Collection policy, Finance Basics

Assignment Help:

Collection Policy

The firm's collection policy may affect also our study.  The higher the cost of collecting accounts obtainable the lower the bad debt losses.  Therefore the firm must consider if the reduction in bad debt is extra than the increase in collection costs.

As saturation point improved expenditure in collection efforts does not conclude in reduced bad debt and hence the firm must not spend more after reaching this point.

Demonstration

Riffruff Ltd is assuming relaxing its credit standards. The firm's current credit terms are net 30 but the average debtor's collection period is 45 days.  Current annual credit sales amounts to of Sh.6, 000,000.  The firm wants to extend credit duration net 60.  Sales are expected to increase by 20 percent.  Bad debts will rise from 2 percent to 2.5 percent of annual credit sales.  Credit analysis and debt collection costs will increase with Sh.4, 000 p.a.  The return on investment in debtors is 12 percent for of Sh.100 of sales, of Sh.75 are variable costs.  Suppose 360 days p.a.  Should the firm transform the credit policy?

Suggested Solution

Current sales                                         =       Sh.6, 000,000

New sales   =       Sh.6, 000,000 x 1.20    =       Sh.7,200,000

Contribution margin =  Sh.100 - Sh.75     =       Sh.25

Therefore contribution margin ratio          = (Sh.25/Sh.100)* 100  =       25%

Cost advantage analysis

Contribution Margin

New policy           25% x 7,200,000                   =         1,800

Current policy               25% x 6,000,000           =         1,500          =       300

Credit analysis and debt collection costs                                                   (84)

Bad debts

New bad debts       =        2.5% x 7,200,000          =          180

Current bad debts   =      2% x 6,000,000             =           120                  (60)

Debtors

New debtors        = Cr.period/360 days x cr. Sales p.a.

                          =        (60/360) * 7,200,000  

                           =        1,200

Current debtors    =        (45/360) * 6, 00,000   

                         =           750

Increase in debtors (tied up capital)                     450

Forgone profits    =        12% x 450                     (54)

Net benefit (cost)                                             102

Hence, change the credit policy.


Related Discussions:- Collection policy

Explain the term - underwriting, Explain the term - Underwriting Und...

Explain the term - Underwriting Underwriting is an agreement whereby underwriter promises to subscribe to a specified number of debentures or shares or a specified amount of

Basic Business Math, A new pet shop wants to apportion their investment mon...

A new pet shop wants to apportion their investment money $132,000 for advertising, building upgrades, and education in the ratio of 5:4:3. How much money does each category get app

Computing the real rate & flat tax, Quetion1: You are earning 5.2 percent ...

Quetion1: You are earning 5.2 percent on a certificate of deposit. Inflation is running 3.5 percent. What is the real rate of return on your investment? Question2: Search for

Tarniwala and dealer in non-cleared securities, Tarniwala and Dealer in N...

Tarniwala and Dealer in Non-cleared Securities Tarniwala: He/she is a specialist or jobber in selected shares. He/she makes market i.e. provide continuity to dealings. They

project on financial planning, Financial Planning Project Instructions: ...

Financial Planning Project Instructions: You will serve as a financial advisor for your client to develop a financial plan. You can compile all the worksheets introduced in eac

Managerial finance functions, Managerial Finance Functions Require ski...

Managerial Finance Functions Require skilful execution, control and planning of financial activities.  Hence there are four significant managerial finance functions. Such are

Calculate the expected sale, 1. Suppose company A expects to increase unit ...

1. Suppose company A expects to increase unit sales of i-phone by 15% per year for the next 5 years. If you currently sell 3 million i-phones in one year, how many phones do you ex

Fiscal federalism, What are the principles of multiunit finance?

What are the principles of multiunit finance?

Return on the annuity, An insurance company offers you and end of year annu...

An insurance company offers you and end of year annuity of $48,000 per year for the next 20 years. They claim your return on the annuity is 9%. What is the most you would be willin

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd