(^232) Financial Management
simultaneously. For example, the Mitsui Corporation may seek to evaluate new credit
terms in which the credit period, credit discount, and discount period all change
simultaneously. As we have seen previously, extending the credit period influences
sales most strongly, whereas changing the other two credit terms has a strong impact
on the level of receivables outstanding. A firm considering changing all credit terms
needs to carefully examine the potential impact of the changes on incremental profits.
Assume that Mitsui is considering changing from terms of 2/10, net 30 either to 2/15,
net 45 in plan G or 2.5/15, net 60 in plan H. Under plan G sales are expected to
increases by 5 per cent, whereas with plan H sales would have a potential of increasing
by 10 per cent. Marginal returns before credit-adjusted costs and taxes would be 20
per cent of sales.
Under the present credit terms, the average collection period is 20 days (as shown in
Table 1). Under plan G, 45 per cent of sales would involve the discount. Those who
take the discount would pay at the end of the discount would, on the average, pay by
the end of the credit period. Bad-debt losses would increase by 1 per cent of incremental
sales for plan G and 2 per cent of incremental sales for plan H. Collection costs would
increase by Rs 10,000 and Rs 30,000 under plans G and H, respectively which credit
term plan appears to be best for Mitsui.
Under plan G sales and marginal profits would increase by Rs 1.8 crore and Rs 360,000,
respectively. For plan H sales would increase by Rs 3.6 crore and profits by Rs 720,000.
These marginal profits are before credit adjusted costs and need to be adjusted for
changes in the investment levels in receivables and in discount taken.
Given credit terms of 2/15, net 45, average collection period for plan G is 0.45 (15 days)
- 0.55 (45 days) = 31.5 days. Since daily sales are Rs 37.8 crore/360 days = Rs
105,000. Total receivables for plan G would be 31.5 days ◊ Rs 105,000 = Rs 3,307,500.
Similarly, total receivables for plan H would be [0.40 (15 days) + 0.6 (60 days)] = 42
days ◊ 39.6 crore/360 = Rs 4,620,000 (see Table 4).
For plan G bad debt losses would be Rs 1.8 crore ◊ 0.01 = Rs 15,000 and Rs 72,000 for
plan H. Cost of giving discounts and increased collection costs are shown in Table 4.
Given the total credit related cost increases of Rs 165,100 for plan G, its profitability
before taxes is Rs 360,000 ñ Rs 165,000 = Rs 194,900. Similarly, plan H would increase
pretax profits by Rs 267,600. Of these two plans, H is the better one. Plan H is also the
best plan among all eight plans discussed in this section.
From total receivables we can calculate incremental receivables and the cost of increased
investments in receivables, as shown in Table 4.