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1 4/11/2010
2
3 Chapter 27. Tool Kit for Providing and Obtaining Credit
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5
In Chapter 16, we addressed the topic of working capital management with a brief discussion of trade credit. In this
6 chapter, we extend those analyses to several more advanced issues, including monitoring the receivables position and the
7 cost of short term bank loans.
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10 THE PAYMENTS PATTERN APPROACH Total Inventory
TOCosts Slope
(TIC) = SalesTotal
MONITORING Rate
TotalOrdering
CarryingCosts
Costs(TOC)
RECEIVABLES (TCC) (Section 27.6)
= 500 Shirts per Week
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12 Table 27-1 Hanover Company: Receivables Data for 2010 (Thousands of Dollars)
13 Based on Quarterly Sales Data Based on Year-to-Date Sales Data
Receivables
14 Credit Sales at End of
Month (1) for Month (2) Month ADS (4) DSO (5) ADS (6) DSO (7)
15 January $60 $54
16 February $60 $90
17 March $60 $102 $1.98 52 $1.98 52
18 April $60 $102
19 May $90 $129
20 June $120 $174 $2.97 59 $2.47 70
21 July $120 $198
22 August $90 $177
23 September $60 $132 $2.97 44 $2.64 50
24 October $60 $108
25 November $60 $102
26 December $60 $102 $1.98 52 $2.47 41
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29 Table 27-2 Hanover Company: Quarterly Aging Schedules for 2010 (Thousands of Dollars)
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31 Age of Accounts Value and Percentage of Total Accounts Receivable at the End of Each Quarter
32 (Days) 31-Mar 30-Jun 30-Sep 31-Dec
33 0-30 $54 53% $108 62% $54 41% $54 53%
34 31-60 $36 35% $54 31% $54 41% $36 35%
35 61-90 $12 12% $12 7% $24 18% $12 12%
36 $102 100% $174 100% $132 100% $102 100%
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39 Table 27-3 Hanover Company: Quarterly Uncollected Balances Schedules for 2010 (Thousands of Dollars)
40
Remaining
Remaining Receivables as
41 Receivables Percent of
at End of Month's Sales at
Quarter Monthly Sales Quarter End of Quarter
42
43 Quarter 1:
44 January $60 $12 20%
45 February $60 $36 60%
46 March $60 $54 90%
47 $102 170%
48 Quarter 2:
49 April $60 $12 20%
50 May $90 $54 60%
51 June $120 $108 90%
52 $174 170%
53 Quarter 3:
54 July $120 $24 20%
55 August $90 $54 60%
56 September $60 $54 90%
57 $132 170%
58 Quarter 4:
59 October $60 $12 20%
60 November $60 $36 60%
61 December $60 $54 90%
62 $102 170%
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64
65 ANALYZING PROPOSED CHANGES IN CREDIT POLICY (Section 27.7)
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67 Monroe Manufacturing Company's current credit terms are 1/10, net 30. Monroe is considering changing its
68 terms to 2/10, net 40, relaxing its credit standards, and putting less pressure on slow-paying customers. It
69 has annual sales of $400 million. Under its current policy, 50% of customers who pay do so on Day 10 and
70 take the discount, 40% pay on Day 30, and 10% pay late on Day 40.
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72 Current New
Policy Policy
73 Annual sales (in millions) = $400 $530
74 Discount = 1% 2%
75 % customers who take discount = 50% 60%
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76 % customers who pay on day 10 = 50% 60%
77 % customers who pay on day 30 = 40% 0%
78 % customers who pay on day 40 = 10% 20%
79 % customers who pay on day 50 = 0% 20%
80 Variable cost ratio = 70% 70%
81 Cost of funds = 20% 20%
82 Bad debt percent = 2.5% 6.0%
83 Credit analysis and collections expenses = $5 $2
84
85 Current DSO = 21 24
86 Current discounts (in millions) = $2 $6
87 Cost of carrying (in millions) = (DSO)(Sales per day)(VC ratio)(Cost of funds)
88 Cost of carrying (in millions) = $3.2 $4.9
89 Bad debt losses = $10.0 $31.8
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91
92 Table 27-4 Monroe Manufacturing Company: Analysis of Changing Credit Policy (Millions of Dollars)
93

