available practice in the company. 1.5.2 Sampling techniques and design

Here descriptive research method will be used as a research design from a given population. The total population size is 3253.These total population comprises government offices, business companies and non government organizations. The government offices 2714, the business companies are 418 and the rest 121 are non government organizations. Many researchers (and research texts) suggest that the first column within the table should suffice (Confidence Level = 95%, Margin of Error = 5%).(research advisors.com) Based on this information the proportion who would be repeat customers within plus or minus 5% margin
error. This will enable the researcher have a sample size of 346 representing almost 1 to10.

5|Page

Convenience simple random sampling will be used because of its simplicity and accessibility to the customer. Besides it is economical in terms of money time. (Ahmed,2011) 1.5.3 Data collection method

The companys credit policy as well as the account receivable reports is the main sources in order to see the practice. But in order to have the views of the customers it is important to have primary data by distributing questionnaires. As the customers are obliged to come to their local collection office of Ethio telecom the questionnaires will be distributed conveniently as it is described in the above section.

1.5.4

Method of analysis

The researcher is going to apply the descriptive research approach. The data processing is to be conducted manually and in house editing will be applied, additionally the data collected from the questionnaires will be tabulated and converted into percentages. These figures are expected to show the efforts made to collect accounts receivable early and based on the data to be collected from customers it will be revealed the practice of managing accounts receivable and its status comparing with the policy of the company , theories in managing accounts receivable and other related practices.

6|Page

1.6. Scope of the study The study will have theories about management of accounts receivables. The researcher will see why companies trade on credit, the significance of credit policies, and the collection policy such as types of aging of accounts receivables the valuation accounts receivable. The application of these theories and their relationship with balance of accounts receivable in the case of Ethiotelecom is to be analyzed. And it will focus the investigation on the problems pertaining to bill preparation problem and bad debt problems in collecting the amounts, write-off account receivable. These projects will be conducted in Ethio telecom northern region.

1.7. Limitation of the study Because of financial and time constraints this study will not cover all region of Ethio telecom. The data analyzed and interpreted will not have the capacity to represent another region as it may have different situation in other regions. Time is also another constraint which will not allow minimizing some statistical errors. The researcher is expecting none response error. Some of the respondents may not respond to the available primary data because of time constraint because some of the customers are business persons. Since the organization is in transformation period the organizations documentation of previous data may not be easily found. Besides managers and staff who are not happy with the current condition may refuse to respond.

7|Page

1.8 Conceptual framework Accounts receivable management directly impacts the profitability of the firm. It includes determining discount policy and credit policy for marginal customers, investigating ways of speeding up collections and reducing bad debts, and setting terms of sale to assure ultimate collection.(Keiso,2010) Account receivable means money which is billed to a company by a customer for products and services provided on credit. This is treated as an existing asset on a balance sheet. A detailed sale is normally only treated as an account receivable after the customer is sent an invoice. In any way since the account receivable is a liquid asset it may become uncollectible account if mishandled by the respected body. And Some policies and application can create distorted accounting information that will hamper collecting the liquid asset account receivable. (Leitch,2009)

8|Page

CHAPTER TWO 2. Literature Review

2.1 Definition of Receivables Receivables are aliens of various types and by an entity for the future receipt of cash, goods or services. Most commonly, receivables are claims for the receipt of cash, which cause from normal trade or other type of transactions an event. Such as sales of goods or services, loans made amount due from leasing of assets etc. Receivables from Client most of the time represent a substantial part of a business enterprises liquid resources and should appear as a separate items in the current assets section of the balance sheet at their net realizable value.(Hoyle, 1991)

2.2 Trade Account Receivables Trade account receivable causes in the course of sales of good or services to customers. Trade credit is generated when goods or services are exchanged for a loan which is subsequently exchanged for cash. Trade credit is generated through credit sales and managed through accounts receivable.(Leitch,2009)

2.3 Credit Policy The firms credit policies are the chief influences on the level of a firms account receivable .as with the other current assets, however the manager can vary the level of receivable in keeping with the trade off between profitability and risk lowering credit standards may stimulate demands which item should lead to larger profitability.(FM,27-2)But there is cost to carrying the

9|Page

additional receivable as well as a greater risk of bad debt losses. The policy includes the quality of the trade accounts accepted. The length of credit period the cash discount (if any) for early payment. Generally, the firms financial manager directly controls accounts receivable through involvement in the establishment and management of credit policy includes determining credit selection, credit standards, and credit terms. (James, 1998)

