Changes in Credit Terms Rich Jackson, a recent finance graduate, owns a wholesal

Question

Changes in Credit Terms Rich Jackson, a recent finance graduate, owns a wholesale building supply business with his brother, Jim, who majored in building construction. The firm sells primarily to general contractors. Sales are slow during the cold months, rise during the spring, and then fall off again in the summer, when new construction in the area slows. The brothers are concerned about the firm's current credit policy. The terms of sale are net 30, but the brothers expect only 80% of the customers (by dollar value) to pay the full amount on day 30, while the other 20% pay, on average, on Day 40 Gross sales are currently $1,000,000 per year. Of the gross sales, 2% end up as bad debt losses. The brothers are considering a change in credit policy. The change would entail 1) changing the credit terms to 2/10, net 20, 2) employing stricter credit standards before granting credit, and 3) enforcing collections with greater vigor than in the past. Thus, cash customers and those paying within 10 days would receive a 2% discount, but all others would have to the pay the full amount within 20 days. The brothers believe the discount would both attract additional customers and encourage some exsting customers to purchase more from the firm- after all, the discount amounts to a price reduction. The net expected result is for sales to increase to $1,100,000, for 60% of the paying customers to take the discount and pay on the 10th day, for 30% to pay the full amount on day 20, for 10% to pay late on day 30, and for bad debt losses to fa from 2% to 1% of gross sales. The firm's operating (variable) cost ratio will remain unchanged at 75%, and its cost of carrying receivables (notes payable or required return on investments) will remain unchanged at 10%. The company would have to purchase some new inventory to cover t Inventory turnover information is given below. he additional sales. averages 6 times per year. The current income statement with relevant

Explanation / Answer

Answer:1

Answer:2 'Old (current) situation: DSO0 = 0.8(30) + 0.2(40) = 32 days. New situation: DSOn = 0.6(10) + 0.3(20) + 0.1(30) = 15 days. Thus, the new credit policy is expected to cut the dso in half.

Answer:3

Answer:4

Answer:5

Answer:7

Answer:9

The four variables which make up a firm's credit policy are (1) the discount offered, including the amount and period; (2) the credit period; (3) the credit standards used when determining who shall receive credit, and how much credit; and (4) the collection policy.     Cash discounts generally produce two benefits: (1) they attract both new customers and expanded sales from current customers, because people view discounts as a price reduction, and (2) discounts cause a reduction in the days sales outstanding, since both new customers and some established customers will pay more promptly in order to get the discount. Of course, these benefits are offset to some degree by the dollar cost of the discounts themselves.     The credit period is the length of time allowed to all "qualified" customers to pay for their purchases. In order to qualify for credit in the first place, customers must meet the firm's credit standards. These dictate the minimum acceptable financial position required of customers to receive credit. Also, a firm may impose differing credit limits depending on the customer's financial strength as judged by the credit department.     Finally, collection policy refers to the procedures that the firm follows to collect past-due accounts. These can range from a simple letter or phone call to turning the account over to a collection agency.     How the firm handles each element of credit policy will have an influence on sales, speed of collections, and bad debt losses. The object is to be tough enough to get timely payments and to minimize bad debt losses, yet not to create ill will and thus lose customers.

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.