Accounts Receivables

Prepared By:

Name ID
Salma Khatun B-180203008
Maghba Hossain Rashed B-180203018
Md.Abir Hasan B-180203048
 CREDIT AND RECEIVABLES
When a firm sells goods and services, it can demand cash on or before the delivery
date or it can extend credit to customers and allow some delay in payment. The
next few sections provide an idea of what is involved in the firm’s decision to grant
credit to its customers. Granting credit is making an investment in a customer—an
investment tied to the sale of a product or service.
Reason for firm grant credit
*The obvious reason is that offering credit is a way of stimulating sales. The costs
associated with granting credit are not trivial
*First, there is the chance that the customer will not pay.
* Second, the firm has to bear the costs of carrying the receivables. The credit
policy decision thus involves a trade-off between the benefits of increased sales
and the costs of granting credit.
COMPONENTS OF CREDIT POLICY
If a firm decides to grant credit to its customers, then it must establish procedures
for extending credit and collecting. In particular, the firm will have to deal with the
following components of credit policy:
1. Terms of sale: The terms of sale establish how the firm proposes to sell its
goods and services. A basic decision is whether the firm will require cash or will
extend credit. If the firm does grant credit to a customer, the terms of sale will
specify (perhaps implicitly) the credit period, the cash discount and discount
period, and the type of credit instrument.
2. Credit analysis: In granting credit, a firm determines how much effort to
expend trying to distinguish between customers who will pay and customers who
will not pay. Firms use a number of devices and procedures to determine the
probability that customers will not pay; put together, these are called credit
analysis.
3. Collection policy: After credit has been granted, the firm has the potential
problem of collecting the cash, for which it must establish a collection policy.
THE CASH FLOWS FROM GRANTING CREDIT
There are several events that occur during this period. These events are the cash
flows associated with granting credit:
The typical sequence of events when a firm grants credit is as follows:
(1) The credit sale is made.
(2) The customer sends a check to the firm.
(3) The firm deposits the check, and
(4) The firm’s account is credited for the amount of the check.

