CA.CS.MBA.Naveen.

Rohatgi Receivables Management OBJECTIVES

TYBMS: Naveen. Rohatgi

The term receivables is defined as debt owed to the firm by customers arising from sale of goods or services in the ordinary course of business. When a firm makes an ordinary sale of goods or services and does not receive payment, the firm grants trade credit and creates accounts receivable which could be collected in the future. Receivables management is also called trade credit management. Thus, accounts receivable represent an extension of credit to customers, allowing them a reasonable period of time in which to pay for the goods received. The sale of goods on credit is an essential part of the modem competitive economic systems. In fact, credit sales and, therefore, receivables, are treated as a marketing tool to aid the sale of goods. The credit sales are generally made on open account in the sense that there are no formal acknowledgements of debt obligations through a financial instrument. As a marketing tool, they are intended to promote sales and thereby profits. However, extension of credit involves risk and cost. Management should weigh the benefits as well as cost to determine the goal of receivables management. The objective of receivables management is to promote sales and profits until that point is reached where the return on investment in further funding receivables is less than the cost of funds raised to finance that additional credit (i.e. cost of capital). The specific costs and benefits which are relevant to the determination of the objectives of receivables management are examined below. Costs (May 2003) The major categories of costs associated with the extension of credit and accounts receivable are: (i) Collection cost, (ii) capital cost, (iii) delinquency cost, and (iv) default cost. Collection Cost: Collection costs are administrative costs incurred in collecting the receivables from the customers to whom credit sales have been made. Included in this category of costs are: (a) additional expenses on the creation and maintenance of a credit department with staff, accounting records, stationery, postage and other related items; (b) expenses involved in acquiring credit information either through outside specialist agencies or by the staff of the firm itself. These expenses would not be incurred if the firm does not sell on credit. Capital Cost The increased level of accounts receivable is an investment in assets. They have to be financed thereby involving a cost. There is a time-lag between the sale of goods to, and payment by, the customers. Meanwhile, the firm has to pay employees and suppliers of raw materials, thereby implying that the firm should arrange for additional funds to meet its own obligations while waiting for payment from its customers. The cost on the use of additional capital to support credit sales, which alternatively could be profitably employed elsewhere, is, therefore, a part of the cost of extending credit or receivables. Delinquency Cost : This cost arises out of the failure of the customers to meet their obligations when payment on credit sales become due after the expiry of the credit period. Such costs are called delinquency costs. The important components of this cost are: (i) blocking-up of funds for an extended

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

period, (ii) cost associated with steps that have to be initiated to collect the overdues, such as, reminders and other collection efforts, legal charges, where necessary, and so on. Default Cost Finally, the firm may not be able to recover the overdues because of the inability of the customers. Such debts are treated as bad debts and have to be written off as they cannot be realised. Such costs are known as default costs associated with credit sales and accounts receivable. Benefits Apart from the costs, another factor that has a bearing, on accounts receivable management is the benefit emanating from credit sales. The benefits are the increased sales and anticipated profits because of a more liberal policy. When firms extend trade credit, that is, invest in receivables, they intend to increase the sales. The impact of a liberal trade credit policy is likely to take two forms. First, it is oriented to sales expansion. In other words, a firm may grant trade credit either to increase sales to existing customers or attract new customers. This motive for investment in receivables is growthoriented. Secondly, the firm may extend credit to protect its current sales against emerging competition. Here, the motive is sales-retention. As a result of increased sales, the profits of the firm will increase. From the above discussion, it is clear that investments in receivables involve both benefits and costs. The extension of trade credit has a major impact on sales, costs and profitability. A relatively liberal policy and, therefore, higher investments in receivables, will produce larger sales. However, costs will be higher with liberal policies than with more stringent measures. Therefore, accounts receivable management should aim at a trade-off between profit (benefit) and risk (cost). That is to say, the decision to commit funds to receivables (or the decision to grant credit) will be based on a comparison of the benefits and costs involved, while determining the optimum level of receivables. The costs and benefits to be compared are marginal costs and benefits. The firm should only consider the incremental (additional) benefits and costs that result from a change in the receivables or trade credit policy. While it is true that general economic conditions and industry practices have a strong impact on the level of receivables, a firms investments in this type of current assets is also greatly affected by its internal policy. A firm has little or no control over environmental factors, such as economic conditions industry practices. But it can improve its profitability through a properly conceived trade credit policy or receivables management. CREDIT POLICES In the preceding discussions it has been clearly shown that the firms objective with respect to receivables management is not merely to collect receivables quickly, but attention should also be given to the benefit-cost trade-off involved in the various areas of accounts receivable management. The first decision area is credit policies. The credit policy of a firm provides the framework to determine (a) whether or not to extend credit to a customer and (b) how much credit to extend. The credit policy decision of a firm has two broad dimensions: (i) Credit standards and (ii) Credit analysis. A firm has to establish and use standards in making credit decisions, develop appropriate sources of credit information and methods of credit analysis. We illustrate below how these two aspects are relevant to the accounts receivable management of a firm.

