Corporate Finance

Receivables Management 
 331

C/S ratio = 0.2

Cost of capital = 16 percent

New credit policy = 2/10, Net 30

Anticipated increase in sales = 10 percent

= Rs 10 crore

40 percent of customers are availing cash discount now.

60 percent of customers are expected to avail cash discount.

Assume that the average collection period remains the same at 20 days.

Profit on new sales = ∆ Sales × C/S

= 10 crore × 0.2

= Rs 2 crore (3)

Current discount = 100 × 0.4 × 0.01

= Rs 0.4 crore (4)

New discount = 110 × 0.6 × 0.02

= Rs 1.32 crore. (5)

Additional cash discount = (3) – (2)

= 1.32 – 0.4 = Rs 0.92 crore (6)

Cost of capital tied up in new receivables:

= .06.0^16

360 days

20 days

Rs. 10 crore× ××

= Rs 0.053 crore (7)

Incremental cost = (4) + (5)

= Rs 0.92 crore + Rs 0.053 crore

= Rs 0.973 crore

Benefit = Rs 2 crore

Since the benefit exceeds cost, the new policy should be adopted. The increase in profit/sale and reduction
in collection period should be significant to justify a change in policy.
The benefit of offering a discount, from the seller’s perspective, is receiving the funds earlier; while the
cost is the discount given to the buyer to encourage early payment. A company offering cash discount would
want to know the likely outflow due to cash discount.

Outflow due to cash discount (in rupees) = [Percentage of customers opting for cash discount]

× [Credit sales] × [Percentage discount]

One could look at past data to assess the percentage of customers opting for cash discount. Suppose, if
historically, 40 percent customers have opted for cash discount on a sale worth Rs 1 crore, a 2 percent
discount would lead to an outflow of:

= 0.4 × Rs 1 crore × 0.02

= Rs 80,000