2.3.1 Credit Decision Business firms extend credit various groups of customers to individual government units, customer credit business, selling goods or services to customers. An event decisions are based primarily on the creditor's assessment of the customer's likelihood of payment. Setting a maximum on the amount of credit offered to a customer limits the exposure of the firm to the risk that the customer will not pay. (Walther,2008)

In deciding to provide credit to customer, the credit manager must evaluate the chance of nonpayment and estimate the benefits of extending credit the benefits results from the additional sales obtained and any interest or fees charged for the credit.(FM,27-2)

2.3.2. Credit standards According to the free accounting dictionary credit standard is the guideline a company follows to determine whether a credit applicant is creditworthy.(freedictionary.com) This shows the company may sell mostly on cash bases, and may extend credit only to the most reliable and financially strengthen customer such standards will result in no bad-debt losses, and less cost of credit administration, but the firm may not be able to expand sales and the profit that should be

10 | P a g e

gained on lost sales may be more than the cost saved by the firm on the other hand , if credit standards are lower, the firm may have larger sales, but the firm will have to carry large receivable.(Gentry,1985) The cost of administering credit and bad debt losses will also increase. Thus the choice of optimum credit standards involves a trade off between incremental return and incremental costs (Gallinger,1986)

The firm's credit standards are the minimum requirements for extending credit to a customer. Understanding the key variables that must be considered when the firm is contemplating relaxing or tightening its credit standards will give a general idea of the kinds of decisions involved. (James, 1998)

The major variables that should be considered when evaluating proposed changes in credit standards are;A. sales volume Changing credit standards can be expected to change the volume of sales. If credits standards are relaxed sales are expected to increase and if credit standards are tightened, sales are expected to decrease. Generally increases in sales affect profits positively whereas decreases in sales affect profits negatively.(Gentry,1985)

B, investment in accounts receivable; Carrying or maintaining accounts receivable involves a cost to the firm. This cost is attributable to the forgone earning opportunities resulting from the necessity to tie-up founds in account receivable. Therefore the higher the firm's investment in accounts receivable the greater the

11 | P a g e

carrying cost and vice - versa. If the firm relaxes its credit standards the volume of accounts receivable increase and so does the firms carrying cost (investment).(Gallinger,1986)

C, Bad debt expenses The probability or risk of acquiring a bad debt increases as credit standards are relaxed. The increase in bad debts associated with relaxation of credit standards raises bad debt expenses ad affects profits negatively. (Leitch,2008)

2.4. Collection policy and procedures A common goal of accounts receivable management is to ensure debts are collected within specified credit terms .The firm determines it's over all collection policy by the combination of collection procedures it under takes.(Leitch,2008) These procedures include things such as letters phone calls personal visit and legal action. A collection policy is needed because all customers do not pay the firms bills in time some customers are slow payers while some are non-payers the collection effort should therefore aim at accelerating collections ensure prompt and regular collection.

Proportion of bad-debt losses and the shorter the average collection period all other things being the same. Prompt collection is needed for fast turnover of working capital keeping collection costs and bad debts with in limits and maintains collection efficiency. Regularly in collection keeps debtors alert and they tend to pay their dues promptly.(Hoyle,1991)

12 | P a g e

The collection policy should lay down clear-cut collection procedure. The collection procedures for past dues or delinquent accounts should also be established in unambiguous terms. The slow paying customers are needed to be handled very factually. The responsibility for collection & follow -up should explicitly fix. It may be entrusted to the accounts or sales department or to a separate credit department. The coordination between accounts and sales department is necessarily and must be ensured formally. (FM,27-4) The accounting department maintains the credit records and information. If it is responsible for collection it should consult the sales department before initiating an action against non- paying customers.(Fess,1984)

Through collection procedures should be firmly established individual cases should be dealt with on their merits. Some customer may be temporarily in tight financial position and in spite of their best intentions may not be able to pay on due date. This may be due to necessary conditions or other factors beyond the control of the customers such cases need special consideration.

2.4.1. The average collection period

It is the average amount of time needed to collect account receivable. Dividing the average daily sales in to the accounts receivable balance arrives as it.(Fess,1984) Average collection period = accounts receivable Average sales per day

The average collection period is meaningful only in relation to the firms credit terms. If for instance a firm extends 30 day credit terms to customers an average collection period which is

13 | P a g e

greater than the 30- day credit term may indicate a poorly managed credit or collection department or both. Of course the lengthened collection period could be the result of an international relaxation of credit term enforcement by the firm in response to competitive pressures and if the firm's average collection period is less than the days of the credit term it would be quite acceptable.

