CCE Trade Credit & Accounts Receivable Management 2 — Questions and Answers
Question 1: What is accounts receivable factoring?
- Pledging receivables as collateral for a bank loan while retaining ownership
- Selling accounts receivable to a third party (factor) at a discount for immediate cash (Correct answer)
- Securitizing receivables into asset-backed securities for capital markets
- Transferring collection responsibilities to a collection agency without selling the debt
Correct answer: Selling accounts receivable to a third party (factor) at a discount for immediate cash
Factoring involves selling receivables outright to a factor at a discount, providing the seller with immediate liquidity and transferring collection risk.
Question 2: The 'dilution rate' in accounts receivable management refers to:
- The percentage of receivables written off as uncollectible
- Reductions to gross receivables from credits, returns, discounts, and allowances (Correct answer)
- The interest rate charged on overdue accounts
- The proportion of receivables collected within the discount period
Correct answer: Reductions to gross receivables from credits, returns, discounts, and allowances
Dilution is the reduction of gross AR from items such as credit memos, returns, trade discounts, and early payment discounts, which reduce the collectible amount.
Question 3: A lockbox system PRIMARILY benefits a company by:
- Reducing the need for credit insurance on receivables
- Accelerating the collection and posting of customer payments to reduce float (Correct answer)
- Automating the generation of customer invoices
- Eliminating the need for an accounts receivable aging schedule
Correct answer: Accelerating the collection and posting of customer payments to reduce float
A lockbox directs customer payments to a bank-managed P.O. box, allowing the bank to process and deposit payments faster, reducing mail and processing float.
Question 4: Under a recourse factoring arrangement, the selling company retains:
- Ownership of the receivables but transfers collection responsibility
- The risk of customer non-payment if the factor cannot collect (Correct answer)
- The right to buy back receivables at the original face value
- Full responsibility for billing and invoicing customers
Correct answer: The risk of customer non-payment if the factor cannot collect
In recourse factoring, if the buyer (debtor) does not pay the factor, the selling company must repurchase the receivable, retaining the credit risk.
Question 5: The Collection Effectiveness Index (CEI) differs from DSO in that CEI:
- Only measures collection performance on past-due accounts
- Measures the quality of collections relative to the amount that was collectible in the period (Correct answer)
- Is expressed as a ratio rather than a number of days
- Focuses exclusively on domestic receivables
Correct answer: Measures the quality of collections relative to the amount that was collectible in the period
CEI measures what percentage of available receivables were collected in a period, providing a more accurate view of collection performance than DSO when sales fluctuate.
Question 6: When a company places a customer account on 'credit hold,' it means:
- The customer's credit limit is permanently reduced
- New shipments or services are suspended until the account is brought current or resolved (Correct answer)
- The account is transferred to a third-party collection agency
- The customer's outstanding balance is written off as uncollectible
Correct answer: New shipments or services are suspended until the account is brought current or resolved
A credit hold temporarily stops fulfillment of new orders for a customer until outstanding payment or credit issues are resolved, protecting the seller from additional exposure.
Question 7: Which metric BEST measures the overall efficiency of the credit and collections function?
- Gross profit margin
- Bad debt as a percentage of credit sales (Correct answer)
- Current ratio
- Inventory turnover
Correct answer: Bad debt as a percentage of credit sales
Bad debt as a percentage of credit sales directly quantifies the effectiveness of the credit function — lower percentages indicate better credit decisions and collection outcomes.
CCE Trade Credit & Accounts Receivable Management 2
What is accounts receivable factoring?