Working Capital and Cash Management
October 1, 2022 | Author: Anonymous | Category: N/A
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Working Capital and Cash Management FM 13- STRATEGIC FINANCIAL MANAGEMENT
Working capital
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the diference between the rms current asset and current liabilies.
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It is used as a measure to check the liquidity o the rm.
Example: FLT FLT and associates has the ollowing assets and liabilies : FLT and Associates Balance Sheet December 31,2011
Assets
Current asset
Cash
liabilies and Stockholder Equity Current Liabilies P20,000
Account payable
P24,000
Accounts receivable
60,000
Interest payable
6,000
In Inv ven enttor ory y
84 84,0 ,000 00 P1 P164 64,0 ,000 00
Sa Sala lari ries es Payab able le
10 10,0 ,000 00
Non- Current Asset
Equipment Investmentt in Bonds Investmen
Long- Term Liabilies
P180,000 72,000
Mortgage Payable 252,000
Stockholders equity Total Asset
P40 40,0 ,000 00
P416,000
276,000
total liabilies and Stockholder Equity P416,000
100,000
The working capital is computed as: Current asset
Cash Ca
P20,000
Accounts receivable In Inve ven nto tory ry Current liabilies
60,000 84,0 84,000 00
Accounts payable Notes payable –short term Accrued expenses payable Working Capital
P1 P164 64,0 ,000 00
P24,000 6,000 10,000 40,000 P124,000
Working Capital Management •
Concerned with the ecient and efecve efecve ulizaon o working capital to aain the predetermined objecves o the company relave relave to protabilityoorisk operaon, liquidity o nancial resources, and minimizaon and company cost.
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Regulates various types o current assets and current liabilies. The goal o management is to maintain a cash level at a minimum without pung the company at risk. The top management determines how much investment should be made in current assets.
Working Capital Policies •
Matching policy- the policy works in arrangement where the current assets o the business are used to perectly match the current liabilies. Total asset uctuang current asset Short term Liabilies
permanent C/A
long-term liabilies o equity nancing
Fixed current assets
me
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Aggressive policy- has a high risk and, oen, high return to company company.. The purpose o adapng an aggressive policy is to take take the opportunity o having a lower interest charge or short-term short-term liabilies instead o long-term liabilies.
total asset
uctuang current assets
permanent current assets xed current assets
me
short-te short-term rm liabilies
long-term liabilies
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Conservave policy- has the lowest risk and lower return. total asset
short-term liabilies
uctuang current asset
permanent current asset
xed current asset
me
long-term liabilies
How is Working Capital Managed? •
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Looking at the fnancial raos. Financial raos play a crucial role in managing working capital. Pung up proper internal control. Internal control has a important part in securing the working capital rm. Changing company policies. Policies serve as a guideline in execung the transacons and acvies a cvies o the company. company. Preparing the budget. Doing the budget or the enre year is a good tool to help the company manage its working capital.
Cash Management •
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Cash is a current asset used to purchase raw materials, pay or labor, buy capital asset, and pay or dividends, taxes and obligaon. Cash management holds on to marketable marketable securies to avoid cash shortage. Cash management is also concerned with the acceleraon o cash receipts and suspension o cash disbursement.
Reason to Maintaining Cash •
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Transacon move. This reers reers to the intenon to meet the minimum business operaon requirement. Speculave move. This leads to the use o cash balances to take advantage advantag e o bargain purchases purchases on material or unusual cash discount. Precauonary move. This results in holding cash or unoreseen uctuaon in cash inows and oulows. Maintaining credit lines with banks is usually done by rms to meet their precauonary needs. The need or maintaining cash is reduced.
Cash equivalents •
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Cash equivalents are short-term, highly liquid investments that are readily converble to cash. These are investment which are so near their maturity dates, making risk inherent to the investment insignicant.
