Illustration 1: A company has prepared the following projections for a year Sales Selling Price per unit Variable Costs per unit Total Costs per unit Credit period allowed
21000 units Rs.40 Rs.25 Rs.35 One month
The company proposes to increase the credit period allowed to its customers from one month to two months .It is envisaged that the change in policy as above will increase the sales by 8%. The company desires a return of 25% on its investment. You are required to examine and advise whether the proposed credit policy should be implemented or not? Solution: Particulars Sales (units) Contribution per unit Total Contribution Variable cost @ Rs.25 Fixed Cost
Present 21000 Rs.15 Rs.3,15,000 5,25,000 2,10,000
Proposed 22680 Rs.15 Rs.3,40,000 5,67,000 2,10,000
Total Cost
7,35,000
7,77,000
Credit period
1 month
2 month
Average debtors at cost
Rs.61250
Rs.1,29,500
Incremental Return = Increased Contribution/Extra Funds Blockage *100 = Rs.25,200/Rs.68,250*100 =36.92%
Incremental 1680 Rs.15 Rs.25,200 42,000 -----42,000 -----
Rs.68,250
Illustration 2: ABC & Company is making sales of Rs.16,00,000 and it extends a credit of 90 days to its customers. However, in order to overcome the financial difficulties, it is considering to change the credit policy. The proposed terms of credit and expected sales are given hereunder: Policy I II III IV V Rs.13,00,000
Terms 75 days 60 days 45 days 30 days
15
Sales Rs.15,00,000 Rs. 14,50,000 Rs 14,25,000 Rs 13,50,000
days
The firm has variable cost of 80% and fixed cost of Rs.1,00,000. The cost of capital is 15%. Evaluate different policies and which policy should be adopted? Solution: figures in Rs. Particular s Sales Variable cost Fixed Cost Profit (A) Total Cost Average Receivable (Cost¸360x credit period Cost of debtors @ 15% (B) Net profit (A – B)
Present
I
II
III
IV
V
1,600,000 1,280,000 100,000 220,000
1,500,000 1,200,000 100,000 200,000
1,450,000 1,160,000 100,000 190,000
1,425,000 1,140,000 100,000 185,000
1,350,000 1,080,000 100,000 170,000
1,300,000 1,040,000 100,000 160,000
1,380,000
1,300,000
1,260,000
1,240,000
1,180,000
1,140,000
345,000
270,833
210,000
155,000
98,333
47,500
51,750
40,625
31,500
23,250
14,750
7,125
168,250
159,350
158,500
161,750
155,250
152,875
Illustration3: A trader whose current sales are Rs.1,500,000 per annum and average collection period is 30 days wants to pursue a more liberal credit policy to improve sales. A study made by consultant firm reveals the following information. Credit Policy
increase in collection period
A B C D E
Increase in sales
Rs.60,000 90,000 150,000 180,000 200,000
15 days 30 days 45 days 60 days 90 days
The selling price per unit is Rs.5. Average Cost per unit is Rs.4 and variable cost per unit I Rs.2.75 paise per unit. The required rate of return on additional investments is 20 percent (cost of capital). Assume 360 days a year and also assume that there are no bad debts. Which of the above policies would you recommend for adoption. Solution: Particulars Credit period
Present
A
B
C
D
E
30 days
45 days
60 days
75 days
90 days
120 days
300,000
312,000
318,000
330,000
336,000
340,000
Sales Variable cost@ 2.75
1,500,000 8,25,000
1,560,000 8,58,000
1,590,000 874,500
1,650,000 907,500
1,680,000 924,000
1,700,000 935,000
Fixed Cost Total Cost
375,000 1,200,000
375,000 1,233,000
375,000 1,249,500
375,000 1,282,500
375,000 1,299,000
375,000 1,310,000
Profit (A)
300,000
327,000
340,500
367,500
381,000
390,000
Average debtors cost(at cost)
100,000
154,125
208,250
267,188
324,750
436,667
Cost of investment@ 20% (B)
20,000
30,825
41,650
53,437
64,950
87,333
Net Profit (AB)
280,000
296,175
298,850
314,063
316,050
302,667
No. of units @ Rs.5
[(TC )(x/360)]
Lets Sum Up The receivables emerge when goods are sold on credit and the payments are deferred by the customers. So, every firm should have a well-defined credit policy. The receivables management refers to managing the receivables in the light of costs and benefit associated with a particular credit policy. Receivables management involves the careful consideration of the following aspects: Forming of credit policy, Executing the credit policy, Formulating and executing collection policy. The credit policy deals with the setting of credit standards and credit terms relating to discount and credit period. The credit evaluation includes the steps required for collection and analysis of information regarding the credit worthiness of the customer.
