Example of Relaxing Credit Standards Basket Wonders is not operating at full capacity and wants to determine if a relaxation of their credit standards will enhance profitability The firm is currently producing a single product with variable costs of $20 and selling price of $25 Relaxing credit standards is not expected to affect current customer payment habits 10-6
10-6 Example of Relaxing Credit Standards Basket Wonders is not operating at full capacity and wants to determine if a relaxation of their credit standards will enhance profitability. The firm is currently producing a single product with variable costs of $20 and selling price of $25. Relaxing credit standards is not expected to affect current customer payment habits
Example of Relaxing Credit Standards Additional annual credit sales of $120,000 and an average collection period for new accounts of 3 months is expected. The before-tax opportunity cost for each dollar of funds died-up in additional receivables is 20% Ignoring any additional bad-debt losses that may arise, should Basket Wonders relax their credit standards? 10-7
10-7 Example of Relaxing Credit Standards Additional annual credit sales of $120,000 and an average collection period for new accounts of 3 months is expected. The before-tax opportunity cost for each dollar of funds died-up in additional receivables is 20%. Ignoring any additional bad-debt losses that may arise, should Basket Wonders relax their credit standards?
Example of Relaxing Credit Standards Profitability of ( 5 contribution)x(4, 800 units) additional sales 24000 Additional ($120,000 sales)/(4 Turns)= receivables $30,000 Investment in ($20/$25)X($30,000)= add receivables $24,000 Req. pre-tax return (20%opp.cost)x$24,000= on add investment 4.800 Yes! Profits> Required pre-tax return 10-8
10-8 Example of Relaxing Credit Standards Profitability of ($5 contribution) x (4,800 units) = additional sales $24,000 Additional ($120,000 sales) / (4 Turns) = receivables $30,000 Investment in ($20/$25) x ($30,000) = add. receivables $24,000 Req. pre-tax return (20% opp. cost) x $24,000 = on add. investment $4,800 Yes! Profits > Required pre-tax return
Credit and Collection Policies of the firm Quality of Trade Account Leng credit period (1)Average Collection Period (2)Bad-debt Losses Firm Possible cash Collection Discount Program 10-9
10-9 Credit and Collection Policies of the Firm (1) Average Collection Period (2) Bad-debt Losses Quality of Trade Account Length of Credit Period Possible Cash Discount Firm Collection Program
Credit Terms Credit Terms --Specify the length of time over which credit is extended to a customer and the discount, if any, given for early payment. For example, 7/10, net 30 Credit Period - The total length of time over which credit is extended to a customer to pay a bill. For example, net 30?requires full payment to the firm within 30 days from the invoice date 10-10
10-10 Credit Terms Credit Period -- The total length of time over which credit is extended to a customer to pay a bill. For example, net 30?requires full payment to the firm within 30 days from the invoice date. Credit Terms -- Specify the length of time over which credit is extended to a customer and the discount, if any, given for early payment. For example, ?/10, net 30