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi Credit Standards

TYBMS: Naveen. Rohatgi

The term credit standards represents the basic criteria for the extension of credit to customers. The quantitative basis of establishing credit standards are factors such as credit ratings, credit references, average payments period and certain financial ratios. Since we are interested in illustrating the tradeoff between benefit and cost to the firm as a whole, we do not consider here these individual components of credit standards. To illustrate the effect, we have divided the overall standards into (a) tight or restrictive and (b) liberal or non-restrictive. That is to say, our aim is to show what happens to the trade-off when standards are relaxed or, alternatively, tightened. The trade-off with reference to credit standards covers (i) the collection cost, (ii) the average collection period/cost of investment in accounts receivable, (iii) level of bad debt losses, and (iv) level of sales. These factors should be considered while deciding whether to relax credit standards or not. If standards are relaxed, it means more credit will be extended while if standards are tightened, less credit will be extended. The implications of the four factors are elaborated below. Collection Costs The implications of relaxed credit standards are (1) more credit, (ii) a large credit department to service accounts receivable and related matters, (iii) increase in collection costs. The effect of tightening of credit standards will be exactly the opposite. These costs are likely to be semivariable. This is because up-to a certain point the existing staff will be able to carry on the increased workload, but beyond that, additional staff would be required. Investments in Receivables or the Average Collection Period The investment in accounts receivable involves a capital cost as finance have to be arranged by the firm to finance them till customers make payments. Moreover, the higher the average accounts receivable, the higher is the capital or carrying cost. A change in the credit standardsrelaxation or tighteningleads to a change in the level of accounts receivable either through a change in (a) sales, or (b) collections. A relaxation in credit standards, as already stated, implies an increase in sales which, in turn, would lead to higher average accounts receivable. Further, relaxed standards would mean that credit is extended liberally so that it is available to even less creditworthy customers who will take a longer period to pay overdues. The extension of trade credit to slow-paying customers would result in a higher level of accounts receivable. In contrast, a tightening of credit standards would signify (i) a decrease in sales and lower average accounts receivable, and (II) an extension of credit limited to more creditworthy customers who can promptly pay their bills and, thus, a lower average level of accounts receivable. Thus, a change in sales and change in collection period together with a relaxation in standards would produce a higher carrying costs, while changes in sales and collection period result in lower costs when credit standards are tightened. These basic reactions also occur when changes in credit terms r collection procedures are made. We have discussed these in the subsequent sections of this chapter. Bad Debt Expenses Another factor which is expected to be affected by changes in the credit standards is bad debt (default) expenses. They can be expected to increase with relaxation in credit standards and decrease if credit standards become more restrictive. Sales Volume Changing credit standards can also be expected to change the volume of sales. As standards are relaxed, sales are expected to increase; conversely, a tightening is expected to cause a decline in sales.

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

Credit Analysis/ Evaluation/ Credit granting decision (Nov 2001, May 2006, May 2006) Besides establishing credit standards, a firm should develop procedures for evaluating credit applicants. The second aspect of credit policies of a firm is credit analysis and investigation. Two basic steps are involved in the credit investigation process: (a) obtaining credit information, and (b) analysis of credit information. It is on the basis of credit analysis that the decisions to grant credit to a customer as well as the quantum of credit would be taken. Obtaining Credit Information The first step in credit analysis is obtaining credit information on which to base the evaluation of a customer. The sources of information, broadly speaking, are (i) internal, and (ii) external. Internal Usually, firms require their customers to fill various forms and documents giving details about financial operations. They are also required to furnish trade references with whom the firms can have contacts to judge the suitability of the customer for credit. This type of information is obtained from internal sources of credit information. Another internal source of credit information is derived from the records of the firms contemplating an extension of credit. It is likely that a particular customer/applicant may have enjoyed credit facility in the past. In that case, the firm would have information on the behaviour of the applicant(s) in terms of the historical payment pattern. This type of information may not be adequate and may, therefore, have to be supplemented by information from other sources. External The availability of information from external sources to assess the credit-worthiness of customers depends upon the development of institutional facilities and industry practices. In India, the external sources of credit information are not as developed as in the industrially advanced countries of the world. Depending upon the availability, the following external sources may be employed to collect information. Financial Statements One external source of credit information is the published financial statements, that is, the balance sheet and the profit and loss account. The financial statements contain very useful information. They throw light on an applicants financial viability, liquidity, profitability and debt capacity. Although the financial statements do not directly reveal the past payment record of the applicant, they are very helpful in assessing the overall financial position of a firm, which significantly determines its credit standing. Bank References Another useful source of credit information is the bank of the firm which is contemplating the extension of credit. The modus operandi here is that the firms banker collects the necessary information from the applicants banks. Alternatively, the applicant may be required to ask his banker to provide the necessary information either directly to the firm or to its bank. Trade References These refer to the collection of information from firms with whom the applicant has dealings and who on the basis of their experience would vouch for the applicant.