Projected
2011 Net
94 Projected 2011 Income
Net Income Effect of Under New
Under Current Credit Policy Credit Policy
Credit Policy (1) Change (2) (3)
95 Gross sales $400 $130 $530
96 Less discounts $2 $4 $6
97 Net sales $398 $126 $524
98 Production costs, including OH $280 $91 $371
99 Profit before credit costs and taxes $118 $35 $153
100 Credit related costs: $0
101 Cost of carrying receivables $3 $2 $5
102 Credit analysis and collection expenses $5 ($3) $2
103 Bad debt losses $10 $22 $32
104 Profit before taxes $100 $14 $114
105 State-plus-federal taxes (50%) $50 $7 $57
106 Net Income $50 $7 $57
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108
109 ANALYZING PROPOSED CHANGES IN CREDIT POLICY: INCREMENTAL ANALYSIS (Section 27.8)
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111 Sometimes it is preferrable to do an incremental analysis based on a particular division or product.
112
113 S0 = Current gross sales.
114 SN = New gross sales, after the change in credit policy. Note that SN can be greater or less than S0.
115 SN - S0 = Incremental, or change in, gross sales.
116 V= Variable costs as a percentage of gross sales.
117 1-V = Contribution margin, sometimes called gross margin.
118 r= Cost of financing investments in receivables.
119 DSO0 = Days sales outstanding before change in policy.
120 DSON = New days sales outstanding after the change in policy.
121 B0 = Average bad debt loss under current policy as a percent of current gross sales.
122 BN = Average bad debt loss under new policy as a percent of new gross sales.
123 P0 = % of current gross sales that are at the discount.
124 PN = % of new gross sales that are at the discount.
125 D0 = Current discount percent.
126 DN = New discount percent.
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128
129 DI is the incremental change in the level of the firm's investment in receivables. The formula for DI is
130 different for changes in policies that increase sales and those that decrease sales.
131
132 If sales increase:

[Increased investment in [Increased investment in

133 receivables associated with + receivables associated with
DI = the original sales] incremental sales]
[(DSON)
134 [Change in [Old sales per + V (Incremental
days sales day] sales per
DI = outstanding] day)]
[(DSON) (SN -
135 [S0 / 365] + V
DI = [DSON - DSO0] S0)/365]
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138 If sales decrease:

[Decreased investment in
139 [Decreased investment in + receivables associated with
receivables associated with customers who left]
DI = remaining original customers]
[(DSO0)
140 [Change in + V (Incremental
days sales Remaining sales per
DI = outstanding] sales per day] day)]
[(DSO0) (SN -
141 [SN / 365] + V
DI = [DSON - DSO0] S0)/365]
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143
144 DP is the incremental change in pre-tax profitability.
[Change in
145 cost of [Change in
[Change in carrying [Change in bad cost of
DP = gross profit] - receivables] - debt losses] - discounts]
[DNSNPN -
146
DP = [(SN -S0)(1-V)]- [r(DI)] - [BNSN -B0S0] - D0S0P0]
147
148 Example: Lengthening the Credit Period
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150 S0 = $100,000
151 SN = $150,000
152 SN - S0 = $50,000
153 V= 60%
154 1-V = 40%
155 r= 10%
156 DSO0 = 0
157 DSON = 30
158 B0 = 0%
159 BN = 2%
160 P0 = 0%
161 PN = 0%
162 D0 = 0%
163 DN = 0%
164
[(DSON) (SN -
165 [S0 / 365] + V
DI = [DSON - DSO0] S0)/365]
166 DI = 30 $273.97 + 60% $4,109.59
167 DI = $8,219.00 + $2,466.00
168 DI = $10,685
169
170 DP = $20,000 -$1,069 -$3,000 $0
171 DP = $15,931
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173
174 Example: Shortening the Credit Period
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176 S0 = $150,000
177 SN = $130,000
178 SN - S0 = ($20,000)
179 V = 60%
180 1-V = 40%
181 r = 10%
182 DSO0 = 30
183 DSON = 20
184 B0 = 2%
185 BN = 2%
186 P0 = 0%
187 PN = 0%
188 D0 = 0%
189 DN = 0%
190
[(DSO0) (SN -
191 [SN / 365] + V
DI = [DSON - DSO0] S0)/365]
192 DI = -10 $356.16 + 60% -$1,644
193 DI = -$3,562 + -$986
194 DI = -$4,548
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195
196 DP = -$8,000 $455 $400 $0
197 DP = -$7,145