Example: A 90 day treasury bill A 180 day treasury bill purchased within 90 days beore its maturity A 90 day me deposit A 90 day commercial paper Long-term commercial paper purchased within 90 days beore its maturity Other money market instruments whose maturity is within three months
Advantages of Holding Cash or Cash Equivalents •
Taking advantage o the trade discount
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Maintenance o good credit rang
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Favorable business opportunies Favorable Meeng emergencies
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Capacity to compete
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Factors affecting Cash Requirements •
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frms policy on cash management. This reers reers to the amount o cash rm needs to cover a certain number o days o the business
operaons. Availability Av ailability o loans. A rm with good credit standing may hold a cash balance at low levels without pung the rm risk. Forecasted cash inows and oulows. The diference are determined by analyzing the collecng and disbursements records o the rm. Unpredictable events. Esmang unpredictable events may save a lot o me and money or the rm.
Possible Placement for Excess Cash •
Savings or current accounts
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Time deposits
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Stocks
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Commercial papers
Controlling cash flows Controlling cash ows is the main objecves o cash management. Maximizing the use o cash means minimizing cash oulows and minimizing cash inows. Tools or controlling cash ows •
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Synchronizing cash ows Cash oats •
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Payments Collecons
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Extending cash payments
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Availing o cash discount
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Opmum transacon size
Synchronizing Cash Flows This is the process in which the cash inows coincide with the oulows. A synchronized synchronized cash ows is highly dependent on an accura a ccurate te orecast o inows anditoulows. A more orecast orecas t help the rmwhen minimize balance since can immediately determine the me cash its willcash actually be needed.
Floats on disbursements •
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Floats can exit when the rm issues its own check and sends it to the payee company. The number o days rom the issuance o the check to its clearance is known as oat days.
A oat can be classied into three categories: 1.
Mail oat. It is the me the check is issued up to the me the check is received by the payee.
2.
Processing o oat. It is rom the me the check is received by the payee unl the me it is deposited in the payees bank account.
3.
Clearing o oat. It is rom the date the check is deposited up to the date the check is cleared and made available or use.
Accelerating collection collection of funds by reducing collection floats
1. Coll Collec ecn ng g cen cente terr or or age agent ntss
Float can be reduced by strategically strategically locang a collecon center near the customer. customer. The collecon center can be a rm providing a collecon service, or a bank where payment are made directly to the rms account. A rm may also consider the possibility po ssibility o having its own collecng agents or collecng centers, i it is economically possible to reduce the collecon period in certain area.
Example : Cunanan Corporaon has an agreement with Rizal Commercial Banking Corporaon (RCBC) to collect P3,000,000 a day in exchange or a compensang balance o P1,000,000. The rm, with a signicant increase in its customer customer in the area, is thinking o canceling the agreement and dividing the service by RCBC with ABC bank. With RCBC will handle collecon o P2,000,000 with aprovided compensang balance o P800,000. Onthis theplan, other hand, ABC bankthe handle the other P1,000,000 collecon in exchange or compensang balance o P700,000. With the planned arrangement with the two banks perorm the collecon, the rm is expecng to reduce the collecon period by one day. The rms rate o return is 9percent. Should Cunanan Corporaon pursue the division o service between RCBC and ABC bank? Analysis on the problem as ollows: Amoun Amo untt o cash cash collec collecon on per da day y P3,000 P3,000,00 ,000 0 Cunana Cunanan n Corpor Corpora aon on should should pursue pursue the plan plan Numb Nu mber er o da days ys r ree eed d in th the e coll collec eco on n x 1 o divi dividi ding ng the the servi service ce be betw tween een RCBC RCBC and and Amount o cash reed P3,000,000 ABC bank. Despite the increase in Less: Les s: incre increase ase in compe compensa nsang ng balanc balance e 500,00 500,000 0 compen compensa sang ng balanc balance e rom rom P1, P1,000 000,00 ,000 0 to Increase in cash ow P2,500,000 P1,500,000, the rm will be able to increase Rate o return x 0.09 in cash in inow by P2,500,000 resulng to an Incremental income P 225,000 incremental income o P225,000 per year.