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

Credit Bureau Reports Finally, specialist credit bureau reports from organisations specialising in supplying credit information can also be utiised. Analysis of Credit Information Once the credit information has been collected from different sources, it should be analysed to determine the credit worthiness of the applicant. Although there are no established procedures to analyse the information, the firm should devise one to suit its needs The analysis should cover two aspects: (i) quantitative, and (ii) qualitative. Quantitative The assessment of the quantitative aspects is based on the factual information available from the financial statements, the past records of the firm, and so on. The first step involved in this type of assessment is to prepare an Aging Schedule of the accounts payable of the applicant as well as calculate the average age of the accounts payable. This exercise will give an insight into the past payment pattern of the customer. Another step in analysing the credit information is through a ratio analysis of the liquidity, profitability and debt capacity of the applicant. These ratios should be compared with the industry average. Moreover, trend analysis over a period of time would reveal the financial strength of the customer. Qualitative The quantitative assessment should be - supplemented by a qualitative/subjective interpretation of the applicants creditworthiness. The subjective judgement would cover - aspects relating to the quality of management. Here, the -references from other suppliers, bank references and specialist bureau reports would form the basis for the conclusions to be drawn. In the ultimate analysis, therefore, the decision whether to extend credit to the applicant and what amount to extend ill depend upon the subjective interpretation of his credit standing. CREDIT TERMS The second decision area in accounts receivable management is the credit terms. After the credit standards have been established and the creditworthiness of the customers has been assessed, the management of a firm must determine the terms arid conditions on which trade credit will be made available. The stipulations under which goods are sold on credit are referred to as credit terms. These relate to the repayment of the amount under the credit sale. Thus, credit terms specify the repayment terms of receivables. Credit terms have three components: (1) credit period, in terms of the duration of time for which trade credit is extendedduring this period the overdue amount must be paid by the customer; (b) cash discount, if any, which the customer can take advantage of, that is, the overdue amount will be reduced by this amount; and (c) cash discount period, which refers to the duration during which the discount can be availed of. These terms are usually written in abbreviations, for instance, 2/10 net 30. The three numerals are explained below: 2 signifies the rate of cash discount (2 per cent), which will be available to the customers if they pay the overdue within the stipulated time; 10 represents the time duration (10 days) within which a customer must pay to be entitled to the discount; 30 means the maximum period for which credit is available and the amount must be paid in any case before the expiry of 30 days. In other words, the abbreviation 2/10 net 30 means that the customer is entitled to 2 per cent cash discount (discount rate) if he pays within 10 days (discount period) after the beginning of the credit period (30 days). If, however, he does not want to take advantage of the discount, he may pay within