Terms of the Sale

The terms of a sale are made up of three distinct elements:
1. The period for which credit is granted (the credit period).
2. The cash discount and the discount period.
3. The type of credit instrument.
THE BASIC FORM:
The easiest way to understand the terms of sale is to consider an example. Terms
such as 210, net 60 are common. This means that customers have 60 days from the
invoice date (discussed a bit later) to pay the full amount; however, if payment is
made within 10 days, a 2 percent cash discount can be taken.
THE CREDIT PERIOD:
The credit period is the basic length of time for which credit is granted. The credit
period varies widely from industry to industry, but it is almost always between 30
and 120 days. If a cash discount is offered, then the credit period has two
components: the net credit period and the cash discount period.
The Invoice Date:
 The invoice date is the beginning of the credit period. An invoice is a written
account of merchandise shipped to the buyer. For individual items, by convention,
the invoice date is usually the shipping date or the billing date, not the date on
which the buyer receives the goods or the bill. Many other arrangements exist.
For example, terms of 2/10th, EOM tell the buyer to take a 2 percent discount if
payment is made by the 10th of the month; otherwise the full amount is due.
Confusingly, the end of the month is sometimes taken to be the 25th day of the
month. MOM, for middle of month, is another variation.
Length of the Credit Period: Several factors influence the length of the credit
period. Two important ones are the buyer’s inventory period and operating cycle.
There are a number of other factors that influence the credit period. Many of these
also influence our customer’s operating cycles; so, once again, these are related
subjects. Among the most important are these:
1. Perishability and collateral value: Perishable items have relatively rapid
turnover and relatively low collateral value. Credit periods are thus shorter for such
goods. For example, a food wholesaler selling fresh fruit and produce might use
net seven days. Alternatively, jewelry might be sold for 530, net four months.
2. Consumer demand: Products that are well established generally have more
rapid turnover. Newer or slow-moving products will often have longer credit
periods associated with them to entice buyers. Also, as we have seen, sellers may
choose to extend much longer credit periods for off-season sales (when customer
demand is low).
3. Cost, profitability, and standardization: Relatively inexpensive goods tend to
have shorter credit periods. The same is true for relatively standardized goods and
raw materials. These all tend to have lower markups and higher turnover rates,
both of which lead to shorter credit periods. However, there are exceptions. Auto
dealers, for example, generally pay for cars as they are received.
4. Credit risk: The greater the credit risk of the buyer, the shorter the credit
period is likely to be (if credit is granted at all).
5. Size of the account: If an account is small, the credit period may be shorter
because small accounts cost more to manage, and the customers are less important.
6. Competition: When the seller is in a highly competitive market, longer credit
periods may be offered as a way of attracting customers.
 7. Customer type: A single seller might offer different credit terms to different
buyers. A food wholesaler, for example, might supply groceries, bakeries, and
restaurants. Each group would probably have different credit terms. More
generally, sellers often have both wholesale and retail customers, and they
frequently quote different terms .
CASH DISCOUNTS
As we have seen, cash discounts are often part of the terms of sale. The practice of
granting discounts for cash purchases in the United States dates to the Civil War
and is widespread today. One reason discounts are offered is to speed up the
collection of receivables.
CREDIT INSTRUMENTS
The credit instrument is the basic evidence of indebtedness. Most trade credit is
offered on open account. This means that the only formal instrument of credit is
the invoice, which is sent with the shipment of goods and which the customer signs
as evidence that the goods have been received. Afterward, the firm and its
customers record the exchange on their books of account.
Analyzing Credit Policy
In this section, we take a closer look at the factors that influence the decision to
grant credit .Granting credit makes sense only if the NPV from doing so is
positive. We thus need to look at the NPV of the decision to grant credit.
CREDIT POLICY EFFECTS
In evaluating credit policy, there are five basic factors to consider
1. Revenue effects: If the firm grants credit, then there will be a delay in revenue
collections
as some customers take advantage of the credit offered and pay later. However, the
firm may be able to charge a higher price if it grants credit and it may be able to
increase the quantity sold. Total revenues may thus increase.
2. Cost effects: Although the firm may experience delayed revenues if it grants
credit, it
will still incur the costs of sales immediately. Whether the firm sells for cash or
credit,
it will still have to acquire or produce the merchandise (and pay for it).
3. The cost of debt: When the firm grants credit, it must arrange to finance the
resulting
receivables. As a result, the firm’s cost of short-term borrowing is a factor in the
decision
to grant credit.
4. The probability of nonpayment: If the firm grants credit, some percentage of
the credit
buyers will not pay. This can’t happen, of course, if the firm sells for cash.
5. The cash discount: When the firm offers a cash discount as part of its credit
terms,
some customers will choose to pay early to take advantage of the discount.
Credit Analysis
Thus far, we have focused on establishing credit terms. Once a fi rm decides to
grant credit to its customers, it must then establish guidelines for determining who
will and who will not be allowed to buy on credit. Credit analysis refers to the
process of deciding whether or not to extend credit to a particular customer. It
usually involves two steps: gathering relevant information and determining
creditworthiness.

CREDIT INFORMATION
If a firm wants credit information about customers, there are a number of sources.
Information
sources commonly used to assess creditworthiness include the following:
1. Financial statements: A firm can ask a customer to supply financial statements
such as
balance sheets and income statements.
2. Credit reports about the customer’s payment history with other firms:
Quite a few organizations sell information about the credit strength and credit
history of business firms. The best-known and largest firm of this type is Dun &
Bradstreet, which provides subscribers with credit reports on individual fi rms.
Experian is another wellknown credit-reporting fi rm. Ratings and information are
available for a huge number of firms, including very small ones. Equifax,
Transunion, and Experian are the major suppliers of consumer credit information.
3. Banks: Banks will generally provide some assistance to their business
customers in acquiring information about the creditworthiness of other fi rms.
4. The customer’s payment history with the firm: The most obvious way to
obtain information about the likelihood of customers not paying is to examine
whether they have settled past obligations (and how quickly).

CREDIT EVALUATION AND SCORING

There are no magical formulas for assessing the probability that a customer will
not pay. In very general terms, the classic five Cs of credit are the basic factors to
be evaluated:
1. Character: The customer’s willingness to meet credit obligations.
2. Capacity: The customer’s ability to meet credit obligations out of operating
cash
flows.
3. Capital: The customer’s financial reserves.
4. Collateral: An asset pledged in the case of default.
5. Conditions: General economic conditions in the customer’s line of business.
Credit scoring is the process of calculating a numerical rating for a customer
based on information collected; credit is then granted or refused based on the
result. For example, a firm might rate a customer on a scale of 1 (very poor) to 10
(very good) on each of the five Cs of credit using all the information available
about the customer. A credit score could then be calculated by totaling these
ratings. Based on experience, a firm might choose to grant credit only to customers
with a score above, say, 30.
MONITORING RECEIVABLES
To keep track of payments by customers, most firms will monitor outstanding
accounts. First of all, a firm will normally keep track of its average collection
period (ACP) through time. If a firm is in a seasonal business, the ACP will
fluctuate during the year; but unexpected increases in the ACP are a cause for
concern. Either customers in general are taking longer to pay, or some percentage
of accounts receivable are seriously overdue. To see just how important timely
collection of receivables is to investors, consider the case of Art Technology Group
(ATG), a company that provides Internet customer relationship management and e-
commerce software. In late 2000, ATG announced an unusual sale of accounts
receivable to a bank. The sale helped lower ATG’s reported September days’ sales
outstanding, an important indicator of receivables management. However, after
this information became public, investors became concerned about the quality of
the firm’s sales, and ATG’s stock sank 18 percent.
The aging schedule is a second basic tool for monitoring receivables. To prepare
one,the credit department classifies accounts by age.2 Suppose a firm has $100,000
in receivables.
Some of these accounts are only a few days old, but others have been outstanding
for quite some time. The following is an example of an aging schedule:

Age of Account Amount Percentage of total value

of account receivable
0-10 days 50000 50%
11-60 days 25000 25
61-80 days 20000 20
Over 80 days 50000 5
Total=100000
Total = 100%
Theoritiecal Question
Question Number 1: What are the basic components of the terms of sale if a
firm chooses to sell on credit?
Answer:
THE BASIC FORM: The easiest way to understand the terms of sale is to consider
an example. Terms such as 2 10, net 60 are common. This means that customers
have 60 days from the invoice date (discussed a bit later) to pay the full amount;
however, if payment is made within 10 days, a 2 percent cash discount can be
taken.
THE CREDIT PERIOD:
The credit period is the basic length of time for which credit is granted. The credit
period varies widely from industry to industry, but it is almost always between 30
and 120 days. If a cash discount is offered, then the credit period has two
components: the net credit period and the cash discount period.
The Invoice Date:
The invoice date is the beginning of the credit period. An invoice is a written
account of merchandise shipped to the buyer. For individual items, by convention,
the invoice date is usually the shipping date or the billing date, not the date on
which the buyer receives the goods or the bill. Many other arrangements exist.
For example, terms of 2/10th, EOM tell the buyer to take a 2 percent discount if
payment is made by the 10th of the month; otherwise the full amount is due.
Confusingly, the end of the month is sometimes taken to be the 25th day of the
month. MOM, for middle of month, is another variation.
Length of the Credit Period: Several factors influence the length of the credit
period. Two important ones are the buyer’s inventory period and operating cycle.
There are a number of other factors that influence the credit period. Many of these
also influence our customer’s operating cycles; so, once again, these are related
subjects. Among the most important are these
1. Perishability and collateral value .
2. Consumer demand.
3. Cost profitability and standardization .
4. Credit risk.
 5. Size of account.
6. Competition.
7. Customer type.
Question no 2 : Explain what terms of 3/45 ,net 90 mean . what is effective
interest rate?
The terms "3/45, net 90" are payment terms commonly used in business
transactions, particularly for credit sales between suppliers and customers. These
terms specify the discount available to the customer for making early payment and
the final due date for the invoice. Let's break down what each part of these terms
means:
3/45: This part of the terms indicates a cash discount that is available to the
customer for early payment. In this case, "3" represents the percentage discount,
and "45" represents the number of days within which the customer can take
advantage of this discount. So, if the customer pays the invoice within 45 days of
the invoice date, they can deduct 3% from the total invoice amount as a discount.
Net 90: This part of the terms specifies the final due date for payment. "Net" means
the total amount is due within the specified number of days, which in this case is
"90" days from the invoice date. This represents the maximum allowable time for
payment without incurring any late fees or penalties.
The effective interest rate associated with these payment terms. The effective
interest rate shows how much you would save or earn as a result of taking
advantage of the early payment discount.
Question no 3: What are the effects to consider in a decision to offer credit ?
Answer: CREDIT POLICY EFFECTS
In evaluating credit policy, there are five basic factors to consider
1. Revenue effects: If the firm grants credit, then there will be a delay in revenue
collections as some customers take advantage of the credit offered and pay later.
However, the firm may be able to charge a higher price if it grants credit and it
may be able to increase the quantity sold. Total revenues may thus increase.
2. Cost effects: Although the firm may experience delayed revenues if it grants
credit, it will still incur the costs of sales immediately. Whether the firm sells for
cash or credit,it will still have to acquire or produce the merchandise (and pay for
it).
3. The cost of debt: When the firm grants credit, it must arrange to finance the
resulting receivables. As a result, the firm’s cost of short-term borrowing is a factor
in the decision to grant credit.
4. The probability of nonpayment: If the firm grants credit, some percentage of
the credit buyers will not pay. This can’t happen, of course, if the firm sells for
cash.
5. The cash discount: When the firm offers a cash discount as part of its credit
terms,some customers will choose to pay early to take advantage of the discount
Question no 4: What is credit analysis?
Credit analysis is the process of evaluating the creditworthiness of an individual,
company, or entity to assess their ability to repay debt or meet their financial
obligations. It is a critical function in the financial industry, used by lenders,
investors, and financial institutions to make informed decisions about extending
credit, issuing loans, or investing in bonds or other debt securities. The primary
goal of credit analysis is to estimate the risk associated with lending money or
investing in a particular entity.
Key components of credit analysis include:
Financial Statement Analysis: This involves reviewing an entity's financial
statements, including the balance sheet, income statement, and cash flow
statement, to assess its financial health, liquidity, profitability, and solvency.
Risk Assessment: Credit analysts evaluate various types of risk, including credit
risk (the risk of default on debt payments), market risk, and operational risk, to
determine the overall risk profile of the entity.
Industry and Economic Analysis: Analysts consider the economic environment
and industry-specific factors that may affect the entity's ability to repay debt. This
includes analyzing industry trends, competitive forces, and market conditions.
Management Evaluation: Understanding the competence and integrity of the
entity's management team is crucial. Credit analysts assess management's track
record, experience, and strategic decisions.
Collateral Evaluation: In cases where loans are secured by collateral (assets that
can be seized if the borrower defaults), analysts assess the value and quality of the
collateral.
Credit Score and Credit History: Personal and business credit scores and credit
histories are important factors in assessing creditworthiness. These scores provide
a quantitative measure of an individual or entity's credit risk.
Cash Flow Analysis: Examining cash flow is vital to determine if the entity
generates sufficient cash to meet its debt obligations. Analysts assess cash flow
from operations, investments, and financing activities.
Legal and Regulatory Compliance: Credit analysts also review legal and
regulatory compliance to ensure that the entity is not facing any legal issues that
could impact its ability to repay debt.
Based on the analysis, credit analysts assign a credit rating or credit score, which
summarizes their assessment of the entity's creditworthiness. These ratings or
scores are used by lenders and investors to make decisions about granting credit or
investing in bonds or other debt instruments. A higher credit rating indicates lower
credit risk, while a lower rating suggests higher risk. Credit analysis is essential for
maintaining the stability and integrity of financial markets, as it helps prevent
excessive lending to high-risk borrowers and guides investors toward suitable
investment opportunities.