2. Lockbox system •
a lockbox system is a service whereby checks are mailed to a local PO box address.
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The checks are picked up daily ( or even mulple mes per day) by
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the servicing rm. The checks are deposited into the local branch bank.
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The balances are electronically transerr transerred ed to the rms branch o bank, available or use immediately.
Example :
Cunanan Corporaon has average cash receiptsor o P150,000 per day. Normally, it takes 7days rom the me the check is received it to be made available as cash. How much cash is ed up? Computaon shall be as ollows: Average cash receipts per day Number o days ed up Amount o cash ed up
P150,000 x 7 P1,050,000
Example: Cunanan Corporaon has an average o seven days to receive and deposit the checks rom customers. The owner believes that it takes too long or the rm to use the unds to support its operaons. a bank ofers the its service through the use lockbox to system. The banker explains that with the system is place, expected oat me willo beareduced 4 days. The bank charges P10,000 per month or its overhead cost on the service. Should Cunanan Corporaon avai availl o the service ofered by the bank? How much is the advantage or disadvantage o the lockbox system, considering the rm average daily collecon o P450,000 and the annual rate return o 12 percent in the market? The cost-benet analysis is as ollows: Average cash receipts per day P 450,000 Numb Nu mber er o days days ca cash sh is r ree eed( d( 7 days days -4 days days)) x Amount o cash reed-up P1,350,000 Rate o return x 12%
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Expected return (benet) P 162,000 Less: cost cost o the lockbox lockbox system system (P10,000 (P10,000 x 12) 120,000 120,000 Nett adva Ne advant ntag age e o avai availi ling ng the the lock lockbo boxx sy syst stem em P 42,0 42,000 00 Since the net advantage is worth P42,000, the Cunanan Corporaon should avail o the service ofered by the bank.
3. Concentraon banking. •
It is a system decentralizing collecon
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According to this system, a large number o collecon centers are
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established by the rm in diferent areas. System Syst em whereby customers make payments to a regional collecon center, which then transer unds to a principal bank.
Example: a rms monthly average cash balances computed as ollows: Monthly
average cca ash ba balance
1
P 25,000
2
30,000
3 4
40,000 60,000
Total
P155,000
the monthly average cash balance is: P155,000 = P38,750
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I the annual interest rate is at 15%, the monthly return earned on the average cash balance is: P38,750 x 0.15 x 30/360 = P484.48
Extending Cash Disbursement
Ways to Conduct Disbursement •
Playing the oat. This is the process o taking advantage o the clearing system in order to make make use o unds in the rms bank account. Playing the oat reects that the outstanding checks o the rm not presented to the bank are more than the amount covered by the bank balance. It is the process o wring a check with no bank balance covering the check in the hope that in the due date o the check there will be a balance in the bank.
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Payment by dra. A dra is an uncondional order made in wring
addressed by one person to another, another, signed by the person giving it, requiring the receiver to pay on demand or at a xed or determined uture me a certain sum o money to order or to the bearer. A dra is issued by the debtor or the creditor creditor.. The creditor then presents the dra to the issuers bank or collecon.
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Auto-debit transer. Is one o the services ofered by the bank. Debit transer transer.. The eature o this service are praccally the same
as those o auto- debit transer. •
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o extending payments Stretching o payable. This is the process o to suppliers or creditors.