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

30, days. If the payment is not made within a maximum period of 30 days, the customer would be deemed to have defaulted. Cash Discount The cash discount has implications for the sales volume, average collection period/average investment in receivables, bad debt expenses and profit per unit. In taking a decision regarding the grant of cash discount, the management has to see what happens to these factors if it initiates increase, or decrease in the discount rate. The changes in the discount rate would have both positive and negative effects. The implications of increasing or initiating cash discount are as follows: 1. The sales volume will increase. The grant of discount implies reduced prices. If the demand for the products is elastic, reduction in prices will result in higher sales volume. 2. Since the customers, to take advantage of the discount, would like to pay within the discount period, the average collection period would be reduced. The reduction in the collection period would lead to a reduction in the investment in receivables as also the cost. The decrease in the average collection period would also cause a fall in bad debt expenses. As a result, profits would increase. 3. The discount would have a negative effect on the profits. This is because the decrease in prices would affect the profit margin per unit of sale. Del crede commission ( May 2004) : Del Crede agent, is an agent who bears the risk of non payment by the customers to whom the agent has sold goods on behalf of the principal . Del crede commission is extra commission paid by the principal to a del crede agent to cover the risk of non payment by the customer to whom the agent has sold the goods on behalf of the principal. Board question paper: Q1. Explain the step involved in credit analysis in details. (NOV 2001) Q2. Explain the various cost associated with accounts receivable ( MAY 2003) Q3. What is credit Evaluation . (MAY 2006) Q4.As a marketing executive before extending credit facilities to the customers introduced by salesman, what precautions would you take to protect the interest of the company. (NOV 2008) Q5.Write a note on credit delinquency cost and del credre commission. (MAY 2004 ) Q6. Write a note on credit granting decision. (MAY 2006 ) RECEIVABLE MANAGEMENT Illustration 1 H ltd. has present annual sales 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 period to 2 months and 3 months and has made the following estimates: Existing Proposed Credit policy 1 month 2 months 3 months Increase in sales --15% 30% % Of Bad Debts 1% 3% 5%

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

There will be increase in fixed cost by Rs. 50,000/- on account of sales beyond 25% of present level. The company plans on a pre-tax return of 20% on investment in receivables. You are required to calculate the most paying credit policy for the company. Illustration 2 A company sells 40000 units of its product per year @ Rs. 35/unit. The average cost/unit is Rs 31 out of which variable cost per unit is Rs 28 The average collection period is 60 days. Bad debts losses are 3% on sales and the collection charges amount to Rs. 15,000. The company is considering the proposal to follow stricter collection policy, which would bring down the losses on account of Bad debts to 1% of sales and average collection period to 45 days. It would, however, reduce the sales volume by 1000 units and increase collection expenses to Rs. 25,000. The company requires a rate of return of 20%. Would you recommend adoption of the new credit policy (Assume 360 days in a year for the purpose of your calculation) Illustration 3Suraj ltd is a company having an annual credit sale Rs 30 lakhs It deals in only one product. Currently it has an average collection period of 30 days. It is anticipated that liberalization of credit terms can lead to increased sales as indicated below: Increase in collection period Increase in sales (Rs. 000) Bad debts % on sales (days) 15 200 0.5 30 300 1.0 45 350 1.5 60 375 2.0 The unit selling price for the product is Rs 50 and unit variable cost is Rs 30, at current volume it has a unit total cost of Rs. 35. Currently the company is free from bad debts losses. What will be the most rewarding credit policy under these circumstances? The company expects a return of 18 percent on investments. Tabulate your presentation. OCT 2003 Illustration 4 The present annual sales are Rs 2.4 million of Humpty and dumpty a wholesales may now try to liberalize credit standards. Currently, the firm has an average collection period of 30 days. It believes that with increasing liberal credit standards, the following will result: Credit Policy I II III IV Increase in sales from Previous Level (in lakhs) 2.8 1.8 1.2 0.6 Average collection period from incremental sales (in 45 60 90 144 days) The price of its product is Rs. 20 per unit and variable costs is Rs. 18 per unit. No bad debts losses are expected. If the company has an opportunity cost of funds of 30%, which credit policy, should be pursued. Illustration 5 PQR Ltd. Is considering relaxing its credit policy and evaluating two proposed policies. Currently, annual credit sales of Rs. 50 lakhs and A/cs. Receivable is Rs. 12,50,000. The firm is required to give a return of 20% on investment in the new (additional) accounts receivable. The companys variable costs are 70% of the selling price. Present Policy Policy I Policy II Annual Credit Sales 50,00,000 60,00,00 67,50,00 A/cs Receivable 12,50 000 0 0 Bad debt losses 150,000 20,00 28,12

