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CHAPTER – 8 “MANAGEMENT OF RECEIVABLES”

Q.1 A firm has a current sales of Rs. 2,56,48,750. The firm has unutilized capacity. In order to boost
its sales, it is considering the relaxation in its credit policy. The proposed terms of credit will be 60
days credit against the present policy of 45 days. As a result, the bad debts will increase from 1.5 % to
2 % of sales. The firms sales are expected to increase by 10 %. The variable operating costs are 72 %
of the sales. The firm’s corporate tax rate is 35 % and it requires an after tax return of 15 % on its
investment. Should the firm change its credit policy? [P.E.II Nov. 03]

Q.2 A firm allows one month credit to its customers, but actual collection are received on an average,
one and half month after delivery. Credit sales amount to Rs. 48 lakhs per annum being 80 % of total
sales. Receivables are valued at 85 % of selling price. The sales manager of a firm proposes 2 % cash
discount on credit sales, for prompt payment. He anticipates that 75 % of customers who buy on credit
will avail of this benefit and that this will reduce the current amount of receivables by 75 %. If the cost
of capital of the firm is 20 %. Give the recommendation for the acceptance of the proposal?

Q.3 A company has prepared the following projections for a year:

Sales 21,000 units
Selling price per unit Rs.40
Variable cost per unit Rs.25
Total cost per unit Rs.35
Credit period allowed One month
The company proposes to increase the credit period allowed to its customers from one month to two
months. It is envisaged that the change in the policy as above will increase the sales by 8 %. The
company desires a return of 25 % on its investment. You are required to examine and advise whether
the proposed credit policy should be implemented or not.

Q.4 Yati Ltd. sells its products through a widely distributed dealer net work, allowing a credit period
of 15 days only. The average variable cost is 60 % of sales value and current sales amount to Rs.100
lakhs. To meet growing competition the firm is trying to revamp its marketing strategy. This entails
changing the credit period suitably and also increasing the sales promotion expenses which will
increase the fixed costs. The marketing department has given the following estimates for various
options, along with current results:
Current Option 1 Option 2 Option 3
Credit period (months) ½ 1 1.5 2
Sales (lakhs of rupees) per annum 100 120 135 150
Fixed costs (lakhs of rupees) per annum 15 18 20 24
Bad debts (% of sales) 1 1.5 2 3
You are required to analyse the above details in a suitable format and suggest the best strategy for the
firm. Additional funds, if required, can be raised by the firm at a cost of 16 % p.a.

Q.5 Household appliances Ltd. deals with consumer durables, having an annual turnover of Rs.80
lakhs, 75 % of which are credit sales effected through a large number of dealers while the balance
sales are made through show rooms on cash basis. Normal credit allowed is 30 days. The company
proposes to expand its business substantially and there is good demand as well. However, the
marketing manager finds that the dealers have difficulty in holding more stocks due to financial
problems. He, therefore, proposes a change in the credit policy as follows:
Proposal Credit period Anticipated credit sales (in lakhs of rupees)
Plan I 60 days 70
Plan II 90 days 75
The products yield an average contribution of 25 % on sales. Fixed costs amount to Rs.5 lakhs per
annum. The company expects a pre tax return of 20 % on capital employed. The finance manager after

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a review of the proposal has recommended increasing the provision for bad debts from the current 1%
to 1.5 % for plan I and 2 % for plan II.
Evaluate the merits of the new proposals and recommend the best policy.

Q.6 Surya industries Ltd. is marketing all its products through a network of dealers. All sales
are on credit and the dealers are given one month time to settle bills. The company is
thinking of changing the credit with a view to increase its overall profits. The marketing
department has prepared the following estimates for different periods of credit:
Present policy Plan I Plan II Plan III
Credit period (in months) 1 1.5 2 3
Sales (in lakhs of rupees) 120 130 150 180
Fixed costs (in lakhs of
rupees) 30 30 35 40
Bad debts (% of sales) 0.5 0.8 1 2
The company has a contribution / sales ratio of 40 %. Further it requires a pre tax return on
investment at 20 %. Evaluate each of the above proposals and recommend the best credit policy for
the company.

Q.7 Sakthi traders has a contribution / sales ratio of 20 % and average book debts of Rs.10 lakhs
which it collects in an average collection period of 24 days. The company reorganized its credit
administration department recently and introduced a cash incentive of 5 % to speed up collection of
outstandings. The incentive is payable to customers making payment with in 10 days. When the
company reviewed the position after few months it was found that the average collection period had
actually fallen to 20 days only and the average book debts had increased to Rs.10.50 lakhs mainly as a
result of some increase in sales. It was also noticed that only about half the total sales availed of the
cash discount. The company’s cost of raising additional funds is 20 %. Do you recommend
continuance of the cash incentive scheme?
Show workings. Assume one year = 360 days.