2.4.2. Aging Accounts Receivable Aging is a technique that indicates the proportion of the accounts receivable balance that has been outstanding for a specified period of time. By highlighting irregularities it allows the analyst to pinpoint the cause of credit or collection problems. Aging requires that the firm's accounts receivable be broken down in to groups based on the time of origin.(Keiso,2010) The objective of preparing an aging schedule is to have a closer look at the quality of individual accounts this requires as ascertaining the sales made to payment received from each customer by checking the receivable ledgers. If debts are collected on time, most debts should be younger, and few should be older. It is assumed that increased collection efficiency would reduce the percentage of debt in the older category. (Gallinger,1986) The deficiency of aging technique rises as its interdependence is reality and when changes in credit sales occur. The total sum must be be 100%.(Fess,1984) Rising credit sales will result in a schedule exhibiting increasing values in the younger categories, and a misleading suggestion of increased collection efficiency for the older categories Leitch The schedule may be prepared as follows.(Leitch,2008)

14 | P a g e

Example of Aging schedule of receivables

As on December 31,2009 Balance of Percent Age classes Month sales December November October September earlier total of receivables (days) 1. ............. 30 31............. 60 61............ 90 91.............11 0 >121 $ 25,000 $ 62, 000 $ 12,000 $ 10,000 $ 500 $ 110,000 receivables 22.7 56.8 10.9 9.1 .5 100

As on December 31,2010 Balance of Percentage of receivables $ 10,350 $ 13, 550 $ 46,400 $ 8, 825 $ 2.700 $ 86, 850 receivables 11.90 21.40 53.40 10.20 3.10 100

2.5 Valuation of account receivables The major account problems associated with the valuation of account receivables are the initial recording of the receivable based on the expected future cash flows and the estimation of the probability of collection. The uncertainty of collection affects the value of receivable. (Bernstein, 1996).

Whenever credit is extended the likelihood exists that some receivables will not be collected and this factor should be recognized in the valuation of receivable on the balance sheet. Most credit sales are made on unsecured days of accounts and the dollar amount of each sale is recorded as an account receivable.(Fess,1984)

Business enterprises sell on credit in order to increase sales, but it must be recognized that credit sales create the need for a credit department to investigate credit ratings approve the 15 | P a g e

extension of credit, and attempt to collect delinquent accounts. Credit sales result in a certain amount of bad debt losses due to non- payment by customers.(Walther,2009)

When a company is considering whether to sell on credit it must consider the trade off between the additional gross profits received from the expected credit sales and the additional expenses and losses incurred due to these credit sales.(Keiso, 2010) In the case of a firm that has no experience of its own reference to the experience of other enterprises in the same business may be appropriate. Another factor to be considered in the valuation of receivable is the length of time until collection. The valuation of accounts receivable is related directly with the amount of revenue ultimately realized. There is no way of measuring revenue independently of the value of claims resulting form revenue transactions. According to (Bernstein,1996) The problem of valuation of accounts receivable centers on three issues:-

1. The amount due 2. The time of collection 3. The estimate of the probability that the receivable will be collected.

2.5.1. Determining the amount due

16 | P a g e

Determining the value of the credit is among the main factors that the valuation of the accounts receivable hard. This constitutes the list price of the credit, the trade discount and the cash discount. (Bernstein,1996) The list prices quoted in catalogs are often subject to discounts for purchases in excess of a certain quantity. Trade discounts are usually re-suggested price for resale and it represents the difference between the list price and the price to the purchaser before cash discounts. Trade discounts (also known as volume or quantity) discounts are usually quoted as a percentage of the list price. (Keiso,2010) Companies may offer another type of discount to induce prompt payment. They are used to establish a cash price when payment is received shortly after giving of service as distinct from a higher time payment price. If cash discounts are not taken only the initial entry is recorded. No journal entry is made at the end of the accounting period to anticipate discounts that may be taken by customers on outstanding accounts receivables.(Fess,1984)

2.5.2. Time of Collection Here there is a need to consider the length of the collection period and assign a present value to receivables. The procedure is particularly significant when the collection period is long and interest is not charged to customers.(Garllinger,1986) Example:- if receivable of 5, 500.00 is expected to be collected after one year and the interest rate is 10% the receivable and sales are recorded at a net amount of $ 5,000.00 and interest revenue of $500.00 is recognized during the period the receivable is outstanding.