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

000 500 3,00,000 4,50,000 You are the management auditor of the firm. Advise the M.D. which option should be exercised. Illustration 6 ABC firm is considering to make certain relaxation in its credit policy. The ABC Management has started two new policies. From the following details advise the ABC Management which policy has to be adopted. 1) Annual credit sales at present Rs. 87.5 lakhs 2) Proposed credit sales: Under alternative I Under alternative II Rs. 105 lakhs Rs. 118 lakhs 3) Accounts receivable turnover ratio: Existing I II 7 times 5.25 times 4.2 times 4) Bad debts Rs. 2.63 lakhs Rs.5.25 lakhs 7.88 lakhs 5) The ABC is to get a return over 30% on the investment in new accounts receivable. Its P/V ratio is 30%. Illustration 7 Easy ltd. specializes in manufacture of computer component. The component is currently sold for Rs. 1,000/- and its variable cost is Rs. 800. For the year-ended 31.12.92 the company sold on an average 400 components per month. At present the company grants one-month credit to is customers. The company is thinking of extending the same to two months on accounts of which the following is expected: Increase in Sales 25%; Increase in Stock 2,00,000; Increase in Creditors Rs. 1,00,000 You are required: To advise the company on whether or not extended the credit terms. The company expects a minimum return of 40% on the investment. Illustration 8 You have an established, market for a product. A new customer who will buy annually goods worth Rs. 2,00,000 from you. The customer expects a credit period of 30 days. The ratio of contribution to sales is 25%. The risk of non-payment is 10%. You expect a post tax return of 10% on your investment. The rate if tax applicable to you is 40%. Would you accept the proposal? Would you accept the proposal if the risk of non-payment is 5% only? Illustration 9 The present terms of P. Co. is (1/10 net 30) Annual Sales - 80L. Average collection period 20 days. Variable Cost & avg. total cost to sales 0.85 and 0.95 respectively. Cost of capital = 10%. Proportion of sales on which customers currently take discount is 0.50 P. Co. is considering relaxing discount terms to 2/10 net 30. Such relaxation is expected to increase sales by 5 lakhs. Reduce average collection period to 14 days & proportion of discount to sales 0.8. What will be the effect of relaxing the discount policy on companys profit? Take 360 days = 1 yr. Illustration 10 NOV 2005 M/S Bharat Industries Ltd has annual credit sales of Rs 24 lacs. Mr. Patil, the newly appointed Sales Manager has ambitious plans to increase the Sales and also the profitability of the Company. At present the sales price per unit is Rs. 20 and present age of accounts receivable is one month and variable cost is @50% and net profit is @20%. Mr. Patil has put forward the following two proposals before the management.

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

Proposal I: Increase the credit period to debtors from one month to 3 months. The expected sale will be Rs. 30 lacs. Chances of bad debts @2% of the credit sale. Proposal II: Reduce the Selling Price by 5% per unit. Expected Sales would be Rs. 28.50 lacs. All cash sales no credit sale. Assuming that the cost of funds is 12% p.a., and other conditions remaining same, which would you recommend? Illustration11 May 2002 Given below is the age analysis of debtors of Robin Ltd. as at 30th Sept 2001 Age analysis of debtors as at 30th September 2001. (Rs in 000) Account Customer Name Balance Up to 30 days 3 1-60 6 1-90 Over 90 no. days days days Reliance Ltd. 294.35 220.15 65.40 8.80 GXL Ltd. 949.50 853.00 0.00 96.50 0.00 Sona Ltd. 371.26 340.66 30.60 0.00 0.00 Thomas Cook 1438.93 0.00 0.00 567.98 870.95 Ltd T011 Times Ltd. 423.48 312.71 110.77 0.00 0.00 Total 3477.52 1726.52 206.77 673.28 870.95 Answer the following: (i) What does an age-analysis of debtors show (ii) How much percentage of Robin Ltd.s debtors is outstanding for more than 30 days? (iii) Explain any relevant problem you if the company allows a normal credit period of 30 days and suggest some measures to improve the collection efforts. Illustration 12 May 2004 In order to increase sales from normal level of Rs. 2.4 lakhs per annum, the marketing manager submits the proposal for liberalizing credit policy as under: Normal sales Rs. 2.4 lakhs Normal Credit period 30 days Proposed increase in credit period Relevant increase over normal beyond normal 30 days Sales 15 days Rs. 12000 30 days Rs. 18000 45 days Rs. 21000 60 days Rs. 24000 The P/V ratio of the company is 33 1/3 %. The company expects a pre-tax return of 20% on investment. Evaluate the above four alternatives and advise the management (Assume 360 days a year) Illustration 13 Star limited manufactures colour TV sets, are considering liberalization of existing credit terms to these three customers . The credit period and likely quantity of TV sets that will be lifted by the customers are as follows Credit Period (days) A Quantity lifted B C 9 B002 G007 T005 T010

.We all have ability, the difference is how we use it.