Question no 5: What are the carrying cost of granting credit and what are the
opportunity cost of not granting credit?
Carrying costs of granting credit and opportunity costs of not granting credit are
two important considerations for businesses and financial institutions when making
decisions about extending credit to customers or borrowers. Let's explore each
concept:
Carrying Costs of Granting Credit:
Carrying costs refer to the expenses and financial burdens associated with offering
credit terms to customers or borrowers. These costs can erode a company's
profitability and financial health. Here are some common carrying costs of
granting credit:
a. Interest Expense: If a company borrows money to finance its operations or has
a line of credit for financing customer purchases, it incurs interest expenses on the
borrowed funds.
b. Bad Debt Expense: This is the cost associated with customers who do not pay
their bills or default on their credit obligations. Companies may need to write off
these unpaid accounts as bad debts, which can result in a direct financial loss.
c. Administrative Costs: Managing credit accounts, monitoring customer
creditworthiness, and collecting payments require administrative resources.
Salaries, technology, and other overhead costs associated with credit management
contribute to carrying costs.
d. Opportunity Cost of Tied-Up Capital: When a company extends credit to
customers, it ties up capital that could be used for other purposes, such as
investments in growth, inventory, or debt reduction. The opportunity cost is the
return the company could have earned if it had invested the capital elsewhere.
Opportunity Costs of Not Granting Credit:
Opportunity costs represent the potential benefits or profits that a business forgoes
when it decides not to offer credit to customers or borrowers. While granting credit
comes with risks, not granting credit can also have its drawbacks:
a. Lost Sales: By not extending credit, a business may lose potential sales to
competitors who offer more flexible payment terms. This can result in a lower
market share and reduced revenue.
b. Reduced Customer Loyalty: Offering credit can build customer loyalty and
encourage repeat business. Without this option, customers might be less inclined to
return to the business for future purchases.
c. Stifled Growth: Not granting credit can limit a company's ability to expand its
customer base or enter new markets where credit terms are common. This may
hinder growth opportunities.
d. Cash Flow Impact: If a company insists on cash-only transactions, it might
experience uneven cash flow, especially in industries where credit is the norm.
This can make it challenging to manage day-to-day operations.
Question no 6 :
what are the five Cs of credit ?
Answer : In very general terms, the classic five Cs of credit are the basic factors
to be evaluated:
1. Character: The customer’s willingness to meet credit obligations.
2. Capacity: The customer’s ability to meet credit obligations out of operating
cash
flows.
3. Capital: The customer’s financial reserves.
4. Collateral: An asset pledged in the case of default.
5. Conditions: General economic conditions in the customer’s line of business.
Question no 7 : what is aging schedule ?
The aging schedule is a second basic tool for monitoring receivables. To prepare
one,
the credit department classifies accounts by age.2 Suppose a firm has $100,000 in
receivables.
Some of these accounts are only a few days old, but others have been outstanding
for
quite some time. The following is an example of an aging schedule:

Age of Account Amount Percentage of total value of account receivable

0-10 days 50000
50%
11-60 days 25000
25
61-80 days 20000
20
Over 80 days 50000
5
Total=100000
Total = 100%

Mathmatical Question
Question No. 01)
You place an order for 300 units of inventory at a unit price of $115. The
supplier offers terms of 1/10, net 30.
a. How long do you have to pay before the account is overdue? If you take the
full period, how much should you remit?
b. What is the discount being offered? How quickly must you pay to get the
discount? If you do take the discount, how much should you remit?
Answer:
a) The supplier offers terms of "1/10, net 30." This means you have two
payment options:
1. Take the discount: You can take a 1% discount if you pay within 10 days.
2. Pay the net amount: If you don't take the discount, you should pay the full
invoice amount within 30 days
If you choose not to take the discount, you should remit the full amount within
30 days to avoid being overdue

b) The discount being offered is 1%, and to get this discount, you need to pay
within 10 days.
To calculate how much you should remit if you take the discount:
Discount Amount = Total Invoice Amount * Discount Rate Discount
Amount
= (300 units * $115) * 0.01 = $345
So, if you take the discount, you should remit $345 within 10 days.
Question No.02)
The Wind Surfer Corporation has annual sales of $57 million. The average
collection period is 39 days. What is the average investment in accounts
receivable as shown on the balance sheet?
Answer: To calculate the average investment in accounts receivable, you can use
the following formula:
Average Investment in Accounts Receivable = (Annual Sales / 365) * Average
Collection Period
Where:
 Annual Sales = $57 million
 Average Collection Period = 39 days
 365 represents the number of days in a year

Average Investment in Accounts Receivable = ($57,000,000 / 365) * 39

Average Investment in Accounts Receivable = $6,123,835.62
So, the average investment in accounts receivable, as shown on the balance
sheet, is approximately $6,123,835.62.

Question 03)
A firm offers terms of 2/10, net 35. What effective annual interest rate does
the firm earn when a customer does not take the discount? what will happen
to this rate if:
a. The discount is changed to 3 percent.
b. The credit period is increased to 60 days.
c. The discount period is increased to 15 days.
Answer:
If they not take the discount then the firm earns equal the cost of trade credit
Cost of trade credit
 Cost of trade credit
𝐸𝑎𝑟𝑙𝑦 𝑃𝑚𝑡 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡
=
(1 − 𝐸𝑎𝑟𝑙𝑦 𝑃𝑚𝑡 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡)
365
∗
𝑁𝑒𝑡 𝑃𝑚𝑡 𝑃𝑒𝑟𝑖𝑜𝑑 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃𝑚𝑡 𝑃𝑒𝑟𝑖𝑜𝑑
.02 365
= ∗
1−.02 35−10
.02 365
= ∗ = .0204081* 14.6
.98 25

=.2979 or 29.79%
Self check (a,b,c)

Question No. 04)

Music City, Inc., has an average collection period of 42 days. Its average daily
investment in receivables is $43,000. What are annual credit sales? What is
the receivables turnover?

Answer: To calculate annual credit sales and receivables turnover, you can use the
following formulas:
 Annual Credit Sales = (Average Daily Investment in Receivables) x
(Number of Days in a Year)
 Receivables Turnover = (Total Credit Sales) / (Average Accounts
Receivable)

Given the information provided:

 Average Daily Investment in Receivables = $43,000
 Average Collection Period = 42 days
 Number of Days in a Year = 365 days
Let's calculate:

1. Annual Credit Sales: Annual Credit Sales = ($43,000) x (365 days)

Annual Credit Sales = $15,695,000
 So, the annual credit sales for Music City, Inc., are $15,695,000.

