Working Capital Management-2
CREDIT MANAGEMENT
Credit Standards:
Δ̇ s
ΔI= 360
∗ACP∗V
ΔS (1 − V) measures the increase in gross profit (defined here as sales minus variable costs)
on account of incremental sales,
ΔSbn reflects the bad debt loss on incremental sales,
[ΔS (1 − V) − ΔS bn] (1 − t) represents the post-tax profit arising from increase in sales after
considering bad debt losses,
k ΔI measures the post-tax opportunity cost of additional funds locked in receivables.
1)The current sales of Pioneer Company are ₹100 million. The company classifies its
customers into 4 credit categories, 1 through 4. Credit rating diminishes as one goes from
category 1 to category 4. (Customers in category 1 have the highest credit rating and
customers in category 4 have the lowest credit rating). Pioneer presently extends unlimited
credit to customers in categories 1 and 2, limited credit to customers in category 3, and no
credit to customers in category 4. As a result of this credit policy, the company is foregoing
sales to the extent of ₹10 million to customers in category 4. The firm is considering the
adoption of a more liberal credit policy under which customers in category 3 would be
extended unlimited credit and customers in category 4 would be extended limited credit. Such
relaxation would increase the sales by ₹15 million on which bad debt losses would be 10
percent. The contribution margin ratio, (1 − V), for the firm is 20 percent, the average
collection period, ACP, is 40 days, and the post-tax cost of funds, k, is 10 percent. The tax
rate for Pioneer is 40 percent.
2) Apex Limited classifies its customers into five risk categories, 1 through 5. Presently Apex
extends unlimited credit to customers in categories 1 through 3, limited credit to customers in
category 4, and no credit to customers in category 5. Due to this policy, the company is
foregoing sales of ₹ 3 million to customers in category 4 and ₹ 6 million to customers in
category 5. Apex is considering the adoption of a more liberal credit policy under which
customers in category 4 would be extended unlimited credit and customers in category 5
would be extended limited credit. Such relaxation would increase sales by ₹ 9,000,000 on
which bad debt losses would be 10 percent. The contribution margin ratio (1 − V) for Apex is
20 percent. The average collection period, ACP, is 50 days and the post-tax cost of funds, k,
is 12 percent. The tax rate for Apex is 40 percent. What will be the effect of relaxing the
credit policy on residual income?
CREDIT PERIOD
Excepting Δ I, the components of this formula are calculated as discussed earlier. ΔI, here, is
calculated as follows
where ΔI is the increase in receivables investment,
ACPn is the new average collection period (after lengthening the credit period),
ACPo is the old average collection period, V is the ratio of variable cost to sales,
and ΔS is the increase in sales.
3)Zenith Corporation currently provides 30 days of credit to its customers. Its present level of sales is
₹ 50 million. The firm’s cost of capital is 10 percent and the ratio of variable costs to sales is 0.85.
Zenith is considering extending its credit period to 60 days. Such an extension is likely to push sales
up by ₹ 5 million. The bad debt proportion on additional sales would be 8 percent. The tax rate for
Zenith is 40 percent. Given the above information, the effect of lengthening the credit period on the
residual income of Zenith would be?
4)Manish Corporation currently provides 45 days of credit to its customers. Its present sales are ₹ 80
million. The firm’s cost of capital is 13 percent and the ratio of variable costs to sales is 0.75. Manish
is considering extending its credit period to 60 days. Such an extension is likely to push sales up by ₹
20 million. The bad debt proportion on additional sales would be 10 percent. The tax rate for Manish
is 35 percent. What will be the effect of lengthening the credit period on the residual income of
Manish?
CASH DISCOUNT
where ΔRI is the change in residual income,
ΔS is the increase in sales,
V is the variable cost to sales ratio,
ΔDIS2 is the increase in discount cost,
t is the tax rate,
k is the cost of capital,
and ΔI3 is the savings in receivable investment.
5)The present credit terms of Progressive Company are 1/10, net 30. Its sales are ₹ 80 million, its
average collection period, ACP, is 20 days, its variable costs to sales ratio, V, is 0.85, and its cost of
capital, k, is 10 percent. The proportion of sales on which customers currently take discount, po, is
0.5. Progressive is considering relaxing its discount terms to 2/10, net 30. Such a relaxation is
expected to increase sales by ₹ 5 million, reduce the ACP to 14 days, and increase the proportion of
discount sales to 0.8. Progressive’s tax rate is 40 percent.
6) The present credit terms of Multimedia Company are 2/15, net 45. Its sales are ₹ 200 million, its
average collection period, ACP, is 30 days, its variable costs to sales ratio, V, is 0.80, and its cost of
capital, k, is 12 percent. The proportion of sales on which customers currently take discount, po, is
0.5. Multimedia is considering relaxing its discount terms to 3/15, net 45. Such a relaxation is
expected to increase sales by ₹ 10 million, reduce the ACP to 27 days, and increase the proportion of
discount sales to 0.6. Multimedia’s tax rate is 40 percent. What will be the effect of liberalising the
cash discount on residual income?
COLLECTION EFFORT
where ΔRI is the change in residual income,
ΔS is the increase in sales,
V is the variable costs to sales ratio,
ΔBD is the increase in bad debt cost4,
t is the tax rate,
k is the cost of capital,
and ΔI is the increase in investment in receivables
7)ABC Company is considering relaxing its collection effort. Its sales are ₹ 40 million, its average
collection period, ACP, is 20 days, its variable costs to sales ratio, V, is 0.80, its cost of capital, k, is 12
percent, and its bad debt ratio is 0.05. The relaxation in collection effort is expected to push sales up
by ₹ 5 million, increase the average collection period to 40 days, and raise the bad debt ratio to 0.06.
ABC’s tax rate is 40 percent.
8) Vibgyor Limited is considering relaxing its collection effort. Its sales are ₹ 100 million, its average
collection period, ACP, is 30 days, its variable costs to sales ratio, V, is 0.75, its cost of capital, k, is 14
percent, and its bad debt ratio, bo, is 0.04. Vibgyor’s tax rate is 30 percent. The relaxation in
collection effort is expected to push sales up by ₹ 10 million, increase the average collection period
to 40 days, and raise the bad debts ratio to 0.05. What will be the effect of relaxing the collection
effort on residual income?
ACCOUNTS RECEIVABLES
9)Vineeta Enterprises sells on terms 2/10, net 45. Annual sales are ₹ 90 million. 30 percent of its
customers pay on the 10th day and take the discount. If accounts receivable average to ₹ 12 million,
what is the average collection period (ACP) on non-discount sales?
DAILY SALES OUTSTANDING
10) The monthly sales and month-end accounts receivable for a company
Required:
Calculate the days sales outstanding’s (DSO) at the end of each quarter for averaging periods of 30
days and 60 days.
Draw up the ageing schedules (A/S) at the end of each quarter using the age brackets 0-30, 31-60,
and 61-90 days.
11)The following information is available for Avinash Company:
Required:
Calculate the day’s sales outstanding (DSO) at the end of each quarter for averaging periods of 30
days and 60 days.
Draw up the ageing schedules (A/S) at the end of each quarter using the age brackets 0-30, 31-60,
and 61-90 days.