Page 175 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes 10.6 Keywords

Lenient Credit Policy: It is that policy where the seller sells goods on very liberal credit terms
and standards.

Receivable: The term receivable is defined as “debt owed to the firm by customers arising from
sale of goods or services in the ordinary course of business”.
Receivable Turnover: Receivables turnover provides relationship between credit sales and debtors
(receivables) of a firm.
Stringent Credit Policy: Stringent credit policy seller sells goods on credit on a highly selective
basis only i.e., the customers who have proven credit worthiness and financially sound.
Time Value: A Diagram specifying the timing of cash flows.
Trade credit: Trade credit exists when one firm provides goods or services to a customer with an
agreement to bill them later, or receive a shipment or service from a supplier under an agreement
to pay them later.

Yield to Maturity: The rate of return earned on a security if it is held till maturity.
10.7 Review Questions

1. Dream Well Company’s present annual sales are ` 5,00,000, cost of capital is 15% and the
company is in the 40% tax bracket. Company categorized its customers into four categories,
viz., C1, C2, C3 and C4 (C1 customer have the highest credit standing and those in C4 have
lowest credit standing). At present Company has provided unlimited credit to categories
C1 and C2, where as limited credit facility to Category C3 and no credit to Category C4,
since their credit standing (rating) is very low. Due to the present credit standards the
company foregoing sales to the extent of ` 50,000 to the customers in category C3 and
` 40,000 to the C4 category customers. To grab the foregoing sales to the C3 and C4
category customers, company is considering to relax, credit standards, under that category
C3 customers would be provided unlimited credit facility and customers in C4 category
would be provided limited credit facility. As a result of relaxation in credit standards the
sales are expected to increase by ` 75,000 and it involves 12 per cent bad debt loss on
increased sales. The estimated contribution margin ration is 25 per cent and average
collection period if 50 days.

Determine the change in net profit and suggest whether the company consider the
relaxation of credit standards or not.
2. As a finance manager, how would you know that you organization needs receivables
management?
3. Critically analyse the traditional techniques available for monitoring accounts receivables.
4. Trade credit is most prominent force of modern business. Comment.

5. Critically examine factoring in accounts receivables management.
6. Factoring is a method of financing available to organizations that are considered as high
risk. Why so?

7. What can be the different ways in which the accounts receivable management specialists
can help an organization?
8. Will there be any situation in which, you would not suggest the involvement of a factor in
ARM? If yes, elucidate. If no, why doesn’t every company rush to a factor for its ARM?

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