FNCE371 Assignment 1
CASE 3: CREDIT POLICY MANAGEMENT
QUESTION 1
There are three components of a credit policy. They are:
1. Terms of Sale (in this case, net 50)
2. Credit Analysis (in this case, there is a forecasted bad debt of 1%. However, it appears
that all customers are given credit without looking into each and scoring to see if credit
should be allowed)
3. Collection policy (In this case, Margaret calls if bills go past 60 days)
Since the second component is not fulfilled, Luvly Jubbly does not have a credit policy. Rather, they have
credit terms and a collection procedure.
QUESTION 2
Given:
R= 15%
Current: net 30
85% by day 50
14% by day 60
1% bad debt
Alternative 1: 2/20 net 30
Lose 5% sales
50% by day 20
40% by day 30
10% by day 60
Alternative 2: 2/25 net 45
60% by day 25
35% by day 45
5% by day 60
Costs of switching, Alternative 1:
Sales grow by 10%, but 5% are lost
500,000 * 1.05 = 525,000
Costs increase with sales
300,000 * 1.05 = 315,000
Cost of switching = PQ + V(Q’-Q)
Cost of switching = current sales + (cost of new sales – cost of current sales)
= 500,000 + (315,000 – 300,000)
= 515,000
Cost of switching, Alternative 2:
Sales increase by 10%
500,000 * 1.10 = 550,000
Costs increase with sales
300,000 * 1.10 = 330,000
Cost = current sales + (cost of new sales – cost of current sales)
= 500,000 + (330,000 – 300,000)
= 530,000
QUESTION 3:
Current Aging Schedule:
Step 1: Ave sales per day
= sales / Days = 550000/365
=1506.85
Step 2: Amounts
Amounts o/s for accounts paid by day 50
= probability * average sales per days * 50
= 0.85 * 1506.85 * 50
= 64014.13
Amounts o/s for accounts paid by day 60
= 0.14*1506.85*60
= 12657.54
Age Amount O/S % of AR
0-50 54014.13 83.5%
50-60 12657.54 16.5%
Total 76698.67 100%
Alternative 1 Aging Schedule
Ave sales per day = 525000/365= 1438.26
Amounts O/S at day 20 = 0.5*1438.26*20 = 14383.6
Amounts O/S at day 30 = 0.4*1438.36*30 = 17260.32
Amounts O/S at day 60 = 0.1*1438.36*60 = 8630.16
Age Amounts O/S % of AR
0-20 14383.67 35.71%
20-30 17260.32 42.86%
30-60 8630.16 21.43%
Total 40274.08 100%
Alternative 2 Aging Schedule
Ave sales per day = 550000/365= 1506.85
Amounts OS at day 25 = 0.35*1506.85*25 = 22602.75
Amounts O/S at day 45 = 0.35*1506.85*45 = 23732.89
Amounts O/S at day 60 = 0.05*1506.85860= 4520.55
Age Amounts O/S % of AR
0-25 22602.75 44.44%
25-45 23732.89 46.67%
45-60 4520.55 8.89%
Total 50856.19 100%
QUESTION 4
Current Proforma Statements:
Current Statement of Financial Position
Cash 10000 AP 15000
AR 76798.67 NP 41698.67
Inv 20000 Total 56698.67
Current: 106698.67 Long term debt 200000
Fixed: 500000 Equity 350000
Total Assets: 606698.67 Total Liabilities/ Equity: 606698.67
Current Statement of Comprehensive Income
Sales 550000
COGS 330000
Gross margin 220000
Operating Expense 110000
EBIT 110000
Interest 36254.80
EBT 73745.20
Tax 25810.82
Net Income 47934.38
Alternative 1 Financial Statements
Alternative 1 Statement of Financial Position
Cash 10000 AP 15000
AR 40274.08 NP 5274.08
Inv 20000 Total 20274.08
Current: 70274.08 Long term debt 200000
Fixed: 500000 Equity 350000
Total Assets: 570274.08 Total Liabilities/ Equity: 570274.08
Alternative 1 Statement of Comprehensive Income
Sales 525000
COGS 315000
Gross margin 210000
Operating Expense 105000
EBIT 105000
Interest 30791.11
EBT 74208.89
Tax 25973.11
Net Income 48235.78
Alternative 2 Financial Statements
Alternative 2 Statement of Financial Position
Cash 10000 AP 15000
AR 50856.19 NP 15856.19
Inv 20000 Total 30856.19
Current: 80856.19 Long term debt 200000
Fixed: 500000 Equity 350000
Total Assets: 580856.19 Total Liabilities/ Equity: 580856.19
Alternative 2 Statement of Comprehensive Income
Sales 550000
COGS 330000
Gross margin 220000
Operating Expense 110000
EBIT 110000
Interest 32378.43
EBT 77621.67
Tax 27167.55
Net Income 50454.02
QUESTION 5
Current Ratios
Ave Collection Period:
= AR / Ave Sales per day
= 76698.67/1506.85
= 50.90
Net profit margin
= Net Income / Sales
= 0.08715 = 8.72%
ROA
=Net Income / Total Assets
= 0.0790 = 7.90%
ROE
= Net Income / Equity
= 47934.38 / 350000
-= 0.13695 = 13.70%
Alternative 1 Ratios
Ave Collection Period:
= AR / Ave Sales per day
= 28 days
Net profit margin
= Net Income / Sales
= 0.09187 = 9.19%
ROA
=Net Income / Total Assets
= 0.08458 = 8.46%
ROE
= Net Income / Equity
= 0.1378 = 13.78%
Alternative 2 Ratios
Ave Collection Period:
= AR / Ave Sales per day
= 33.75 days
Net profit margin
= Net Income / Sales
= 0.09173 = 9.17%
ROA
=Net Income / Total Assets
= 0.08686 = 8.69%
ROE
= Net Income / Equity
= 0.14415 = 14.42%
QUESTION 6
Industry Comparisons
Industry Average Current Alternative 1 Alternative 2
Ave Coll Period 28 50.9 28 33.75
Profit Margin 5% 8.72% 9.19% 9.17%
ROA 5.2% 7.9% 8.46% 8.69%
ROE 13% 13.7% 13.78% 14.42%
QUESTIONO 7
Alternative 1 should be chosen. It most closely aligns with industry average, and provides the highest
ROA, ROE, and profitability along with the lowest AR. However this Alternative should only be selected if
the estimated loss of sales is reasonably accurate.
CASE 2: FLOAT MANAGEMENT
QUESTION1
Inventory Period
=365 / (COGS/Inventory)
= 365 / [2,625,000 / (80,000 + 120,000 / 2)]
= 365 / 26.25
= 13.9 = 14 days
The inventory holding period is 14 days.
Receivables Period
= 365 / (Credit Sales / Ave AR)
= 365 / [(0.7 * 3,500,000) / ((175,000 + 145,000)/2)]
= 365 / (2,450,000 / 160,000)
= 365 / 15.3125
= 23.83 = 24 days
The receivables period is 24 days.
Payables Period
= 365 / (COGS/Ave AP)
= 365 / [(0.75 * 3,500,000) / ((130,000 + 110,000)/2))]
= 365 / (2,625,000 / 120,000)
= 365 / 21.85
= 16.6857 = 17 days
The payables period is 17 days.
QUESTION 2
Operating Cash Cycle
= Inventory Period + AR Period
= 14 + 24
= 38 days
The operating cash cycle is 38 days.
Cash Cycle
= Operating Cycle – AP Period
= 38 – 17
= 21 days
The cash cycle is 21 days.
QUESTION 3
Operating cash cycle is almost 10 days higher than industry average, while the cash cycle is on par with
the industry.
QUESTION 5
Collection delay
= Mail Delay + Processing Delay + Availability Delay
= [(1+2+4)/3] + 1 + 3
= 6.33 = 7 days
Disbursement delay
=1+3+4
=8
Average Daily Collection
= (3,500,000 * 0.7) / 365
= 6,712.33
Average Daily Collection Float
= 6,712.33 * 7
= 25,986.31
Average Daily Disbursement
= (3,500,000 * 0.75) / 365
= 7,191.78
Average Daily Disbursement Float
= 7,191.78 * 4
= 28,767.12
The average daily collection float is $25,986.31 and the average daily disbursement float is $28,767.12
QUESTION 6
Net float
= Disbursement Float – Collection Float
= 28,767.12 – 25,986.31
= 2,780.81
The daily net float is $2,780.81 and the annual net float is 1,014,995.65 annually.