2.5.3. Estimating the probability of collection

17 | P a g e

In the previous we have considered the problem of determining the amount due and the time of collection under the terms of credit sales. A third major valuation problem is to evaluate the probability that customers will be willing and able to pay their accounts. Even the best efforts of a capable credit department can't eliminate all un-collectible accounts.(Fess,1984) The managerial objective is to maximize net income and not to maximize un-collectible expenses. (Leitch,2010)

Too stringent a credit policy may cause loss of sales volume which more than off sets the reduction in the doubtful accounts expenses. Receivables that will never be collected have a zero present value and the corresponding revenue will no be realized. The objective in the estimation of doubtful accounts expenses is to prevent an overstatement of assets and revenue in the accounting period in which sales are made.(James,1998)

In practice doubtful accounts usually appears among operating expenses. Finally it is considered as a financial management item and report is a "other expense".(Walther,2008 and Fess,1984)

Two kinds of evidence are used in estimates of doubtful expenses:1. 2. The average relationship between sales and un-collectible account in past years. The analysis of the quality and age of outstanding receivables at the end of an accounting period.

2.5.3.1. Estimating of doubtful accounts expense based on sales

18 | P a g e

(Income statement approach) The average percentage of credit sales not collected in past accounting period is a logical basis for estimating the portion of current credit sales that will prove un-collectible. This approach often referred to as the income statement approach, is simple to apply and makes possible an estimate of doubtful accounts expenses as soon as credit sales are recorded.(Keiso,2010) It results in a sound matching of costs and revenue and is especially appropriate in the preparation of interim reports.(Walther,2008) example: if sales for the lst quarter of the current year are $50,000.00 and doubtful accounts expense is estimated at 1% of sales , the following journal entry is required:Doubtful accounts expense Allowance for doubtful accounts 500 500

If the ratio of cash sales to credit sales is relatively constant, estimate of doubtful accounts expense as a percentage of total sales my produce reasonably accurate results. Strictly speaking however, the estimate of doubtful accounts expense should be based on credit sales. (Hoyle,1991)

2.5.3.2. Estimating of doubtful accounts expense Based on receivable (Balance Sheet Approach) A good way to test the adequacy of the allowance for doubtful accounts and to recognize the current charge against revenue is to make an analysis of accounts by age group and probability of collection. This procedure is known as a balance sheet approach of estimating doubt full accounts expense. (Keiso,2010)

19 | P a g e

Generally a significant correlation exists between the length of time an account is past due and its collectibles. A summary which classifies the balance of all accounts receivables according to whether the amounts are not yet due or past due by varying lengths of time is known as an aging of accounts receivable. The number of different age classes to be used depends on the actual experience and the terms of sale. An estimate of the average collection experience for each age class provides a basis for estimating the portion of outstanding accounts receivable that may prove to be uncollectible. (Leitch,2009)

20 | P a g e

I. Budget and Time Schedule Item Transportation Quantity 4 weeks Cost 1,500 Total 6,000

Internet services

7 weeks

400

2800

Audio cassette tapes Stationery Laptop Computer Total

10

40 1500

400 1500 13,000 23700

13000

21 | P a g e

Activity August 1-September 1 18, 2011 Literature Review Interview Questionnaire schedule development Data collection Data analysis Report writing and 2 3 4

Week 5 6 7

22 | P a g e

Reference 1. Bernstein ,1996. Modern Advanced accounting, McGraw-Hill, New York. 2. Leitch and Lamminmaki 2009, Refining measures to improve performance measurement of the accounts receivable collection function, working paper, Griffith Business College 3. Giannetti Burkart Ellingsen,2008, What You Sell Is What You Lend? Explaining Trade Credit Contracts The Review of Financial Studies / v 24 n 4 2011, Oxford University. 4. Gentry, Vaidyanathan, and Lee 1990, A Weighted Cash Conversion Cycle, Journal of The Financial Management Association Volume 19/ 1 Spring 1990 5. Fess,Warren 1984,Accounting Principles,14th edition, South western publishing Co. Cincinnati, Ohio. 6. Hoyle, Joe B, 1991,Advanced Accounting, 7th edition McGraw-Hill, New York. 7. James ,Horne, 1998,financial Management & Policy South western publishing Co. Cincinnati, Ohio. 8. Kieso,Weygandt,Warfield, 2010. Intermediate accounting,John Wiley and Sons, Inc.USA 9. Walther,2008,Principles of Accounting.com.

23 | P a g e

24 | P a g e