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

Calculate the firms wacc, The Genesis operations management team, nearing c...

The Genesis operations management team, nearing completion of its agreement with Sensible Essentials, was asked by senior management to present a capital plan for the operating exp

Clientele effect theory, Clientele Effect Theory Advance via Richardso...

Clientele Effect Theory Advance via Richardson Petit in 1977.It stated such different types of groups of shareholders or clientele have different type of preferences for divid

Functions of central bank, Functions of Central Bank a) Ensure Economi...

Functions of Central Bank a) Ensure Economic stability b) Lender to the government c) Printing of currency notes d) Banker to the government e) Lender of last reso

Working Capital, AsStudents will analyze and synthesize the financial repor...

AsStudents will analyze and synthesize the financial reports of an organization of their choice and present their findings in a PowerPoint presentation (with completed Notes sectio

Stock split and reverse split, Stock Split and Reverse Split This is w...

Stock Split and Reverse Split This is whereas a block of shares is broken down into smaller units or shares hence the number of ordinary shares rises and their respective par

Role of venture capital in economic development, Role of Venture Capital in...

Role of Venture Capital in Economic Development The categories of venture that capitalists might invest will include: a) Business start-ups - Whenever a business has been

Differentiate between initial and termination expenses, (a) State the most ...

(a) State the most appropriate drivers for the following direct expenses: (i) New business administration department's salary costs (ii) Medical examinations for temporary life

Political and technological factor - investment decisions, Political Factor...

Political Factors and Technological Factors - Investment Decisions i) Political factors - Under conditions of political uncertainty, that decisions cannot be completed as it

Channelling of funds from savers to spenders important, How is the channell...

How is the channelling of funds from savers to spenders very important? The channelling of funds by savers to spenders is very significant for two purposes: • One, lender-sa

IS LM, After carefully reading all the available information, prepare a two...

After carefully reading all the available information, prepare a two page (double-spaced) essay and answer the following questions: Assume that we have the following data: C=100+0.

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