QUESTION 7
Effective annual rate
= 2% per months
12 period
EAR = [(1 + 0.02)^12] – 1
= 0.2682
= 26.82%
Borrowing Amount:
Statement of Financial Position
Cash 15,000 AP 110,000
AR 145,000 Short Term Debt 180,000 * plug
Inventory 120,000 Total Current 290,000
Total 280,000 Long Term Debt 440,000 * remain.loan
Fixed Assets 650,000 Equity 200,000
Total Assets 930,000 Total L & E 930,000
180,000 * 0.2682 = $48,276 interest
QUESTION 8
Collection delay with offer
= [(1+2+4)/2] + 1
= 3.33 = 4 days
Average Daily Collection Delay
= (3,500,000 * 0.7) / 365
= 6,712.33
Average Daily Collection Float
= 6712.33 * 4
= 26,849.32
The average daily collection float with the new offer would be $26,849.32. The average daily
disbursement float would be unaffected by the new offer and remain at $28,767.12.
Net float with offer
= 28767.12 – 26849.31
= 1917.803
With the new offer, the daily net float would be $1,917.80 daily and $627,728.10 annually.
QUESTION 9
New AR = 6712.33 * 362 (reduced by 3 days)
= 2,429,863.46
Old AR = 3,500,000 * 0.7
= 2,450,000
Difference: 2,450,000 – 2,429,863.46 = 20,136.54
The additional cash available if the offer is accepted would be $20,136.54.
QUESTION 10
Original shortfall between AP and AR
= 2,450,000 – 2,625,000
= -175,000
+ 20,136.54 additional cash available
= -154,863.46
In order to cover the float, $154,863.46 would have to be borrowed.
QUESTION 11
Find NPV
Float improved by $387,267.56
Costs – 3,000 forever
PV = 3000 / 0,15
= 20,000
NPV = 387,267.56 – 20,000
= 367,267.56
Accept the offer – the net present value is positive.
CASE 3: CASH MANAGEMENT
Cash Collections, Jan Y2 – Jan Y3
January Februar March April May June
y
Sales 200000 400000 800000 2200000 220000 440000
Month 0 100000 200000 400000 1100000 110000 220000
Collections
Month -1 600000 60000 120000 240000 660000 66000
Collections
Month -2 192080 392000 39200 78400 156800 431200
Collections
Total 892080 652000 559200 1418400 926800 717200
Collections
July August
September Octobe November Decembe January
r r
Sales 720000 2640000 330000 660000 1080000 3960000 220000
Month 0 360000 1320000 165000 330000 540000 1980000 110000
Collections
Month -1 132000 216000 792000 99000 198000 324000 1188000
Collections
Month -2 43120 86240 141120 517440 64680 129360 211680
Collections
Total 535120 1622240 1098120 946440 802680 2433360 1509680
Collections
Cash Disbursements
Januar February March April May June
y
Payment of 140000 280000 560000 1540000 154000 308000
Accounts
Payable
Wages, taxes, 60833 100833 180833 460833 64833 108833
and other exp
Capital exp 0 0 0 0 0 0
ST interest 400 0 0 0 347 0
expense
LT interest 50000 50000 50000 50000 50000 50000
expense
Dividends 0 0 30000 0 0 30000
Cash 251233 430833 820833 2050833 269180 496833
disbursement
s
July August September Octobe November December
r
Payment of 504000 184800 231000 462000 756000 2772000
Accounts 0
Payable
Wages, taxes, 164833 548833 86833 152833 236833 812833
and other exp
Capital exp 0 0 0 0 0 0
ST interest 0 0 1759 0 0 0
expense
LT interest 50000 50000 50000 50000 50000 50000
expense
Dividends 0 0 30000 0 0 30000
Cash 718833 244683 399592 664833 1042833 3664833
disbursement 3
s
Net Cash Inflow
Januar February March April May June
y
Cash 892080 652000 559200 1418400 926800 717200
Collections
Cash 251233 430833 820833 2050833 269180 496833
Disbursements
Net cash 640847 221167 -261633 -632433 657620 220367
inflow
July August September Octobe November December
r
Cash 535120 1622240 1098120 946440 802680 2433360
Collections
Cash 718833 2446833 399592 664833 1042833 3664833
Disbursements
Net cash -183713 -824593 698528 281607 -240153 -1231473
inflow
Monthly Cash Budget
January February March April May June