2. Receivables Turnover: Receivables Turnover = ($15,695,000) /

($43,000) Receivables Turnover ≈ 364.30
So, the receivables turnover for Music City, Inc., is approximately 364.30 times
per year.

Question NO. 05)

The Cold Fusion Corp. (manufacturer of the Mr. Fusion home power plant) is
considering a new credit policy. The current policy is cash only. The new
policy would involve extending credit for one period. Based on the following
information, determine if a switch is advisable. The interest rate is 2.0 percent
per period:
Current Policy New Policy
Price per unit $ 175 $ 175
Cost per unit $ 130 $ 130
Sales per period in units 1,000 1,100

Answer. If the switch is made, an extra 100 units per period will be sold at a gross
profit of $175-130=$45 each. The total benefit is thus $45*100=$4,500 per period.
At 2.0 percent per period forever, the PV is $4,500/.02=$225,000. The cost of the
switch is equal to this period’s revenue of $175*1,000 units=$175,000 plus the
cost of producing the extra 100 units: 100*$130=$13,000. The total cost is thus
$188,000, and the NPV is $225,000-188,000=$37,000. The switch should be made.

Question NO. 06) Self check

Quest, Inc., is considering a change in its cash-only sales policy. The new
terms of sale would be net one month. Based on the following information,
determine if Quest should proceed or not. Describe the buildup of receivables
in this case. The required return is 1.5 percent per month
Current Policy New Policy
Price per unit $ 780 $ 780
Cost per unit $ 475 $ 475
Sales per period in units 1420 1505

Question 07
You are trying to decide whether or not to extend credit to a particular
customer. Your variable cost is $15 per unit; the selling price is $22. This
customer wants to buy 1,000 units today and pay in 30 days. You think there
is a 15 percent chance of default. The required return is 3 percent per 30 days.
Should you extend credit? Assume that this is a one-time sale and that the
customer will not buy if credit is not extended.
Answer. If the customer pays in 30 days, then you will collect $22*1,000=-
$22,000. There’s only an 85 percent chance of collecting this; so you expect to get
$22,000*.85=$18,700 in 30 days. The present value of this is
$18,700/1.03=$18,155.34. Your cost is $15*1,000=$15,000; so the NPV is
$18,155.34-15,000=$3,155.34. Credit should be extended.

Question 08)
Assume that a company has outstanding receivables of $350,000 at the end of
the first quarter and credit sales of $425,000 for the quarter. Using a 90-day
averaging period,
a) What would be the DSO (Days Sales Outstanding) for this
company?
b) If the company's credit terms are net 60, What is the average past
due?
Ans.
Sales During Period 425000
a) Avg. Daily Credit Sales = = = 4722.22
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐷𝑎𝑦𝑠 𝑖𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 90
𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝐴/𝑅 350000
DSO= = = 74.11 Days
𝐴𝑣𝑔.𝐷𝑎𝑖𝑙𝑦 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 4722.22

b) Average Past Due = DSO - Avg. Days of Credit Terms

 = 74.11 Days-60 Days = 14.11 Days

Question 09)
Assuming terms of 2/10, net 45, What would be the cost of not taking the
discount?
Answer: Cost of trade credit
Cost of trade credit
𝐸𝑎𝑟𝑙𝑦 𝑃𝑚𝑡 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡
=
(1 − 𝐸𝑎𝑟𝑙𝑦 𝑃𝑚𝑡 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡)
365
∗
𝑁𝑒𝑡 𝑃𝑚𝑡 𝑃𝑒𝑟𝑖𝑜𝑑 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑃𝑚𝑡 𝑃𝑒𝑟𝑖𝑜𝑑
.02 365
= ∗
1−.02 45−10
.02 365
= ∗ = .0204081* 10.428571
.98 35

= .2128 or 21.28%
Question No-10)
A company expects credit sales of $110,000 in July, rising by $10,000 each
month for the next two months, Outstanding trade receivables at the
beginning of July were $165,000, representing all of June sales and 22 days of
May sales. Sales in June were $95,000. The company wishes to reduce the
average days sales outstanding to 45 days by the end of July and 40 days by
the end of August .On the assumption that the target should be to collect first
the receivables that have been unpaid for the longest time, calculate
thecollection targets for:
(a) July, and
(b) August.
Answer: Target receivables
End of July Days $
July sales 31 110,000
June sales (balance) 14 44,333
 (14/30 x $95,000)