Q.8 A firm which has only credit sales allows one month credit to its customers. By changing the
credit period to two months it finds that its outstanding debtors has increased to three times the
previous average. To what extent has the change in credit period affected the sales?

Q.9 The average period of credit allowed by a company to its customers last year was one month and
the average amount of debtors was Rs.10 lakhs. To increase sales and profitability the company
doubled the period of credit during the current year. As a result the average amount of debtors
increased to Rs. 25 lakhs. If the company has a contribution: sales ratio of 40 %, what additional
contribution has been earned by the company during the current year?

Q.10 Future kidd corporation presently gives credit terms of net 30 days. It has Rs. 60 million in credit
sales and its average collection period is 45 days. To stimulate sales, the company may give credit
terms on net 60 days. If it does instigate these terms, sales are expected to increase by 15 %. After the
change the average collection period to be 75 days with no difference in payment habits between old
and new customers. Variable cost is Re. 0.80 for every Re. 1 of sales; and the company’s before – tax
required rate of return on investmnet in receivables is 20%. Should the company extend its credit
period? (Assume a 360 days year).

Q.11 H Ltd. has a present sales level of 10,000 units at Rs. 300 per unit. The variable cost is Rs. 200
per unit and the fixed costs amount to Rs. 3,00,000 per annum. The present credit period allowed by
the company is 1 month. The company is considering a proposal to increase the credit periods to 2
months and 3 months and has made the following estimates:
Credit policy Existing 1 month Proposed
2 months 3 months

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Increase in sales - 15 % 30 %
% of bad debts 1% 3% 5%
There will be increase in fixed cost by Rs. 50,000 on account of increase of sales beyond 25 % of
present level. The compay plans on a pre – tax return of 20 % on investment in receivables. You are
required to calcualte the most paying credit policy for the company.

Q.12 Radiance Garments Ltd. manufacturers readymade garments and sells them on credit basis
through a network of dealers. It present sale is Rs. 60,00,000 per annum with 20 days credit period.
The company is contemplating an increase in the credit period with a view to increasing sales. Present
variable costs are 70 % of sales and the total fixed costs Rs. 8,00,000 per annum. The company
expects pre – tax return on investment @ 25%. Some other details are given as under:
Proposed credit Average collection period(days) Expected annual sales (Rs. in lakhs)
policy
I 30 65
II 40 70
III 50 74
IV 60 75
Required: Which credit policy should the company adopts? Present your answer in a tabular form.
Assume 360 days in a year.

Q.13 ABC Ltd. is examining the question of relaxing its credit policy. It sells at present 20,000 units
at a price of Rs. 100 per unit, the variable cost per unit Rs. 88 and average cost per unit at the current
sales volume is Rs. 92. All the sales are on credit, the average collection being 36 days. A relaxed
credit policy is expected to increase sales by 10 % and the average age of receivables to 60 days.
Assuming 15 % return, should the firm relax its credit policy?

Q.14 The sales manager of AB Ltd. suggests that if credit period is given for 1.5 months then sales
may likely to increase by Rs. 1,20,000 per annum. Cost of sales amounted to 90 % of sales. The risk
of non – payment is 5 %. Income tax rate is 30 %. The expected return on investment is Rs. 3,375
(after tax). Should the company accept the suggestion of sales manager?

Q.15 A company has sales of Rs. 25,00,000. Average collection period is 50 days, bad debt losses are
5 % of sales and collection expenses are Rs. 25,000. The cost of funds is 15 %. The company has two
alternative collection programmes:
Programme I Programme II
Average collection period reduced to 40 days 30 days
Bad debt losses reduced to 4 % of sales 3 % of sales
Collection expenses Rs. 50,000 Rs. 80,000
Evaluate which programme is viable.
Q.16 Yati Ltd. is considering relaxing its credit policy and evaluating two proposed policies.
Currently, the firm has annual credit sales of Rs. 50,00,000 and accounts receivables of Rs. 12,50,000.
The current level of loss due to bad debts is Rs. 1,50,000. The firm is to give a return of 20 % on
investment in the new (additional) accounts receivables. The company’s variable costs are 70 % of the
selling price. The following further information is furnished:
Present policy Policy I Policy II
Annual credit sales Rs. 50,00,000 Rs. 60,00,000 Rs. 67,50,000
Accounts receivable 12,50,000 20,00,000 28,12,000
Bad debt losses 1,50,000 3,00,000 4,50,000
You are the management accountant of the firm. Advise the managing director which option should be
adopted.

