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(^228) Financial Management
will be that more customers will take the discount. However, they feel that with the
present plans there will be no change in the rupee volume of sales on which the discount
is taken. That is, all incremental sales will be paid for after the 10-day discount period.
In addition, management feels that 1 per cent of all incremental sales under plan A and
2 per cent under plan B will prove to be uncollectible. No additional credit costs will be
involved in clerical or administrative functions. Which credit period policy appears to be
the most desirable?
The variables to be considered in deciding between the present credit terms and plans
A and B are profits on increased sales, increases in accounts receivables, increases in
the cost of financing the additional receivables, and increased in bad-debt losses. The
effects of the three credit terms on these variables are summarized in Table 1. The
analytical approach is incremental. that is, given the existing credit terms we focus on
the incremental profits and costs of plans A and B. Under plan A sales increase by 5
per cent or 0.05 per cent ◊ Rs 36 crore = Rs 1.8 crore. Sales would increase by Rs 2.52
crore under plan B. Marginal profits before taxes and credit-related expenses are 0.2%.
◊ Rs 1.8 crore = Rs 3,60,000 for plan A and Rs 504,000 for plan B.
Increases in accounts receivable cannot be calculated by just looking at incremental
sales. The reason is that when the credit period is extended, the existing buyers who
are not taking the discount and are paying after 30 days will also take advantage of the
extended credit period and not pay for 45 days. Incremental investment in receivables
is estimated by calculating total receivables first. For present credit terms, 50 per cent
of sales are paid for in 10 days, the other 50 per cent in 30 days. The average sale is
outstanding for 0.5(10) + 0.5(30) = 20 days. Daily sales are Rs 36 crore / 360 days = Rs
100,000. Total accounts receivable equal 20 days ◊ Rs 100,000 = Rs 2 crore.^1
Table 1: Analysis of credit terms changing credit periods for Mitsui Corporation
Present Plan A Plan B
(d) Increase in sales (%) 0 % 5 % 7 %
(e) Increase in sales (Rs=1×Rs 36 crore) Rs 0 Rs 1,800,000 Rs 2,520,000
(f) Margin on sales (%) 20% 20% 20%
(g) Marginal profits (Rs = 2 × 3)a Rs 0 Rs 360,000 Rs 504,000
(h) Average sales outstanding 20 days 28.34 days 36.65 days
(i) Daily sales Rs 100,000 Rs 105,000 Rs 107,000
(j) Total receivables (5 × 6) Rs 2,000,000 Rs 2,975,000 Rs 3,921,600
(k) Increase in receivables 0 975,700 1,921,600
(l) Increase in investment costs (8×12 %) 0 117,084 230,592
(m) Increase in bad debt losses (2 × x%) 0 18,000 50,400
(n) Increase in costs (9+10) 0 135,084 280,992
(o) Increase in profits (4 – 11) 0 224,916 223,008