Centralizaon Centraliz aon o Disbursemen Disbursement. t. Firm are able to monitor their payment and sasy their obligaons to the opmum me. . By
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Use o the stascs todisbursement predict the amount looking historical o the rmo check issued
Example: salary payment o XYZ Company is made every 15th and 30th o the month through issuances o checks. It pays P5,250,000 per payroll. However, based on the historical clearing o checks issued on salary; 50 percent will be presented on the day itsel, 35 percent ve days rom the salary date, and the remaining balance on the tenth day aer the salary date. I the interest rate on market is 12 percent per annum, how much is the incremental income o XYZ Company i the enre amount is not deposited? Incremental income rom salary date to ve days r rom om sal salar ary y da date (P5 (P5,,250, 250,00 000 0 x 50% 50% x 12% 12% x 5/ 5/36 360) 0) Incremental income rom salary date to tenth day From sal salar ary y dat date (P (P5, 5,25 250, 0,00 000 0 x 15% 15% x 12% 12% x 5/3 /360 60)) Total incremental income P5,687,50
P4, 4,35 357. 7.00 00 1, 1,31 312. 2.5 50
Cost of foregoing a cash discount •
Cash discount is categorized categorized under short-term nancing.
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Cash discount is ofered by suppliers o goods to the purchasers to
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encourage them to make an early payment. A rm without ully knowing cost o discount will typically tak take e advantage advantag e o a discount ofered ofered by the creditor because o the aached opportunity cost.
ormula o cash discount: Cost o Discount = Discount% 100% - Discount%
x 360 nal due date – discount period
The trade credit is liability arising rom credit sales. The sel seller ler records it as an account receive and the buyer records it as an account payable. I the sale is 2l10, n/30, the rst 10 days represents represents the ree trade credit and the remaining 20 days represent the costly trade credit. I the buyer does not pay during the discount period, the buyer is obliged to pay in the 30th day. The cost o discount is computed as: Cost o discou Cost discount nt = 2.0% 2.0% x 360 = 36.73% 36.73% 100% - 2.0% 30 – 10 It can be ascertained that the cost o discount i not availed o will cost the rm 36.73%. The cost o discount oregone declines as the net period becomes longer in relaon to the discount period. Thus, i the term above has been 2/10, n/45, the cost o discount oregone oregone will have been: Cost o discount = 2.0% x 360 100% - 2.0% 45 – 10
= 21.0%
When to Avail Avail of Discount?
Ex. ABC Company is considering the discount on the credit term ofered by the supplier. supplier. The term are 4/10, n/60. At the me the term is ofered, the borrowing rate in the market is 12% per annum. Should ABC Company avail o the discount ofered? Cost o discount = 4.0% 100% - 4.0%
x
360 60 – 10
= 30.0%
Since the cost o borrowing is 12% which is lower than the cost o discount orgone. ABC Company should avail the discount. Thus, the rm may borrow the bank at the rate o 12% and pay the supplier at a discount rate. rate. The net advantage o the rm rom the discount is 18% (30% - 12%)
Determination Determinatio n optimal transaction size •
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William J. Baumol is the rst economist to observe that the economic order quanty (EOQ) applied to inventory management may also be integrated in the management o cash balance where cash will be considered as a parcular type o inventory. The cash management model recognize two types o cost relave to the level o working cash balance.
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There are the transacon cost and the opportunity cost.
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The transacon cost are xed cost in buying or selling the securies while the opportunity cost
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reer to the interest income i marketable securies are obtained. The main objecve o cash management model is to minimize the transacon cost and the opportunity cost o retaining cash balances.