Q.17 A Ltd has total sales of Rs. 3.2 crores and its average collection period is 90 days. The past
experience indicates that the bad debts losses are 1.5 % on sales. Total expenditure incurred by the

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firm in administering its receivable collection efforts are Rs. 5,00,000. A factor is prepared to buy the
firm’s receivables by charging 2 % commission. The factor will pay advance on receivables to the
firm at an interest rate of 8 % p.a. after withholding 10 % as reserve. [May 2002]

Q.18 A company is considering to engaged a factor, the following information is available:

(i) The current average collection period for the company’s debtors is 80 days and ½ % of debtors
default. The factor has agree to pay money due after 60 days and will take the responsibility of any
loss on account of bad debts.
(ii) The annual charge for the factoring is 2 % of turnover payable annually in arrears. Administration
cost saving is likely to be Rs. 1,00,000 per annum.
(iii) Annual sales all on credit, are Rs. 1,00,00,000. cost is 80 % sales price. The company’s cost of
borrowing is 15 % per annum. Assume the year is consisting of 365 days.
Should the company enter into a factoring agreement. [May 2006]

Q.19 The turnover of PQR Ltd. is Rs. 120 lakhs of which 75 % is on credit. The cost of sales ratio is
80 %. The credit terms are 2/10, net 30. On the current level of sales, the bad debts are 1 % of sales.
The company spends Rs. 1,20,000 per annum on administrating its credit sales. The cost includes
salaries of staff who handle credit checking, collection etc. these are avoidable costs. The past
experience indicates that 60 % of the customers avail of the cash discount, the remaining customers
pay on an average 60 days after the date of sale. The book debts (receivable) of the company are
presently being financed in the ratio of 1:1 by a mix of bank borrowings and owned funds which cost
per annum 15 % and 14 % respectively. A factoring firm has offered to buy the firm’s receivables.
The main elements of such structured by the factor are:
(i) Factor reserve, 12 %
(ii) Guaranteed payment, 25 days
(iii) Commission 4 % of the value of receivables.
Assume 360 days in a year.
Required: What advise would you give to PQR Ltd. – Whether to continue with the in house
management to receivables or accept the factoring firm’s offer. [PCE – May 2007]

Q.20 JKL Ltd. is considering the revision of its credit policy with a view to increasing its sales and
profit. Currently all its sales are on credit and the customers are given one month’s time to settle the
dues. It has a contribution of 40 % on sales and it can raise additional funds at a cost of 20 % per
annum. The marketing manager of the company has given the following options along with estimates
for considerations:
Particulars Current position I option II option III option
Sales (Rs. In lakhs) 200 210 220 250
Credit period (in months) 1 1.5 2 3
Bad debts (% of sales) 2 2.5 3 5
Cost of credit administration
(Rs. In lakhs) 1.20 1.30 1.50 3.00
[PE – II Nov. 2007]

Q.21Vamana & Co. currently has a centralised billing system. All customers make payments to the
central billing location. It requires, on the average, 4 days for customers’ mailed payment to reach the
central location. An additional 1.5 days are required to process payments before a deposit can be
made. The firm has a daily average collection of Rs.5,00,000. It has recently analysed the possibility
of initiating a lock-box system.
It is estimated that with a lock-box system, customers’ mailed payments would reach the receipt
location 2.5 days sooner. Further, the processing time could be reduced by 1 additional day, because
each lock-box bank would pick up mailed deposits twice daily. From the above information, answer
the following questions –
1. Determine the reduction in cash balances that can be achieved through the use of a lock-box system.

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2. Determine the opportunity cost of the present system, assuming a 5% return on short-term
investments.
3. If the annual cost of the lock-box system were Rs.75,000, should such a system be initiated?

Q.22 Aakash ltd sells on credit terms “2/15 net 45”. Its present sales are Rs.100 lakhs per annum,
variable costs are 70% of Sales and Fixed Costs are Rs.12 lakhs per annum. The company’s cost of
funds is 24% and it is observed that 40% of the customers avail the discount, while the rest pay on the
due date.
The company is considering relaxing its credit terms to “3/18 net 45”. This relaxation is expected to
increase sales by 25% and fixed costs by Rs.3 lakhs per annum. Due to economy of operations,
variable costs will be reduced to 68% on all sales. It is expected that 80% of the customers will avail
the discount, the rest paying on the due date.
Advise whether the relaxation in credit terms is worthwhile, Show workings clearly.

Q.23 Under an advance factoring arrangement, Super Factors Ltd (SFL) has advanced a sum of a
Rs.14 Lakhs against the Book Debts of Ramesh Ltd. The agreement provides for 80% advance
(maintaining a reserve of 20% to provide for disputes, allowances, returns and other deductions) of the
value of factored Book Debts. The advance carries an interest of 20% p.a. compounded quarterly;
Factoring Commission is 1.5% of the value of factored Book Debts. Both interest and commission are
collected upfront. Answer the following questions –
1. What is the amount of advance payable? What is the effective cost of funds made available to
Ramesh Ltd?
2. Suppose SFL collects the commission upfront but interest is collected in arrears, what is the
effective cost of funds made available to Ramesh Ltd?

