Garcia Industries has sales of $167,500 and accounts receivable of $18,500, and

Question

Garcia Industries has sales of $167,500 and accounts receivable of $18,500, and it gives its customers 25 days to pay. The industry average DSO is 27 days, based on a 365-day year. If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed-up by this change, how would that affect its net income, assuming other things are held constant? Assume all sales to be on credit. Do not round your intermediate calculations.

Explanation / Answer

Rate of return on cash generated                                                                       8.0% Sales                                                                                                             $167500 A/R                                                                                                                  $18,500 Days in Year                                                                                                           365 Sales/day = Sales/365 =                                                                                 $458.90 Company DSO = Receivables/Sales per day =                                                    40.31 Industry DSO                                                                                                        27 Difference = Company DSO – Industry DSO =                                                   13.31 Cash flow from reducing the DSO = Difference × Sales/day =                 $6109.59 Additional Net Income = Return on cash × Added cash flow =                 $488.8 Net income would be increased by $ 488.8 becasue of change in policy.

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