Relevant cost = transacon cost + opportunity cost = FC x CR + I x MS MS 2 Where: MS = the amount o marketable securies sold each me the cash balance is replenished FC = the xed cost associated with the transacon CR = the total cash required or the given period o me I = the rate to return return on the marketable securies The opmum transacon size is MS = 2(FC)(CR) I
ex. Astra Corporaon experts a cash requirement o P5,000 over a 1 month period in which cash is expected to be paid constantly. The opportunity interest rate is 15% per annum. The transacon with each borrowing or withdrawal is P75. Quesons: What is the opmal transacon size? What is the average average cash balance? What is the relevant cost o the transacon? Answer: Opmal transacon transacon size: MS = 2(FC)(CR) I =2(P75)(P5,000) 0.15/12
=P7,746.00
Average cash balance
MS = P7,746 = P3,873
2 2 Total relevant cost = FC x CR + I x MS MS 2 = P75 x P5,000 + (0.15/12) x P7,746 P7,746 2 = P48.41 + 48.41 = P96.82 Decision: the enty must borrow or withdraw withdraw an amount o P7,746 every me the cash balance is replenished. The relevant cost in this transacon size will be lowest. I the company withdraw a bigger amount, the opportunity cost will increase aster than the decrease in transacon cost. On the other hand i the company withdraws a smaller amount, the transacon cost will grow higher than the opportunity cost. In both cases relevant cost will be more than P96.82
Receivable Management Receivable represent represent the amount o money to be collected rom individuals or rm Two general classes o receivables Two 1. Trade ade rec recei eiv vable ables. s. These reer to claims arising rom the sale o merchandise or services in the ordinary course o business operaon. so urces 2. NonNon-tr trad ade e rece receiv ivab able less. These represent claims arising rom sources other than the sale o merchandise or service in the ordinary course o business.
Factors that Affect the Size of Receivable •
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Term credit. The level o account receivable depends on the length o the term credit. Paying pracce o the customers. Firms with customers who prolong payments are expected to have a higher level o receivables. Collecon policies. Firms with a lenient collecon policy have higher levels o receivable thus rms with a stricter collecon policy. policy. Volume o credit e sales. Firms that mostly grant sale on credit have a higher level receivable.
Accounts Receivable Management •
Account receivable management incorporates incorporates is all about ensuring that customers pay their invoices. Good receivable management helps prevent overdue payment or non- payment. It is there thereore ore a quick and efecve way to strengthen the company's nancial or liquidity posion.
Trade credit. The granting of trade credit is a consideration that has to be a well studied. Firms grant credits in order to increase the sale volume. Ex. GUM Corporaon sells on tem o net/30. on the average, its accounts are 30 days past due. Annual credit sales are P150,000. what is the average accounts receivable? answer: 60 60 x P150,000 =25,000 360 The P25,000 represent the average thecost investment The computed amoun amount t is based on salesaccounts incurredreceivable and not onand thenot inial outlay oitsel. the rm. Ex. The cost o a given product is 45% o the selling price and carrying cost is 10% o the selling price. On the average, accounts are paid 60days subsequent to the date o sale. The sale average is P120,000 per month. What is the investment on receivable? Answer: account receivable 2months x P12,000 = P240,000 investment on receivable P240,000 x (0.45 + 0.10) = P132,000 The amount o P132,000 represent the cost o investment made on the accounts receivable being the inial cost outlay made by rm.
Ex. A company has accounts receivable o P900,000. the average manuacturing cost is 45% o the sales price. The beore- tax prot margin is 12%. The carrying cost o inventory is 5% o the selling price. The sales commission is 10%. What is the investment in the accounts receivable? Answer: Manuacturing co cost ((P P900,000 x 45%) P405,000 Carrying cost( t(P P900,000 x 5%) 45,000 Sales ales commissi ssion(P9 on(P900 00,0 ,000 00 x 10% 10%) 90, 90,000 000 Investment in in ac accounts rre eceivable P540,000 ex. IFJKL Company's credit sales are P180,000, the collecon period is 90 days, and the cost is 75% o the sales price, what is the average accounts receivable balance and the average in accounts receivable? Answer: average averag e accounts receivable receivable = P180,000/360 x90days= P45,000 Investment in A/R = 45,000 x 0.75 = P33,750
Firm invest in accounts receivable through trade credits or the ollowing purposes: 1. To incr increase ease the curren currentt sales sales volume volume.. 2. To ret retai ain n cur curre rent nt sa sale less
Possible cost to be expected by the company: receivable with the possibility o bad debt expenses – are accounts receivable non-collecon by the rm selling goods or service. Ex: FLT Company has a current sale o P12,000,000 with bad debt expenses at 5% o sales. The
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owner, desiring to increase prot, decided to grant trade credit to increase the rms current sales. The expected sales upon implementaon is P20,000,000. with the granng o trade credit, the bad debt expenses is also expected to increase by 3%. I the rms variable cost is 60%o sales, how much is the advantage or disadvantage o granng trade credit? Current sale
expected sale
diference
asless: variable cost 60%P12,000,0(070,200,0P00 2)0,000,0 P080,0 LSe (1020,000,0 ) 00,000 (4,800,000) Contribuon margin P 4,800,000 P 8,000,000 P 3,200,000 Less: bad debt expense (600,000) (1,600,000) (1,000,000) Net income P4,200,000 P6,400,000 P 2,200,000
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Variable and fxed cost. As sale increase, variable also increase.