Q.24 Jaidev Ltd has total credit sales of Rs.40 lakhs p.a. and its average collection period is 90 days.
The past experience indicates that the bad debt losses are around 3% of credit sales. Jaidev spends
about Rs.1,00,000 per annum on administrating its credit sales. It is considering availing the services
of a factoring firm. It has received offer from Uday ltd, which agrees to buy the receivables of
company. Uday will charge commission of 3% and also agrees to pay advance against receivables at
an interest rate of 18% p.a. after withholding 10% as Reserve. Should Jaidev accept Uday’s offer if
the former’s ROI is 15%? Assume 360 days in a year.

Q.25 The turnover of Raghav Ltd. is Rs.60 lakhs of which 80% is on credit. Debtors are allowed one
month to clear off the dues. A factoring institution is willing to advance 90% of the bills raised on
credit for a fee of 2% per month plus a commission of 4% on the total amount of debts. Raghav Ltd,
as a result of this arrangement, is likely to save Rs.21,600 annually in management costs and avoid
bad debts at 1% on the credit sales.
A scheduled bank has come forward to make an advance equal to 90% of the debts at an interest rate
of 18% p.a. However its processing fee will be at 2% on the debts. Would you accept factoring or the
offer from the bank?

Q.26 Ramana Ltd sells on credit terms 2/10 net 30. It has an annual credit sales of Rs.900 lakhs, with
a variable cost of 80% and bad debts of 0.75%. Past experience shows that 50% of the customers avail
cash discount and the remaining customers pay 50 days after the date of sale. Presently the company’s
investment in receivables are financed in the ratio of 2:1 by a mix of bank borrowings and own funds,
which cost 24% and 27% p.a. respectively. The company also incurs Rs.16 lakhs on credit collection
costs.
The company is considering a “non-recourse factoring” arrangement with Trustme Factors ltd on the
following terms – (a) 15% Factor Reserve; (b) Guaranteed Payment date = 24 days after the date of
purchase; (c) 22% interest / discount; (d) 4% Factoring Commission. Evaluation whether the factoring
proposal is worthwhile. (Use suitable assumptions, wherever applicable)

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Q.27 Kansal Limited specialises in the manufacture of a computer component. The component is
currently sold for Rs.1,000 and its variable cost is Rs.800. For the year ended 31 st March, 2006 the
company sold on an average 400 components per month.
At present the company grants one month credit to its customers. The company is thinking of
extending the same to two months on account of which the following is expected.
Increase in sales 25%
Increase in stock Rs.2,00,000
Increase in creditors Rs.1,00,000
You are required to advise the company on whether or not to extend the credit terms if all customers
avail the extended credit period of two months.

Q.28 Good Luck Ltd which sells on credit basis has ranked its customers in categories 1 to 5 in order
of credit risk:
Category Percentage of Bad Debts Average Collection Period
1 0.0 30 days
2 1.0 45 days
3 2.0 60 days
4 5.0 90 days
5 10.0 120 days
The company’s current credit policy is to allow unlimited credit to firms in categories 1 to 3; limited
credit to firms in category 4 and no additional credit to firms in category 5.
As a result, orders amounting to Rs.25,00,000 from category 4 and Rs.75,00,000 from category 5 are
rejected every year. If the Good Luck Ltd. makes a 10% gross profit on sales and has an opportunity
cost on investment in receivables of 12% what would be the effect on profits of allowing full credit to
all categories of customers? Should credit be extended to all categories of customers?

Q.29 XYZ Corporation is considering relaxing its present credit policy and is the process of
evaluating two proposed policies. Currently the firm has annual credit sales of Rs.50 lakhs and
accounts receivables turnover ratio of four times a year. The current level of loss due to debts is
Rs.1,50,000. The firm is required to give a return of 25% on the investment in new accounts
receivables. The company’s variable costs are 70% of the selling price. Given the following
information, which is the better option?
Present Policy Policy Option I Policy Option II
Annual Credit Sales (Rs.) 50,00,000 60,00,000 67,50,000
Accounts Receivable Turnover Ratio 4 times 3 times 2.4 times
Bad Debts Losses (Rs.) 1,50,000 3,00,000 4,50,000

Q. 30 A Company’s collection pattern is as follows:

10% of the sales in the same month
20% of the sales in the second month
40% of the sales in the third month
30% of the sales in the fourth month
The sales of the company for the first three quarters of the year are as follows:
Month Quarter –I Quarter – II Quarter – III
Rs. Rs. Rs.
First 15,000 7,500 22,500
Second 15,000 15,000 15,000
Third 15,000 22,500 7,500
45,000 45,000 45,000
Working Days 90 90 90
You are required to calculate the average age of receivables and comment upon the results.

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