Ilustration:

RST Limited is considering relaxing its present credit policy and is in the
process of evaluating two proposed policies.Currently the firm has annual
credit sales of Rs.22500000 and accounts receivable turnover ratio of 5 times
a year.The current level of loss due to bad debts is Rs.7,50,000.The firm is
required to give a return of 20% on the investment in new accounts
receivables.The company’s variable costs are 60% of the selling price.Given
the following information,which is a better option?
  Present Policy Policy option 1 Policy option 2
Annual credit sales(Rs) 22500000 27500000 35000000
Account receivable turnover
ratio 5 4 3
Bad debt losses(Rs) 750000 2250000 4750000
Solution:
Details Present Policy Policy option 1 Policy option 2
Debtors Turnover 5 times 4 times 3 times
Collection Period 2,4 months 3 months 4 months
Sales 22500000 27500000 35000000
Variable Cost(60%) - - -
Fixed Cost 13500000 16500000 21000000
Bad Debts 750000 2250000 4750000
Opportunity Cost 540000 825000 1400000

Profit 7710000 7925000 7850000

Decision:The company should change the existing policy of 3 months to the

new policy of 4 months as it maximizes the profit.
Illustartion:
A firm has a current sales of Rs.25648750.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%
sales.The firm’s sales 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 period?

Details Present Policy New

Collection Period 45 days 60 days
Sales 25648750 28213625
Variable Cost(72%) 18467100 20313810
Bad debts 384731 564273
Profit Before Tax 6796919 7335542
Less Tax 2378922 2567440
Profit After Tax 4417997 4768102
Less Opportunity Cost 341515 500888
Net 4076482 4267214
Solution:

Decision:

The company should change the existing policy of 45 days to the new policy of 60 days
as it maximizes the profit.