Page 268 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes
Present Policy Policy Option I Policy Option II
Annual credit sales 50,00,000 60,00,000 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
Solution: XYZ Corporation

Decision-making (liberalization of credit terms)

Present Policy Policy Option 1 Policy Option II
( ) ( ) ( )
Sales revenue 50,00,000 60,00,000 67,50,000
Less variable cost 35,00,000 42,00,000 47,25,000
 – –
contribution 15,00,000 18,00,000 20,25,000
Less other relevant costs
Bad debt losses 1,50,000 300,000 4,50,000
Investment cost (Notes) 218,750 3,50,000 4,92,187.50
Contribution margin-final 11,31,250 11,50,000 10,82,812.50.

Policy option I is the better option.
Notes: Present policy: 35,00,000/4times = 875,000. Its cost @ 25% = 218,750
Option 1 : 42,00,000/3times = 14,00,000. Its cost @ 25% = 3,50,000
Option 2 : 47,25, 000/2.4times = 19,68,750.Its cost @ 25% = 4,92,187.50

12.2.3 Collection Policies

Efficient and timely collection of debtors ensure that bad debt losses are reduced to the minimum
and the average collection period is shorter. If the firm spends more resources, on utilization of
debts, it is likely to have smaller bad debts. Thus, a firm must work out the optimum amount
that it should spend on collection of debtors. This involves a trade-off between the levels of
expenditure on the one hand and decreases in bad debt losses and appropriate investment in
debtors on the other.
The collection cost of the firm has to work in a manner that it does not create too much resentment
amongst the customers. On the other hand, it has to keep the amount of outstanding payments
in check. Hence, it has to work in a very smooth manner and diplomatically too.
It is important that clear-cut procedures regarding credit collection are set up. Such procedures
must answer questions like the following:
1. How long a is debtor balance allowed to exist before collection process is started?

2. What should be the procedure of follow up with defaulting customer? How are reminders
are to be sent and how should each successive reminder be drafted?
3. Should there be collection machinery whereby personal calls by company’s representatives
are made?
4. What should be the procedure for dealing with doubtful accounts? Is legal action to be
initiated? How should account be handled?

262 LOVELY PROFESSIONAL UNIVERSITY