Example: FLT current sales volume is P10,000 units. The rm is planning to increase its sales by granng a trade credit. Once implemented, the rm is expected to increase its sales by 5,000 units. The normal capacity o the rm is P12,000 units, o which the xed cost is P250,000. Any producon in excess o the normal capacity o the rm would result in an addional cost o P5 per unit. The bad debt expense rate is at 5%and 9% or sale units o 10,000 and 15,000, respecvely. I the variable cost is 70%, what is the advantage or disadvantage o increasing the sale to 15,000 units? current sale expected sale diference Sales P1,100,000 P1,650,000 P550,000 Less: variable cost (770,000) (1,155,000) (385,000) Contribuon margin P 33 330,000 P 49 495,000 P 165,000 Less: bad debt expense (55,000) (148,500) (93,500) Addional xed cost (15,000) (15,000) Net income P 275,000 P 331,500 P 56 5 6,500
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Cost o capital. As the level o accounts receivable rises, the cost o unds invested in the accounts receivable also increase. The concept o cost o capital in the accounts receivable is the same as the concept o placing money in a special me deposit. I P1,000,000 will earn 12% per annum, it becomes the benchmark in other investment acvies. Less than 12% return is no longer acceptable. Another example is when granng trade credit, the accounts receivable together with inventory will increase in order to meet the increase in sales. Thus, the rm needs addional nancing with cost o capital equivalent to 15%. For this increased accounts receivable and inventory acceptable acceptable , and incremental to 15% is necessary. necessary. Thus, i the combined increase in accounts receivable and inventory is equivalent to P100,000, the incremental income should at least be P15,000.
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Cash discount. Is normally given to ence prompt payment payment o
Ex.obligaon. Riverbank gave the ollowing data or analysis: Annuall current Annua current sales sales on credit credit P15,000,00 P15,000,000 0 Collecon period 2months Terms net/30 Rate o return 15% Riverbank proposes to ofer a 3/10, net/discount. The corporaon ancipates 25% o its customer will take advantage o the discount. As a result o the discount policy, the collecon period will decline to 1 ½ months. Should riverbank ofer the new term? Collecon period reduced by (60-45) = 15days Reducon in accounts receivable receivable is: P15,000,000 x 15 = P625,000 360 Expected re return (6 (625,000 x 0.15) P93,750 Cost o discount (0.25 x 15,000,000 x 0.03) 112,500 Disadvantage o discount policy P(18,750)
Components of a credit policy •
Term credit
1. Credit period is length o me in which the credit sales are allowed. Ex. FLT company sold goods amounng to P50,000 to SGT. Term: n/30. The term n/30 means net o 30 days. The obligaon od SGT amounng to P50,000 without a discount will be paid on the 30th day. 2. Cash discount are given to customers to ence prompt payment. Ex. FLT company company sold P100,000 worth o goods to SGT. SGT. The transacon has the ollowing. Term: Term: 2/10, n/30 The credit term 2/10, n/30 means that the customer is given a 2% cash discount i the obligaon is paid on the 10th day rom the invoice date. The amount to be paid by SGT will be P98,000 (P100,000 (P100,00 0 – [P100,000 x 0.02]). I SGT oregoes oregoes the discount, discount, the enre enre amount o P100,000 will bw paid on the 30th day.
