Management of Accounts Receivable Sample Problems

Illustration 1: A company has prepared the following projections for a year Sales Selling Price per unit Variable Costs per unit Total Costs per unit Credit period allowed

21000 units Rs.40 Rs.25 Rs.35 One month

The company proposes to increase the credit period allowed to its customers from one month to two months .It is envisaged that the change in policy as above will increase the sales by 8%. The company desires a return of 25% on its investment. You are required to examine and advise whether the proposed credit policy should be implemented or not? Solution: Particulars Sales (units) Contribution per unit Total Contribution Variable cost @ Rs.25 Fixed Cost

Present 21000 Rs.15 Rs.3,15,000 5,25,000 2,10,000

Proposed 22680 Rs.15 Rs.3,40,000 5,67,000 2,10,000

Total Cost

7,35,000

7,77,000

Credit period

1 month

2 month

Average debtors at cost

Rs.61250

Rs.1,29,500

Incremental Return = Increased Contribution/Extra Funds Blockage *100 = Rs.25,200/Rs.68,250*100 =36.92%

Incremental 1680 Rs.15 Rs.25,200 42,000 -----42,000 -----

Rs.68,250

Illustration 2: ABC & Company is making sales of Rs.16,00,000 and it extends a credit of 90 days to its customers. However, in order to overcome the financial difficulties, it is considering to change the credit policy. The proposed terms of credit and expected sales are given hereunder: Policy I II III IV V Rs.13,00,000

Terms 75 days 60 days 45 days 30 days

15

Sales Rs.15,00,000 Rs. 14,50,000 Rs 14,25,000 Rs 13,50,000

days

The firm has variable cost of 80% and fixed cost of Rs.1,00,000. The cost of capital is 15%. Evaluate different policies and which policy should be adopted? Solution: figures in Rs. Particular s Sales Variable cost Fixed Cost Profit (A) Total Cost Average Receivable (Cost¸360x credit period Cost of debtors @ 15% (B) Net profit (A – B)

Present

I

II

III

IV

V

1,600,000 1,280,000 100,000 220,000

1,500,000 1,200,000 100,000 200,000

1,450,000 1,160,000 100,000 190,000

1,425,000 1,140,000 100,000 185,000

1,350,000 1,080,000 100,000 170,000

1,300,000 1,040,000 100,000 160,000

1,380,000

1,300,000

1,260,000

1,240,000

1,180,000

1,140,000

345,000

270,833

210,000

155,000

98,333

47,500

51,750

40,625

31,500

23,250

14,750

7,125

168,250

159,350

158,500

161,750

155,250

152,875

Illustration3: A trader whose current sales are Rs.1,500,000 per annum and average collection period is 30 days wants to pursue a more liberal credit policy to improve sales. A study made by consultant firm reveals the following information. Credit Policy

increase in collection period

A B C D E

Increase in sales

Rs.60,000 90,000 150,000 180,000 200,000

15 days 30 days 45 days 60 days 90 days

The selling price per unit is Rs.5. Average Cost per unit is Rs.4 and variable cost per unit I Rs.2.75 paise per unit. The required rate of return on additional investments is 20 percent (cost of capital). Assume 360 days a year and also assume that there are no bad debts. Which of the above policies would you recommend for adoption. Solution: Particulars Credit period

Present

A

B

C

D

E

30 days

45 days

60 days

75 days

90 days

120 days

300,000

312,000

318,000

330,000

336,000

340,000

Sales Variable cost@ 2.75

1,500,000 8,25,000

1,560,000 8,58,000

1,590,000 874,500

1,650,000 907,500

1,680,000 924,000

1,700,000 935,000

Fixed Cost Total Cost

375,000 1,200,000

375,000 1,233,000

375,000 1,249,500

375,000 1,282,500

375,000 1,299,000

375,000 1,310,000

Profit (A)

300,000

327,000

340,500

367,500

381,000

390,000

Average debtors cost(at cost)

100,000

154,125

208,250

267,188

324,750

436,667

Cost of investment@ 20% (B)

20,000

30,825

41,650

53,437

64,950

87,333

Net Profit (AB)

280,000

296,175

298,850

314,063

316,050

302,667

No. of units @ Rs.5

[(TC )(x/360)]

Lets Sum Up  The receivables emerge when goods are sold on credit and the payments are deferred by the customers. So, every firm should have a well-defined credit policy.  The receivables management refers to managing the receivables in the light of costs and benefit associated with a particular credit policy.  Receivables management involves the careful consideration of the following aspects: Forming of credit policy, Executing the credit policy, Formulating and executing collection policy.  The credit policy deals with the setting of credit standards and credit terms relating to discount and credit period.  The credit evaluation includes the steps required for collection and analysis of information regarding the credit worthiness of the customer.