Essence of Skunk Fragrances, Ltd., sells 6,700 units of its perfume collection e

Question

Essence of Skunk Fragrances, Ltd., sells 6,700 units of its perfume collection each year at a price per unit of $397. All sales are on credit with terms of 3/20, net 40. The discount is taken by 45 percent of the customers. (Enter your answer as directed, but do not round intermediate calculations.) Requirement 1: What is the amount of the company’s accounts receivable? (Round your answer to 2 decimal places (e.g., 32.16).) Average receivables $ Requirement 2: In reaction to sales by its main competitor, Sewage Spray, Essence of Skunk is considering a change in its credit policy to terms of 5/20, net 40 to preserve its market share. Will this change in policy increase or decrease accounts receivable?

Explanation / Answer

Requirement 1:

The total sales of the firm are equal to the total credit sales, with credit term 3/20 net 40 means if paid within 20 days then 3% discount on total amount of sales otherwise have to pay within 40 days of credit sale

Here we have

Total credit sales = no. of units * price per unit = 6,700 *$397

Total credit sales = $2,659,900

The average collection period is the percentage of accounts taking the discount multiplied by the discount period plus the percentage of accounts not taking the discount multiplied by the days’ until full payment is required.

Here taking discount is 45 % or 0.45 therefore not taking discount = 1- 0.45 = 0.55

Average collection period = 0.45(20) + 0.55(40)

Average collection period = 31 days

The receivables turnover is 365 divided by the average collection period

Therefore we have,

Receivables turnover = 365/31

Receivables turnover = 11.77 times

And the average receivables are the credit sales divided by the receivables turnover therefore we have,

Average receivables = $2,659,900/11.77

Average receivables = $225,989.8

Requirement 2: If the firm increases the cash discount by credit term 5/20 net 40, means 2% more discount, in that case more customer will pay early or within 20 days, in that case the average collection period will decrease. And it will increase receivables turnover and finally decrease average account receivables.

Let’s check it by following assumption, suppose after increase discount, 50 % customers has taken discount instead of 45%.

In that case,

Average collection period = 0.50(20) + 0.50(40)

Average collection period = 30 days

The receivables turnover is 365 divided by the average collection period, so:

Receivables turnover = 365/30

Receivables turnover = 12.17 times

And the average receivables are the credit sales divided by the receivables turnover so:

Average receivables = $2,659,900/12.17

Average receivables = $218,562.04 (Decreased)

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