Management of Accounts Receivable and Inventories

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Chapter 17

• Management of Accounts Receivable and Inventories

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Accounts Receivable Management

• Credit standards
• Average collection period
• Bad-debt loss ratio
• Credit terms
• Credit period net 30
• Cash discount 1/7, net 30
• Collection efforts

3
Changing Credit Standards (1)

• Group ACP BDLR Credit Sales
• 1 25 0 900,000
• 2 30 0.5 1,100,000
• 3 45 3 400,000
• 4 60 7 300,000
• 5 90 13 100,000

• Extend credit to group 4 customers
• Variable cost ratio is 0.75
• Additional inventory investment of 120,000 is
  required to expend sales by 300,000
• Required pretax rate of return is 20

4
Changing Credit Standards (2)

• A. Marginal profit from additional sales
• (1 - 0.75) 300,000 75,000
• B. Cost of additional investment in receivables
• (300,000/365) 60 20 9,863
• C. Additional bad-debt loss
• 300,000 7 21,000
• D. Cost of the additional investment in
  inventory
• 120,000 20 24,000
• Net change in pretax profitsMarginal
  returns-Marginal costs
• A - (B C D)
• 75,000 - (9,863 21,000 24,000) 20,137

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Changing Credit Terms (1)

• Change credit terms from net 30 to net 60
• Sales are expected to increase by 10 from 2.2
  million
• Expected average collection period will increase
  from 35 days to 65 days
• Bad-debt ratio will remain at 3
• Additional inventory investment of 50,000
• Variable cost ratio is 0.75
• Required pretax rate of return is 20

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Changing Credit Terms (2)

• A. Marginal profit from additional sales
• (1 - 0.75) 0.1 2,200,000 55,000
• B. Cost of additional investment in receivables
• (2,420,000/365) 65 - (2,200,000/365) 35
  20
• 44,000
• C. Additional bad-debt loss
• 220,000 3 6,600
• D. Cost of the additional investment in
  inventory
• 50,000 20 10,000
• Net change in pretax profitsMarginal
  returns-Marginal costs
• A - (B C D)
• 55,000 - (44,000 6,600 10,000) -5,600

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Changing Cash Discount (1)

• Change net 30 to 1/10, net 30
• Average collection period is now 50 days and is
  expected to decrease to 28 days
• 40 of the customers will take the cash discount.
• Annual credit sales are 2.5 million
• Required pretax rate of return is 20

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Changing Cash Discount (2)

• A. Earnings on the funds released by the decrease
  in receivables
• (2,500,00/365) 50 - (2,500,000/365) 28
  20
• 30,137
• B. Cost of cash discount
• 2,500,000 40 1 10,000
• C. Net change in pretax profits
• Marginal returns - Marginal costs
• A - B
• 30,137 - 10,000
• 20,137

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Homework

• Page 619, questions 3, 5, 9, 10
• Page 655-656, problems 3, 4