Page 267 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 12: Receivables Management

Reduction 17,750 Notes

Int. @ 15% on saving 17750 × 0.15 2,663
38,663
Cost, 2% on 60% of 69000 × 10 8,280

Net benefit 30,383

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

æ 8 ´ 60,000 + ´ 9000 ö
6
Proposed investment = ç è 360 ÷ × 75 = 111,250
ø
Accounts Receivable at time chosen
Present investment = × 45
Average daily sales
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?

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