Chapter 15 Working Capital Management 493(^15) Another technique used to monitor receivables is the Aging Schedule, which shows the dollar amount and
percentage of receivables that have been outstanding for di# erent lengths of time. See Brigham and Daves,
Intermediate Financial Management, 9th edition (Mason, OH: Thomson-SouthWestern, 2007), Chapter 21, pp. 737–738.
Note, though, that if Allied collected its receivables faster and reduced its DSO to
the 36-day industry average, its receivables would decline to $295.89 million, or by
$79.11 million. The DSO can also be compared to the! rm’s own credit terms.
Allied sells on terms of net 30, so its DSO should be no greater than 30 days.
Obviously, some customers are paying late, so there is room for improvement in its
collections policy and practices.^15
SEL
F^ TEST What are credit terms?
What are the four credit policy variables?
De" ne days sales outstanding (DSO). What can be learned from it, and how is
it a! ected by seasonal sales # uctuations?
What is credit quality, and how is it assessed?
How does collection policy in# uence sales, the collection period, and the bad
debt loss percentage?
How can cash discounts be used to in# uence sales volume and the DSO?
How do legal considerations a! ect a " rm’s credit policy?
15-9 ACCOUNTS PAYABLE !TRADE CREDIT"
Firms generally make purchases from other! rms on credit and record the debt as
an account payable. Accounts payable, or trade credit, is the largest single category
of short-term debt, representing about 40% of the average corporation’s current
liabilities. This credit is a spontaneous source of! nancing in the sense that it arises
spontaneously from ordinary business transactions. For example, if a! rm makes a
purchase of $1,000 on terms of net 30, it must pay for goods 30 days after the
invoice date. This instantly and spontaneously provides $1,000 of credit for 30 days.
If the! rm purchases $1,000 of goods each day, on average, it will be receiving 30
times $1,000, or $30,000, of credit from its suppliers. If sales, and consequently
purchases, double, its accounts payable also will double, to $60,000. So simply by
growing, the! rm spontaneously generates another $30,000 of! nancing. Similarly,
if the terms under which it buys are extended from 30 to 40 days, its accounts pay-
able will expand from $30,000 to $40,000. Thus, expanding sales and lengthening
the credit period generate additional! nancing.
Trade credit may be free, or it may be costly. If the seller does not offer dis-
counts, the credit is free in the sense that there is no cost for using it. However, if
discounts are available, a complication arises. To illustrate, suppose PCC Inc. buys
20 microchips each day with a list price of $100 per chip on terms of 2/10, net 30.
Under these terms, the “true” price of the chips is 0.98($100) " $98 because the
chips can be purchased for only $98 by paying within 10 days. Thus, the $100 list
price has two components:
List price! $98 “true” price # $2! nance charge
Trade Credit
Debt arising from credit
sales and recorded as an
account receivable by the
seller and as an account
payable by the buyer.
Trade Credit
Debt arising from credit
sales and recorded as an
account receivable by the
seller and as an account
payable by the buyer.