HANDOUT 11
ACC 7 MANAGEMENT ADVISORY SERVICES II
ACCOUNTS RECEIVABLE MANAGEMENT
Problem 1. MAILA Co. is considering changing its credit terms from 2/15, n/30 to 3/10, n/30 in
order to speed up collections. At present, 40% of MAILA Co.’s customers take the 2% discount.
Under the new term, discount customers are expected to rise to 50%. Regardless of the credit
terms, half of the customers who do not take the discount are expected to pay on time, whereas
the remainder will pay 10 days late. The change does not involve a relaxation of credit standards;
therefore bad debt losses (per peso sales) will remain at status quo.
Currently bad debts expense is 2% of sales. However, the more generous cash discount terms are
expected to increase sales from P2 000 000 to P2 600 000 per year. MAILA Co.’s variable cost ratio
is 75%, the interest rate on funds invested in accounts receivable is 9%, and the firm’s income tax
rate is 40%. (360 days/year)
a. What is the DSO before the change in credit policy
b. What is the DSO after the change in credit policy
c. What is the incremental carrying cost on receivable?
d. What is the incremental after tax profit from the change in credit terms?
Problem 2. IRENE Company plans to tighten its currently liberal credit policy. This new (tight)
policy will decrease the average number of days in collection form 63 days to 50 days and reduce
the ratio of credit sales to total revenue from 70% to 50%. The company estimates that projected
sales would be 10% less if the proposed policy will be implemented. The firm’s short-term interest
cost is 15%. Projected sales for the coming year are P50 million.
a. Calculate the peso impact on accounts receivable of this proposed change in policy (360
days/year)?
Problem 3. CLARISSE Merchandize Inc., has net credit sales of P1 440 000 yearly with credit terms
of n/30, which is also the average collection period. CLARISSE does not offer discounts for early
payment, thus, customers take the full 30 days to pay. (Each “If” is an independent situation unless
otherwise stated, Use 360 days/year)
a. What is the average receivable balance?
b. What is the accounts receivable turnover?
c. If CLARISSE offered 2% discount for payment in 10 days and every customer took advantage
of the new terms, what would the new average receivable balance be?
d. Continuing from the situation in (c.), if CLARISSE reduces its bank loans which cost 10%, by
the cash generated from reduced receivables, what will be the net gain/loss to the firm?
e. If the new trade terms of 2/10, n/30 will increase sales by 15% because the discount makes
CLARISSE’s price competitive and CLARISSE earns 20% on sales before discounts, should it
offer the discount?
Problem 4. LAUREN Inc. currently has sales of P1 million, and its DSO is 30 days, the financial
manager estimates that offering longer credit terms would increase the days sales outstanding to
50 days and increase the sales to P1.2 million. However, bad debt losses, which were 2% on the old
sales, would amount to 5% only on the incremental sales. Variable costs are 80% of sales; LAUREN
has a 15% receivable financing cost. (360 d/y)
a. What would the annual incremental pre-tax profit be if LAUREN extended its credit period?
Problem 5. CEDRICK Inc. currently sells P12 million per annum. Its credit period and DSO are both
30 days, and 1.5% of its sales end up as bad debts. The credit manager estimates that, if the firm
extends its credit period to 40 days so that its DSO increases to 40 days, sales will increase by P3
million, but their bad debts losses on the incremental sales will be 2.5%. Variable costs are 60%,
and the cost of carrying receivables is 10%. Tax rate is 40%. (Assume 360 days per year).
a. Compute the incremental investment required to finance the increase in receivables if the
change is implemented.
b. What would be the incremental cost of carrying receivables?
c. What would be the effect of those changes in net income?
Problem 6. KATE Co. is planning to introduce changes in its collection procedures. The new
procedures are expected to make the collection period longer by 10 days, although there will be no
change in bad debts. For the coming year, KATE Co.’s budgeted sales is P32 400 000 or P90 000 per
day. Short-term interest rates are expected to average at 9% per annum.
a. As a result of the changes in collection procedures, KATE Co.’s average AR balance will
increase (decrease) by?
b. To make the changes in collection procedures cost-beneficial, the minimum savings in
collection costs for the coming year should be?
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Problem 7. CAROL Food Corp normally takes 25 days to pay for average daily credit purchases of
P100 000. Its average daily sales are P120 000, and it collects accounts in 27 days.
a. What is its net credit position? (Use a 360 day year).
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Answer key
Problem 1:
a.
b.
c.
d.
27
22.5
P843.75
P68,493
Problem 2:
a. P3,000,000
Problem 3:
a.
b.
c.
d.
e.
P120 000
12 Days
P40 000
(P20 800)
P10 080
Problem 4:
a. P20 000
Problem 5:
a. P400 000
b. P40 000
c. P651 000
Problem 6:
a. P900 000
b. 81 000
Problem 7:
a. P740 000
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