Untitled-29

(^244) Financial Management
Rs. No credit One month’s Credit Two month’s Credit
Sales 120,000 160,000 240,000
Debtors 13,333 40,000
Stocks (less creditors (Say, 1/12 of sales value) 10,000 13,333 20,000
Total 10,000 26,666 60,000
Increase in working capital through granting credit 16,666 50,000
Marginal contribution 30,000 40,000 60,000
Less: Cost of:
Credit control (6,000) (6,000)
Bad debts (1,600) (4,800)
Relevant comparable profits 30,000 32,400 49,000
Increase in profits 2,400 19,200
But the company requires a return of 15% on the
increase in capital employed; i.e.
2,500 7,500
The net advantage (or disadvantage) of the proposed
changes in credit policy is therefore
(Rs.100) Rs.11,700
The financial decisions relating to stockholding have certain special features, but looking
first at saleable stocks (finished goods) we can postulate that the object of holding
stocks is to increase sales, and that the object of increasing sales is to increase profit.
We can then create a simple model similar to that for debtors.
Example
The Retail Company Ltd makes cash sales from stock and obtains an average rate of
marginal contribution of 25% on sales value. When it holds stocks equivalent to one
monthís cost of sales it achieves sales of Rs.10,000 per annum.
It is estimated that by doubling the stock available an increase of 25% in sales value
could be achieved; alternatively, if three monthsí stocks were held then sales could be
increased by 35% from the present level. The effect on profits of these two alternatives,
including any relevant changes in costs, is illustrated on the following page.
This somewhat exaggerated example draws attention to three points which are relevant
to any further discussion of the financial implications of stockholding policy:
There are some points that you need to note here:
l There may be a point beyond which further increase in stock will not give rise to
sufficient additional sales and gross profit to justify the additional costs involved.
Chapter-10
Inventory Management