Margilyn C.

Dacuya

1. What are some of the factors that determine the length of the credit period? Why is
the length of the buyer's operating cycle often considered an upper bound on the
length of the credit period?
 Perishability and collateral value
 Consumer demand
 Cost, Profitability, and standardization
 Credit Risk
 The size of the account
 Competition
 Customer type
If the credit duration is longer than the customer's operational cycle, the selling firm is
funding the receivables and other components of the customer's business that are not related
to the sale of the selling firm's goods.
2. In what form is trade credit most commonly associated? What is the credit
instrument used in this transaction?
On open account, trade credit is frequently granted. When products and services are
purchased on credit, a trade credit loan is given by one merchant to another. Trade credit
allows you to buy materials without having to pay right away. Business groups frequently
use trade credit as a form of short-term finance. The credit instrument is the invoice.

3. If a company moves to a JIT inventory management system, what will happen to

inventory turnover? What will happen to total asset turnover and ROE?
Inventory levels were lowered thanks to JIT systems. Inventory turnover will
increase assuming no influence on sales. TAT will rise as assets drop. An increase in
TAT will result in a boost in ROE.

4. What are the five Cs of Credit? Explain the importance of each.

 Capacity: The ability of a client to pay credit obligations from operating cash flows. This
is the most crucial of the five elements.
 Character: The customer's propensity to follow through on promises. It's mostly a
subjective assessment of the lender by the potential customer.
 Capital: The borrower's net worth, often known as their financial reserves.
 Collateral: Assets pledged as security in the event of default.
 Conditions: The customer's general business conditions that affect his or her ability to
pay.

5. What cost are associated with carrying receivables? What costs are associated with
not granting credit? What do we call the some of the costs for different levels of
receivables?
 Credit analysis, accounting and collection costs.
Margilyn C. Dacuya

If the company extends credit in the hopes of attracting more business, it must pay for
the hiring of a credit manager as well as assistants and bookkeepers within the finance
department, as well as the cost of acquiring credit information sources and generally
maintaining and operating a credit and collection department.
 Capital costs.
When a company extends credit, it must raise funds to finance it. The cost of funds
that will be tied up in receivables will be the interest to be paid if the funds are
borrowed or the opportunity cost of equity capital.
 Delinquency costs.
These cost are incurred when a consumer fails to pay on time. This delay raises
collection costs above and above those of a standard collection. Delinquency also
incurs an opportunity cost for whatever time the money remains uncollected after the
typical collection period.
 Default costs (Bad debts).
When a customer fails to pay, the company incurs default costs. In addition to the
collection, capital, and delinquency costs incurred thus far, the firm incurs the cost of
goods sold but not paid for. Once it determines that the delinquent account has
defaulted and is no longer collectible, it must write off the entire sales.

o The opportunity costs are the sales that are lost as a result of not granting credit. The
carrying costs of granting credit include the time it takes to receive cash, the losses from
bad debts, and the costs of credit management.

o There are five major costs associated with accounts receivable. 

Bad debts
Every open account sale carries the risk of nonpayment. Nonpayment could be
the result of a legitimate disagreement. Nonpayment of larger sums is frequently the
result of a customer filing for bankruptcy.
Interest Cost
The total amount of interest paid on a debt obligation by a borrower over the life
of the loan is referred to as the interest cost. In addition to repaying the principal,
interest is paid on the debt.
Opportunity Costs
The opportunity cost is the benefit that would have been obtained if a different
option had been chosen. To properly assess opportunity costs, the costs and benefits of
each available option must be considered and weighed against one another.
Administrative Costs
Margilyn C. Dacuya

Administrative expenses are those incurred by an organization that are not

directly related to a specific core function, such as manufacturing, production, or sales.
These overhead costs are incurred by the organization as a whole, rather than by
individual departments or business units.
Miscellaneous Costs
Miscellaneous expense is a term used to define and cover costs that do not typically
fall into specific tax categories or account ledgers. Payroll, office rent, and inventory
supplies will all have their own accounts to track and record associated costs every
month.
6. What are the different types of inventory? How do they differ?
Raw Materials
Raw materials are the materials required to convert your inventory into a finished
product. These inventory items are component parts that are currently in stock... but have not yet
been used in either work-in-process or finished goods inventory.
Raw materials are classified into two types: direct materials, which are used directly in
finished goods, and indirect materials, which are part of overhead or factory costs.
Work-In-Process
The inventory that is being worked on is known as Work-In-Process (WIP). WIP includes
raw materials (plus, sometimes, labor costs) that are still "in production" at the end of the
accounting period.
In other words, whatever direct and indirect raw materials your company uses to produce
finished goods is considered WIP inventory.
Finished Goods
A finished good is a part that has been completed and is ready for a client order. As a
result, finished goods inventory refers to the stock of finished goods. These items have been
inspected and passed final inspection standards, allowing them to be moved from work-in-
process to finished goods inventory. Finished goods can be sold directly to end users, sold to
retailers, sold to wholesalers, sent to distribution facilities, or stored in anticipation of a client
purchase at this point.
Factory supplies
Maintenance materials, janitorial supplies, and products that are deemed ancillary to the
manufacturing process are examples of these supplies. They are normally charged to expense
when they are incurred, in which case the supplies expenditure account is included in the income
statement's cost of goods sold category. Some businesses use the accrual basis of accounting to
record unused factory supplies in an asset account, such as Supplies on Hand, and then charge
items to expense as they are consumed; however, this is only cost-effective if a large quantity of
Margilyn C. Dacuya

factory supplies is kept in storage, because someone must manually track the quantities on hand.
Factory supplies can also be accounted for in an overhead cost pool and assigned to the units
produced.