Relaxing term credit Minimum required = incremental income rate return incremental working capital requirement Ex: the current sales volume o FLT traders is P100,000 units per annum. Other data are as ollow: Units selling price P50 Unit variable cost and expenses 30 Fixed cost and expense Gross prot rate Term o sales
P1,200,000 30% n/30
An increase in sale o 25% is expected i the credit increase to 44 days. Bad debts expenses is expected to increase by 2% o increase sales. The minimum desired rate o return is 20%. Income tax is 32%. Inventory is maintained at a level equivalent to 30 days sales. FLT traders uses 360 days in a year.
Answer: Incremental net income current proposed Sale (100,000 x P50) P5,000,000 (100,000 x 125% x P50) Less: variable cost
increment P6,250,000
(100,000 x P30) P3,000,000 (100,000 x 125% x P30) P3,750,000 bad debts (100,000 x P50 x 125% x 2%) 125,000 total variable cost and bad debts 3,000,000 3,875,000 Contribuon margin P2,000,000 P2,375,000 P 375,000 Less: xed cost 1,200,000 1,200,000 Net income P800,000 P1,175,000 P375,000
P1,250,000
P750,000 125,000 875,000
Incremental working capital requirement Increase in accountcureceivable: sale x4 45/360) rrent (P5,0proposal 00,000 x 3 0/3(P6,250,000 60) 16,667
P 781,250
P 364,583 Incr Increa ease se in inve inven nto tory ry:: prop propos osed ed (P (P6, 6,25 250, 0,00 000 0 x7 x70% 0% x 30/3 30/360 60)) current (P5,000,000 x 70%x 30/360) 291,667 72,916 Total increase:
P364 P364,5 ,583 83
P437,499
Rate return = incremental net income = P375,000 incremental working P437,499 P437,49 9 Since thecapital rate o return on the proposed relaxing o the term credit is 85.71% which is greater than the minimum required rate o return o 20%, then the proposed relaxing is acceptable.
Shortening credit period with discount offering Ex. AZX Corporaon provides the ollowing data: Current an annual cr credit sa sale P15,000,000 Collecon period 3months Terms net/60 Rate o return 10% AZX Corporaon propose to ofer a 2/10, net/30 discount. The corporaon ancipates 20% o its customer will take advantage o discount. As a result o the discount policy, the collecon period will decline to two months. Should AZX Corporaon ofer the new term? The discount policy is advantageous, as indicated below: Current accounts receivable balance (P15,000,0 (P15, 000,000 00 x 3months) 3months) = P3,750,000 P3,750,000 12 months
Less: proposed accounts receivable balance aer policy change. (P15,000,000 x 2months) 12months P2,500,000 Reducon in average age accounts receivable P1,250,000 Mulply by the rate return x 0.20 Return on decreased accounts receivable P 250,000 Cost Co st o disc discou oun nt (0 (0.2 .20 0 x P15, P15,00 000, 0,00 000 0 x 0.20 0.20)) P 60,0 60,000 00 Advanta Adv antage ge o discount discount policy policy (P250,000 (P250,000 – P60,000) P60,000) P 190,000 190,000
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Credit standard
Credit standards areto guidelines ollowed by the in giving credit sales to customers. It reers the nancial strength andcompany credit worthiness a customer must exhibit in order to quality or credit. I a customers does not qualiy or the regular term credit, he or she can sll purchase rom the rm under a more restricve term. Ex: a rms regular term credit might call or payment aer 30days, and this term might be extended to all qualied customer.