45 154,333

End of August Days $

August sales 31 120,000

July sales (balance) 9 31,935 (9/31 x $110,000)

40 151,935
Target collections
July August
$ $
Receivables at the beginning of the month 165,000 154,533
Sales in the month 110,000 120,000

275,000 274, 333

Receivables at the end of the month (154,333) (151,935)

Target collections in the month 120,667 122,398

Question No-11
A company is considering a change in its credit policy. It has estimated that if
credit terms are extended from 30 days to 60 days, total annual sales will
increase by 10% from the current level of $12 milion. It has been estimated
that as a consequence of the change in credit terms and the higher sales
volume, bad debts would increase from 2% to 3% of sales. The company's
cost of capital is 8%.The increase in sales would not affect annual fixed costs.
The contribution to sales ratio is 40%.
Required:
Calculate the effect of the change in credit policy on the annual profit before
taxation. Assume a 360-day year of 30 days each month.
Answer:
Without the new With the new
credit policy credit policy
Annual sales $12,000,000 $13,200,000
Average trade receivables $1,000,000 $2,200,000
($12m x 30/360) ($13.2m x 60/360)

Increase in trade receivables $1,200,000

Bad debts $240,000 (= 2%) $396,000 (= 3%)
Increase in bad debts $156,000
Increase in annual sales $1,200,000
$ $
Increase in annual contribution (40%) 480,000
Increase in bad debts 156,000
Increase in interest cost of receivables
(8% x $1,200,00) 96,000

(252,000)

Net increase in profit before tax 228,000

Question No-12
A company is offering a cash discount of 2.5% to receivables if they agree to
pay debts within one month. The usual credit period taken is three months.
Calculate the effective annualised cost of offering the discount and should it
be offered, if the bank would loan the company at 18% ?
Answer:
Discounta as a percentage of amount paid =2.5/97.5 = 2.56%
Saving is 2months and there are 12/2 = 6 periods in a year
Annualised cost of discount % is
(1+0.0256)^6 -1
= 0.1638
=16.38%.
The loan rate is 18%
It would therefore be worthwhile offering the discount.

Question No-13
Calculate the equivalent annual cost of the following credit terms: 1.75%
discount for payment within three weeks; alternatively, full payment must be
made within eight weeks of the invoice date. Assume there are 50 weeks in a
year.
Answer:
Step 1
Work out the discount available and the amount due if the discount were
taken
Discount available on a $100 invoice = 1.75% x $100 = $1.75.
Amount due after discount = $100 x $1.75 = $98.25
Step 2
The effective interest cost of not taking the discount is:
1.75 / 98.25 = 0.0178
for an 8 - 3 = 5 week period.
Step 3
Calculate the equivalent annual rate. There are ten five-week periodis in
a year.
The equivalent,interest annual rate is (1 + 0.018)^10-1
= 0.195 or 19.5%.

Question No-14
Marton Co produces a range of specialised components, supplying a wide
range of customers, all on credit terms. 20% of revenue is sold to one firm.
Having used generous credit policies to encourage past growth, Marton Co
now has to finance a substantial overdraft and is concerned about its liquidity.
Marton Co borrows from its bank at 13% pa interest. No further sales growth
in volume or value terms is planned for the next year:
Option one
In order to speed up collection from customers, Marton Co is considering two
alternative policies Factoring on a non-recourse basis, the factor administering and
collecting payment from Marton Co's customers. This is expected to generate
administrative savings of $200,000 pa and to lower the average receivable
collection period by 15 days. The factor will make a service charge-of 1% of
Marton Co's revenue and also provide credit insurance facilities for an annual
premium of $80,000.

Option two
Offering discounts to customers who settle their accounts early. The amount of the
discount will depend on speed of payment as follows. Payment within 10 days of
despatch of invoices 3% Payment within 20 days of despatch of invoices 1.5% It is
estimated that customers representing 20% and 30% of Marton Co's sales
respectively will take up these offers, the remainder continuing to take their present
credit period.
Answer:
The relative costs and benefits of each option are calculated as follows
Option 1- Factoring
Reduction in receivables days = 15 days
Reduction in receivables = 15 + 365 x $20m $821,916

Effect on profit before tax:

Finance cost saving (13% + $821 .916) $106,849
Administrative savings $200 000
Service charge (1% % x $20m) (200000)
Insurance premium (80000)

