Management of Receivables^229
Under plan A total sales are Rs 36 crore + 1.8 crore = Rs 37.8 crore. The rupee
amount subject to payment by the tenth day remains at Rs 18 crore or Rs 18 crore / Rs
37.8 crore = 47.6 per cent. The other 52.4 per cent now take 45 days to pay. The
average sale will be outstanding for 0.476 (10 days) + 0.524 (45 days) = 28.34 days.
Daily sales are Rs 37.8 crore/360 days = Rs 105,000. Total receivables are Rs 105,000
◊ 28.34 days = Rs 2,975,700.
Under plan B total sales Rs 38.52 crore. The percentage of discount takers is Rs 18
crore Rs 38.52 crore= 46.7 per cent. The average sales is outstanding for 0.467 (10
days) + 0.533 (60 days) = 36.65 days. Daily sales are Rs 38.52 crore / 360 days = Rs
107,000 and receivables are Rs 107,000 ◊ 36.65 days = Rs 3,921,600.
Incremental receivables for plan A are Rs 2,975,700 - Rs 2,000,000 = Rs 975,700 and
are Rs 1,921,600 for plan B. The before-tax cost of financing these receivables is 12
per cent. Therefore, the increase in investment costs for plan A is Rs 975,700 ◊ 0.12 =
Rs 117,084 and is Rs 1,921,600 ◊ 0.12 = Rs 230,000 for plan A and 0.02 ◊ Rs 2.52 crore
= Rs 50,400 for plan B.
The total incremental credit associated costs for plan A are Rs 117,084 + Rs 18,000 =
Rs 135,084 and are Rs 280,992 for plan B. The incremental profits after adjusting for
credit costs are Rs 224,916 for plan A and Rs 223,008 for plan B. Both plans are
superior to the present plan. However, plan A is slightly preferable to plan B.
Credit Discount: The credit discount is offered as an inducement for the credit buyer to
pay promptly. The credit buyer's opportunity cost of not taking the discount is given by:
credit period discount period360 days ¥ credit discountFor terms of 2/10, net 30 the opportunity cost of not taking the discount is 360 days ◊
2 per cent / (30 10) = 36 per cent. Obviously, this opportunity cost has to be high enough
to motivate a financially strong credit buyer to take the discount. For example, terms of
1/10, net 70 imply an opportunity cost of 6 per cent. At this cost firms will prefer to use
trade credit rather than borrow from banks and the credit discount is no longer a viable
credit policy instrument.
Although changing the credit discount has some influence on demand, its most visible
impact is on reducing the average collection period and the level of accounts receivable.
Assume that Mitsui is considering changing its credit terms from 2/10, net 30 to 2.5/10,
net 30 in plan C or 3/10, net 30 in plan D. Either of the new plans would not affect the
sales volume. However, under plan C, 70 per cent of the credit buyers would take the
credit discount and, under plan D, 90 per cent would take the discount.
Should Mitsui switch to either plan C or D if the previously given information on
investments cost is applicable here?