A B C D E F G H I

1 Tool Kit Chapter 27 10/27/2015

2 Providing and Obtaining Credit
3
4 In Chapter 16, we addressed the topic of working capital management with a brief discussion of trade credit. In this chapter,
5 we extend those analyses to several more advanced issues, including monitoring the receivables position and the cost of
6 short term bank loans.
7
8
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9 27-6 Monitoring Receivables with the
Total Inventory Costs
Uncollected Slope
(TIC)
Balances =Schedule
SalesTotal
Rate
TotalOrdering
Carrying
10 = 500 Shirts
Costs
Costs(TOC)
per
(TCC)
11 Table 27-1 Week
12 Hanover Company: Receivables Data for 2016 (Thousands of Dollars)
13
Based on Quarterly
14 Sales Data Based on Year-to-Date Sales Data
Receivables
15 Credit Sales at End of
Month (1) for Month (2) Month ADS (4) DSO (5) ADS (6) DSO (7)
16 January $60 $54
17 February $60 $90
18 March $60 $102 $1.98 52 $1.98 52
19 April $60 $102
20 May $90 $129
21 June $120 $174 $2.97 59 $2.47 70
22 July $120 $198
23 August $90 $177
24 September $60 $132 $2.97 44 $2.64 50
25 October $60 $108
26 November $60 $102
27 December $60 $102 $1.98 52 $2.47 41
28
29
30 Table 27-2
31 Hanover Company: Quarterly Aging Schedules for 2016 (Thousands of Dollars)
32
33 Age of Accounts Value and Percentage of Total Accounts Receivable at the End of Each Quarter
34 (Days) 31-Mar 30-Jun 30-Sep 31-Dec
35 0-30 $54 53% $108 62% $54 41% $54 53%
36 31-60 $36 35% $54 31% $54 41% $36 35%
37 61-90 $12 12% $12 7% $24 18% $12 12%
38 $102 100% $174 100% $132 100% $102 100%
39
40
41 Table 27-3
42 Hanover Company: Quarterly Uncollected Balances Schedules for 2016 (Thousands of Dollars)
43
44 Remaining
45 Receivables
Remaining as Percent of
46 Receivables Month's
47 at End of Sales at End
48 Quarter Monthly Sales Quarter of Quarter
49
50 Quarter 1:
51 January $60 $12 20%
52 February $60 $36 60%
53 March $60 $54 90%
54 $102 170%
55 Quarter 2:
56 April $60 $12 20%
57 May $90 $54 60%
58 June $120 $108 90%
59 $174 170%
60 Quarter 3:
61 July $120 $24 20%
62 August $90 $54 60%
63 September $60 $54 90%
64 $132 170%
65 Quarter 4:
66 October $60 $12 20%
67 November $60 $36 60%
68 December $60 $54 90%
69 $102 170%
70
71
72 27-7 Analyzing Proposed Changes in Credit Policy
73
74
75
Monroe Manufacturing Company's current credit terms are 1/10, net 30. Monroe is considering changing its
76 terms to 2/10, net 40, relaxing its credit standards, and putting less pressure on slow-paying customers. It
77 has annual sales of $400 million. Under its current policy, 50% of customers who pay do so on Day 10 and
78 take the discount, 40% pay on Day 30, and 10% pay late on Day 40.
79
Current New
80 Policy Policy
81 Annual sales (in millions) = $400 $530
82 Discount = 1% 2%
83 % customers who take discount = 50% 60%
84 % customers who pay on day 10 = 50% 60%
85 % customers who pay on day 30 = 40% 0%
86 % customers who pay on day 40 = 10% 20%
87 % customers who pay on day 50 = 0% 20%
88 Variable cost ratio = 70% 70%
89 Cost of funds = 20% 20%
90 Bad debt percent = 2.5% 6.0%
91 Credit analysis and collections expenses = $5 $2
92
93 Current DSO = 21 24
94 Current discounts (in millions) = $2 $6
95 Cost of carrying (in millions) = (DSO)(Sales per day)(VC ratio)(Cost of funds)
96 Cost of carrying (in millions) = $3.2 $4.9
 A B C D E F G H I
97 Bad debt losses = $10.0 $31.8
98
99
100 Table 27-4
101
Monroe Manufacturing Company: Analysis of Changing Credit Policy (Millions of Dollars)
102
103
104 Projected
105 2017 Net
106 Income
Under Effect of
107 Current Credit Projected 2017 Net
108 Credit Policy Policy Income Under New
109 (1) Change (2) Credit Policy (3)
110 Gross sales $400 $130 $530
111 Less discounts $2 $4 $6
112 Net sales $398 $126 $524
113 Production costs, including OH $280 $91 $371
114 Profit before credit costs and taxes $118 $35 $153
115 Credit related costs: $0
116 Cost of carrying receivables $3 $2 $5
117 Credit analysis and collection expenses $5 ($3) $2
118 Bad debt losses $10 $22 $32
119 Profit before taxes $100 $14 $114
120 State-plus-federal taxes (50%) $50 $7 $57
121 Net Income $50 $7 $57
122
123
124 27-8 Analyzing Proposed Changes in Credit Policy: Incremental Analysis
125
126 Sometimes it is preferrable to do an incremental analysis based on a particular division or product.
127
128 S0 = Current gross sales.
129 SN = New gross sales, after the change in credit policy. Note that S N can be greater or less than S 0.
130 SN - S0 = Incremental, or change in, gross sales.
131 V= Variable costs as a percentage of gross sales.
132 1-V = Contribution margin, sometimes called gross margin.
133 r= Cost of financing investments in receivables.
134 DSO0 = Days sales outstanding before change in policy.
135 DSON = New days sales outstanding after the change in policy.
136 B0 = Average bad debt loss under current policy as a percent of current gross sales.
137 BN = Average bad debt loss under new policy as a percent of new gross sales.
138 P0 = % of current gross sales that are at the discount.
139 PN = % of new gross sales that are at the discount.
140 D0 = Current discount percent.
141 DN = New discount percent.
142
143
ΔI is the incremental change in the level of the firm's investment in receivables. The formula for ΔI is
144 different for changes in policies that increase sales and those that decrease sales.
145
146
147 If sales increase:

[Increased investment in [Increased investment in

148 ΔI = receivables associated with + receivables associated with
the original sales] incremental sales]

[Change in [Old sales per [(DSON)(Incremental

149 ΔI = days sales
day]
+ V
sales per day)]
outstanding]

150 ΔI = [DSON - DSO0] [S0 / 365] + V [(DSON) (SN - S0)/365]

151
152
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153 If sales decrease:
[Decreased investment in
[Decreased investment in
receivables associated with
154 ΔI = remaining original + receivables associated with
customers who left]
customers]

[Change in [(DSO0)(Incremental
Remaining
155 ΔI = days sales + V
outstanding] sales per day] sales per day)]

156 ΔI = [DSON - DSO0] [SN / 365] + V [(DSO0) (SN - S0)/365]

157
158
159 ΔP is the incremental change in pre-tax profitability.

[Change in
[Change in [Change in
[Change in cost of
160 ΔP = gross profit] - carrying bad debt cost of
receivables] - losses] - discounts]

[(SN -S0)(1- [DNSNPN -

161 ΔP =
V)]-
[r(DI)] - [BNSN -B0S0] -
D0S0P0]
162
163 Example: Lengthening the Credit Period
164
165 S0 = $100,000
166 SN = $150,000
167 SN - S0 = $50,000
168 V= 60%
169 1-V = 40%
170 r= 10%
171 DSO0 = 0
172 DSON = 30
173 B0 = 0%
174 BN = 2%
175 P0 = 0%
176 PN = 0%
177 D0 = 0%
178 DN = 0%
179
180 ΔI = [DSON - DSO0] [S0 / 365] + V [(DSON) (SN - S0)/365]

181 ΔI = 30 $273.97 + 60% $4,109.59

182 ΔI = $8,219.00 + $2,466.00
183 ΔI = $10,685
184
185 ΔP = $20,000 -$1,069 -$3,000 $0
186 ΔP = $15,931
187
188
189 Example: Shortening the Credit Period
190
191 S0 = $150,000
192 SN = $130,000
193 SN - S0 = ($20,000)
194 V= 60%
195 1-V = 40%
196 r= 10%
197 DSO0 = 30
198 DSON = 20
199 B0 = 2%
200 BN = 2%
201 P0 = 0%
202 PN = 0%
203 D0 = 0%
204 DN = 0%
205

206 ΔI = [DSON - DSO0] [SN / 365] + V [(DSO0) (SN - S0)/365]

207 ΔI = -10 $356.16 + 60% -$1,644

208 ΔI = -$3,562 + -$986
209 ΔI = -$4,548
210
211 ΔP = -$8,000 $455 $400 $0
212 ΔP = -$7,145