Net profit benefit $26,849

Option 2- The discount

With year-end receivables at $4.5 million, the receivables collection period was:
$4.5m + $20m x 365 = 82 days
The scheme of discounts would change this as follows:
10 days for 20% of customers
20 days for 30% of customers
82 days for 50% of customers
Average receivables days become:
(20% * 10) + (30% * 20) + (50% * 82)= 49 days
Hence. average receivables would reduce from the present $4.5 milion
to:
49 x $20m +365 = $2,684,932
Finance cost saving = 13% x ($4.5m- $2.685m) = $235,950
The cost of the discount:
(3% x 20% x $20m) + (1.5% x 30% x $20m) = ($210,000)
The net benefit to profit before tax: $25.950
The figures imply that factoring is marginally the more attractive, but this result
relies on the predicted proportions of customers actually taking up the discount and
paying on time. It also neglects the possibility that some customers will insist on
taking the discount without bringing forward their payments. Marton Co would
have to consider a suitable response to this problem.
Conversely. the assessment of the value of using the factor depends on the facter
iowering Marton Co's receivables days. If the factor retains n these benefts for
itself, rather than passing them on to Marton Co. this will raise the cost of the
factoring option. The two parties should clearly specify tneir mutual requirements
from the factoring arrangement on a contractal basis.

Question No-01:
A company expects credit sales of $110,000 in July, rising by $10,000
each month for the next two months, Outstanding trade receivables at the
beginning of July were $165,000, representing all of June sales and
22 days of May sales. Sales in June were $95,000.
The company wishes to reduce the average days sales outstanding to
45 days by the end of July and 40 days by the end of August .
On the assumption that the target should be to collect first the
receivables that have been unpaid for the longest time, calculate the
collection targets for:
(a) July, and
(b) August.

Answer: Target receivables

End of July Days $
July sales 31 110,000
June sales (balance) 14 44,333
(14/30 x $95,000)

45 154,333

End of August Days $

August sales 31 120,000

July sales (balance) 9 31,935 (9/31 x $110,000)

40 151,935
Target collections
July August
 $ $
Receivables at the beginning of the month 165,000 154,533
Sales in the month 110,000 120,000

275,000 274, 333

Receivables at the end of the month (154,333) (151,935)

Target collections in the month 120,667 122,398

Question No-02
A company is considering a change in its credit policy. It has estimated
that if credit terms are extended from 30 days to 60 days, total annual
sales will increase by 10% from the current level of $12 milion. It has
been estimated that as a consequence of the change in credit terms and
the higher sales volume, bad debts would increase from 2% to 3% of
sales. The company's cost of capital is 8%.
The increase in sales would not affect annual fixed costs. The
contribution to sales ratio is 40%.
Required:
Calculate the effect of the change in credit policy on the annual profit
before taxation. Assume a 360-day year of 30 days each month.
Answer:
Without the new With the new
credit policy credit policy
Annual sales $12,000,000 $13,200,000
Average trade receivables $1,000,000 $2,200,000
($12m x 30/360) ($13.2m x 60/360)

Increase in trade receivables $1,200,000

Bad debts $240,000 (= 2%) $396,000 (= 3%)
Increase in bad debts $156,000
Increase in annual sales $1,200,000
$ $
Increase in annual contribution (40%) 480,000
Increase in bad debts 156,000
Increase in interest cost of receivables
(8% x $1,200,000) 96,000

(252,000)

Net increase in profit before tax 228,000

Question No-03
A company is offering a cash discount of 2.5% to receivables if they
agree to pay debts within one month. The usual credit period taken is
three months.
Calculate the effective annualised cost of offering the discount and
should it be offered, if the bank would loan the company at 18% ?

Answer:
Discount as a percentage of amount paid =2.5/97.5 = 2.56%
Saving is 2months and there are 12/2 = 6 periods in a year
Annualised cost of discount % is
(1+0.0256)^6 -1
= 0.1638
=16.38%.
The loan rate is 18%
It would therefore be worthwhile offering the discount.

Question No-04
Calculate the equivalent annual cost of the following credit terms: 1.75%
discount for payment within three weeks; alternatively, full payment must
be made within eight weeks of the invoice date. Assume there are
50 weeks in a year.
Answer:
Step 1
Work out the discount available and the amount due if the discount were
taken
Discount available on a $100 invoice = 1.75% x $100 = $1.75.
Amount due after discount = $100 x $1.75 = $98.25
Step 2
The effective interest cost of not taking the discount is:
1.75 / 98.25 = 0.0178
for an 8 - 3 = 5 week period.
Step 3
Calculate the equivalent annual rate. There are ten five-week periodis in
a year.
The equivalent,interest annual rate is (1 + 0.018)^10-1
= 0.195 or 19.5%.