Beginning cash 200000 840847 1062014 800381 200000 825568
balance
Net cash 640847 221167 -261633 -632433 657620 220367
inflow
Ending cash 840847 1062014 800381 167948 857620 1045935
balance
Minimum cash 200000 200000 200000 200000 200000 200000
balance
Surplus/deficit 640847 862014 600381 -32052 657620 845935
July August September October November December
Beginning cash 1045935 862222 200000 736157 1017764 777611
balance
Net cash -183713 -824593 698528 281607 -240153 -1231473
inflow
Ending cash 862222 37629 898528 1017764 777611 -453862
balance
Minimum cash 200000 200000 200000 200000 200000 200000
balance
Surplus/deficit 662222 -162371 698528 817764 577611 -653862
QUESTION 1:
As shown in the above Cash Budget table, the monthly cash deficits and surpluses will be as follows:
Month Surplus/Deficit
January $640,847
February $862,014
March $600,381
April ($32,052)
May $657,620
June $845,935
July $662,222
August ($162,371)
September $698,528
October $817,764
November $577,611
December ($653,862)
Short term borrowing and related interest expense will be as follows:
January Februar March April May June
y
Short-term 0 0 0 32052 0 0
borrowing
Repaymen 0 0 0 0 32052 0
t of ST
debt
Cumulative 0 0 0 32052 0 0
ST debt
ST interest 0 0 0 347 0 0
expense
July August September Octobe November December
r
Short-term 0 162371 0 0 0 653862
borrowing
Repaymen 0 0 162371 0 0 0
t of ST
debt
Cumulative 0 162371 0 0 0 653862
ST debt
ST interest 0 1759 0 0 0 7084
expense
QUESTION 2
Depreciation expense is a large amount; however it is a non-cash figure. This means that while
depreciation is shown as an expense on the Statement of Comprehensive Income, the company is not
actually spending cash. Since a cash budget tracks only actual cash inflows and outflows, depreciation
should not be included.
QUESTION 3
Adjusting the minimum cash balance would have the following effect on the cash surplus/deficits
$0 $5,000 $50,000 $500,000
Month Sur/Def Month Sur/Def Month Sur/Def Month Sur/Def
January $840,847 January $835,847 January $790,847 January $340,847
February $1,016,01 February $1,057,01 February $1,012,01 February $562,014
4 4 4
March $800,381 March $795,381 March $750,381 March $300,381
April $167,948 April $162,948 April $117,948 April ($332,052)
May $825,915 May $820,915 May $775,915 May $654,370
June $1,046,28 June $1,041,28 June $996,282 June $542,685
2 2
July $862,569 July $857,569 July $812,569 July $358,972
August $37,976 August $32,976 August ($12,024) August ($465,621)
Septem $738,263 Septemb $733,263 Septemb $700,157 Septemb $695,243
October $1,019,87 October $1,014,87 October $969,740 October $511,229
0 0
Novembe $779,717 November $774,717 November $729,587 November $271,076
r
December ($451,756) December ($456,756) December ($501,886) December ($960,397)
The $200,000 minimum cash reserve policy results in a surplus in all months except three. In April, a
relatively small deficit is seen, and in August it is bigger and in December much bigger again. Decreasing
the minimum reserve policy would result in very high surpluses, while increasing it to $500,000 will
result in moderate surpluses but an extremely high deficit in December. The $200,000 minimum cash
reserve policy should be maintained as it provides a good medium ground of surpluses and deficits.
QUESTION 5
The sales team typically has the best knowledge of their customers needs and demands, however in my
professional experience I have noticed that they tend to overinflate projections. For this reason,
expected sales numbers provided by the sales team should be carefully scrutinized and forecasting
procedures should be put in place to ensure that projections are accurate.