CA.CS.MBA.Naveen.Rohatgi 0 30 60 90 1,000 1,000 1,000 1,000 1,000 1,500 2,000 2,500 -----------1,000 1,500

TYBMS: Naveen. Rohatgi

The selling price of TV Rs 9,000.The expected contribution is 20% of the selling price. The cost of carrying debtors average 20% p.a You are required: (1) To determine the credit period to be allowed to each customer ( Assume 360 days in the year (2) What are other problems the company might face in allowing the credit period to determined in 1.
HOME WORK SECTION Q1) Present Situation: Sales = Rs. 50 lacs Variable Costs Rs. 40 lacs Fixed Costs = Rs. 6 lacs Credit to Debtors = 30 days Proposed Credit Proposed Credit Sales (Rs. in Policy Period lacs) I 45 days 56 II 60 days 60 II 75 days 62 IV 90 days 63 Determine the credit period that should be allowed by the company. Present your answer in a tabular form. Assume 360 days a year. Calculations should be made upto two digits after decimal. The company expects pre-tax return on investment @ 25%. Q2) Particulars Credit Period 40 days 70 days 100 days Sales (Rs. In Lacs) 16 18 21 Fixed Cost (Rs. In Lacs) 3 4 4 Bad Debts (%) 0.5 1 2.5 P/V Ratio is 30% Required return on additional investments @ 20% Evaluate each of the above proposals and recommend the best Credit Period for the company. Q3)A trader whose current sales is Rs. 10 lacs per annum and has an average collection period of 30 days wants to place a more liberal Policy to improve sales. A study made by a management Consultant reveals the following information. Credit Increase in collection Increase in Default Anticipated Period Period Sales (Percentage) (Days) (Units) A 15 20,000 1.5 B 25 40,000 2.5 C 30 60,000 3.5 D 40 70,000 4.5 Selling price per unit is Rs. 10; average cost per unit is Rs. 6 and variable cost per unit is Rs. 4. Current bad debt loss is 1% Present Policy 20 days 15 3 0.25 Plan I Plan II Plan III

.We all have ability, the difference is how we use it.

10

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

Required return on additional investment is 25% Assume 360 days in a year. Which of the above policies would you recommend for adoption? Q4) Present Situation Sales = Rs. 80 lacs Variable Cost = Rs. 50 lacs Fixed Cost = Rs. 10 lacs Credit to Debtors = 20 days Plan Proposed Credit Sales (Rs. In Period Lacs) I 3Odays 100 II 40 days 120 III 50 days 135 IV 60 days 150 Determine the Credit period that should be allowed by the company. Assume Return On Investment (ROI) @ 18%. Q5) Vajra Ltd. is considering relaxing its present credit policy. At present it has annual credit sales of Rs. 20 lacs and has an accounts receivable turnover ratio of 6 times a year. Bad debts at present account to Rs. -50,000. The firm is required to give a return of 30% on the investment in accounts receivables. The companys variable costs are 60% of selling price. Option I Option II Credit Sales (Rs.) 40 lacs 50 lacs Accounts Receivables Turnover Ratio (Times) 4 3 Bad Debts 70,000 1,00,000 Which is the better option from the two options given? Q6) .ABC company is currently selling 50,000 units of its product at Rs. 50 per unit. At the present level of production, the cost per unit is Rs. 40 and variable cost per unit being Rs. 30. The company is currently extending one months credit to its customers. The company is thinking of extending credit period to one and a half month, with the expectation that sales will increase by 25%. If the companys pre-tax required rate of return is 20 percent, is the new credit policy desirable? Q7) Palam Manufacturing and Trading company is currently selling 60,000 units at the rate of Rs. 20 per unit. The cost per unit is Rs. 16 at current level of production and variable cost per unit Rs. 12. The companys current credit policy is extension of credit for 30 days. The management is contemplating to extend credit for a two-month period so as to boost sales by 30 per cent. The companys required rate of return on investments is 15 per cent. Should the management liberalise credit standards? Q8) Palam manufacturing and electrical Ltd. Sells the goods on cash as well as credit. The following particulars are extracted from their books of accounts for the calendar year 2010. Explain the debt collection period. Particulars Total Gross sales Cash sales included in the above Sales return from credit sales Total debtor for sales as on 31-12-2010 Bill receivable as on 31-03-2010 Provision for bad debts as on 31-12-2010 Total creditor Rs 2,00,000 0 40,000 14,000 18,000 4,000 2,000 20,000

.We all have ability, the difference is how we use it.

11

CA.CS.MBA.Naveen.Rohatgi

TYBMS: Naveen. Rohatgi

=================================================

.We all have ability, the difference is how we use it.

12