Credit standards Five C’s of credit 1. Character . This reers reers to the moral and ethical quality o the individual who is responsible or paying loan. 2. Capacity. It is the applicants ability to pay of the credit extended. 3. C apital. the It is loan. the level nancial resources available to the company seeking
industry- specic economic 4. Condion. These are the general and industrysates 5. Collateral. It consist o asset pledged by the customer
Source of credit information 1. Fina Fi nanc ncia iall stnancial atem atemen enttstatement, . It is not unethical oricompanies to too ask amiliar or the customers stat ement, especially they are not with the customers company. 2. Cred Credit it-- ran rang g agen agenci cies es. These credit agencies sell inormaon to
subscribes containing the credit perormance o many ma ny companies rom diferent industries. 3. Comme ommerrcial cial ban bank ks. 4. Trade che checki cking. Trade Trade checking could be done by asking the prospecve customer their list o suppliers.
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Collecon policy
Collecon policy reers to the guidelines on handling receivables in terms o monitoring and collecon o The collecon process is expensive o Changing the collecon policy afects the sales, the collecon period, and the bad
o
o
debts losses. Implemenng a change in collecon policy a careully designed system should be established. It must ensure that the benets o implemenng the system are not overshadowed by cost
Evaluation receivable management
I. as Ra Rao o o on n acco accoun unts ts rrec ecei eiv vab able le to net net cr cred edit it ssal ales es.. This is used a determinant to see i the company is too lenient or too strict in implemenng its credit and collecon policies. II. II. Rec ecei eiva vabl ble e tu turn rnov over er.. This ormula tells how ast the accounts receivable are converted into cash. III.. Av III Aver erag age e col collec lecon on perio period. d. It reers to the number o days o sales in the accounts receivable. Average collecon period = average accounts receivable x 360days net credit sales = 360days accounts receivable turnover
or
IV. Aging o accounts receivable. The aging o the accounts receivable is one way o idenying clients who are paying their obligaon within the prescribed credit term. This monitoring technique use a schedule that indicates the percentages o the total accounts receivable balance that have been outstanding or a specied period o me. The accounts receivable are ages accordingly and are properly classied into either “not due “ or “past due” The classicaon are: a. 1 to to 30d 30day ayss b. 31 to to 60da 60days ys c. 61 to to 90da 90days ys d. 91 to to 120da 120days ys e. 121 to 180da 180days ys . 181 181 to to 360 360da days ys g. More More than than one one year year h. Bankrupt Bankrupt or under under liga ligaon on
Aging schedules cannot be constructed rom the data presented in the nancial statement.
illustration 1 Aging schedules o FLT and TGS Corporaon Aging schedules December 31,2014 FLT CO CORPO RPORAT RATION TGS CO CORPORAT RATION ION A acccounts(6d0a0y,s0)00value o o6a am %75 o o,0to t0o0tal v va alue 3va o o amount 0-g1e0o a 0m %ount 3 7l,u 5e 0% 11-30 400,000 40% 225,000 22.50% 31-45 0 0 125,000 12.50% 46-60 0 0 175,000 17.50% Oovtearl 6 T re0ceivable 0
1,000,0000
1 000 10 00 0,%
1,00100,0.0000%
100%
%o o total v va alue
Illustration 2 Aging the schedule o UMB Company Com pany UMB Company Aging schedule 31,2014 Age o accounts amDecember ounts percentage o amount due 0-30 120,000 37.85% 31-60 60,000 18.93 61-90 75,000 23.66 91-120 12,000 3.79 121-180 50,000 15.77
Total receivable
317,000
100%
Desired level of receivable
Receivable = net credit sales x required collecon period 360 Ex: FLI Company would like to maintain a balance o 150,000 in its accounts receivable account. I the company has a credit sales 3,500,000 a year, what should be the required collecon period o FLI be? 150,000 = 3,500,000 x required collecon period 360 Required collecon period = P 150,000 P3,500,000 360
=15.43 days
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