Receivables Management 333Another company may be relatively generous in extending credit to the marginal customers. Extending
credit to the less creditworthy increases sales volume, but the probability of bad debt loss also increases. The
increase in profit on new sales should outweigh the cumulative bad debt losses to justify the relaxation of
credit standards.
To illustrate, a company that currently restricts it to the first two categories (described earlier) could relax
the standards by selling to customers under the next two categories.
The consequence of relaxing standards, are:
- The incremental profit on incremental sales,
- New investment in additional receivables, and
- Increase in bad debt losses.
Consider the following data:
Current sales = Rs 100 crore
Anticipated increase in sales = 10 percent
C/S = 0.2
Cost of capital = 16 percent
Anticipated bad debt loss = 10 percent of new sales
Average collection period = 30 days
(a) Incremental profit on new sales:
= New sales × C/S
= 10 crore × 0.2 = Rs 2 crore
(b) Cost of financing increment receivables:
= Cost of capital × Investment in receivables
= Cost of capital × (Receivables × V/S)
= Cost of capital × ∆ Sales × ACP/360 × V/S
= 0.16 × 10 crore × 30/360 × 0.8
= Rs 10.6 lac
(c) Additional bad debt loss:
= 0.1 × Rs 10 crore
= Rs 1 crore
Incremental cost = Rs 110.6 lac
Incremental benefit = Rs 200 lac
Therefore, the new policy should be accepted.
An Illustration
A company currently has a 2/10 Net 35 policy. The marketing executives of the company propose to change
the credit policy. Details of current policy are given below.
Current sales = Rs 10 lac
Current credit terms = 2/10 Net 35
Current bad debt loss = 1 percent of gross sales
60 percent of customers who pay take the discount