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Unit 13: Receivables Management
Notes
Example: Suppose the firm is contemplating an increase in the credit period from 30-60 days.
The average collection period, which is at 45 days, is expected to increase to 75 days. It is also
likely that the bad debt or expenses will increase from the current level of 1% to 3% of sales.
Total credit sales are expected to increase from the current levels of 60,000 units to 69,000 units.
The present average cost per unit is 8; the variable cost sales per unit are 6 and 10 per unit
respectively. Assume the firm expects a return of 15%. Should the firm extend the credit
period?
Solution: The decision should be taken on the basis of comparison of benefits and costs associated
with the decision. The benefits arising from additional profits from additional sales, while
the costs include the cost of additional investments in receivables and additional bad debt
expenses:
1. Profit on additional sales 4 × 9000 = 36,000
2. Cost of additional investment in receivables
Proposed investment = × 75 = 111,250
Present investment = × 45
60,000
Additional investment proposed 51,250
Cost of additional investment at 15% 7,688
3. Additional bad debt expense
Bad debt with proposed credit period 3% on 690,000 20,700
Bad debts with present plan 1% × 600,000 6000
Hence additional bad debt expenses 14,700
Thus, the total cost associated with the extension of credit period is 7688 + 14700 i.e.,
22,388. As against this, the benefit comes to 36,000. There is therefore a net gain of 13,612.
The firm must be advised to extend the credit period from 30 to 60 days.
Example: XYZ Corporation is considering relaxing its present credit policy and is in the
process of evaluating two proposed policies. Currently the firm has annual credit sales of 50
lakhs and accounts receivable turnover ratio of 4 times a year. The current level of loss due to
bad debts is 1,50,000. The firm is required to give a return of 25% on the investment in new
accounts receivable. The company’s variable costs are 70% of the selling price. Given the following
further information, which is a better option?
Present Policy Policy Option I Policy Option II
Annual credit sales 50,00,000 0,00,000 67,50,000
Accounts receivable turnover ratio 4 times 3 times 2.4 times
Bad debt losses 1,50,000 300,000 4,50,000
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