FINC-220 Lecture Notes - Lecture 13: Opportunity Cost, Financial Statement, Experian

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8 May 2018

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Chapter 20

Credit and inventory management

Chapter outline

• Credit and Receivables – cost and benefit

• Components of Credit Policies

• Credit Analysis

• Collection Policy

• Inventory Management

Credit policy effects

 Revenue Effects:

 Delay in receiving cash from sales

 May be able to increase price

 May increase total sales

 Cost Effects:

 Cost of the sale is still incurred even though the cash from the sale has not been

received

 Cost of debt – must finance receivables

 Probability of nonpayment – some percentage of customers will not pay for

products purchased

 Cash discount – some customers will pay early and pay less than the full sales

price

Credit management: key issues

 Credit management examines the trade-off between increased sales and the costs of

granting credit

Components of credit policies

 Terms of sale

 Credit period

 Cash discount and discount period

 Type of credit instrument

 Credit analysis

Distinguishing between “good” customers that will pay and “bad” customers that will

default

 Collection policy

Effort expended on collecting receivables

Credit analysis

 The process of deciding which customers receive credit

 Gathering information

 Determining Creditworthiness

Gathering information

 Financial statements

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Document Summary

Chapter outline: credit and receivables cost and benefit, components of credit policies, credit analysis, collection policy. Cost of the sale is still incurred even though the cash from the sale has not been received. Cost of debt must finance receivables. Probability of nonpayment some percentage of customers will not pay for products purchased. Cash discount some customers will pay early and pay less than the full sales price. Credit management examines the trade-off between increased sales and the costs of granting credit. Distinguishing between good customers that will pay and bad customers that will. The process of deciding which customers receive credit. Credit reports with customer"s payment history to other firms (dun & bradstreet, experian) Character willingness to meet financial obligations. Capacity ability to meet financial obligations out of operating cash flows. Conditions general economic conditions related to customer"s business. Keep an eye on average collection period relative to your credit terms.

Related Questions

10. (TCO 5) Which of the following statements is false regarding the cost of capital? (Points : 4) The cost of capital should consider the flotation costs. All other being equal, it is preferable to use market value weights than book value weights. The WACC is the most appropriate discount rate for all projects. Should include the cost of retained earnings. 11. (TCO 2) Which of the following increases the cash account? (Points : 4) Goods are sold on credit An interest payment on a notes payable is made A payment due is received from a client Raw materials are purchased and paid for with credit 12. (TCO 2) Which of the following statements is true? (Points : 4) The optimal credit policy minimizes the total cost of granting credit. Firms should avoid offering credit at all cost. An increase in a firm's average collection period generally indicates that an increased number of customers are taking advantage of the cash discount. Character, refers to the ability of a firm to meet its credit obligations out its operating cash flows. The optimal credit policy, is the policy that produces the largest amount of sales for a firm. 13. (TCO 2) All else constant, a decrease in the accounts receivable period will: (Points : 4) lengthen the accounts payable period. shorten the inventory period. lengthen the operating cycle. shorten the cash cycle. shorten the accounts payable period. 14. (TCO 2) Delphinia's has the following estimated quarterly sales for next year. The accounts receivable period is 30 days. What is the expected accounts receivable balance at the end of the second quarter? Assume each month has 30 days. Q1 Q2 Q3 Q4 Sales $1,800 $1,700 $2,100 $1,900 (Points : 4) $567 $600 $821 $1,134 $1,200

BUSI 320 Comprehensive Problem 2 Spring 2019 You have been askedto assess the expected financial impact of each of the followingproposals to improve the profitability of credit sales made by yourcompany. Each proposal is independent of the other. Answer allquestions. Showing your work may earn you partial credit. Proposal#1 would extend trade credit to some customers that previously havebeen denied credit because they were considered poor risks. Salesare projected to increase by $120,000 per year if credit isextended to these new customers. Of the new accounts receivablegenerated, 6% are projected to be uncollectible. Additionalcollection costs are projected to be 5% of incremental sales, andproduction and selling costs are projected to be 80% of sales. Yourfirm expects to pay a total of 30% of its income after expenses intaxes. 1) Compute the incremental income after taxes that wouldresult from these projections: 2) Compute the incremental Return onSales if these new credit customers are accepted: If the receivableturnover ratio is expected to be 4 to 1 and no other asset buildupis needed to serve the new customersâ¦ 3) Compute the additionalinvestment in Accounts Receivable 4) Compute the incremental Returnon New Investment 5) If your company requires a 20% Rate of Returnon Investment for all proposals, do the numbers suggest that tradecredit should be extended to these new customers? Explain. Proposal#2 would establish local collection centers throughout the regionto decrease the time it takes to convert credit payments that aremailed in by check to cash. It is estimated that establishing thesecollection centers would reduce the average collection time by 2days. 1) If the company currently averages $25,000 in collectionsper day, how many dollars will this suggested cash managementsystem frees up? 2) If all freed up dollars would be used to paydown debt that has an interest rate of 8%, how much money could besaved each year in interest expense? 3) Do the numbers suggest thatthis new system should be implemented if its total annual cost is$7200? Explain.

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1. (TCO 2) Select any actions that do not affect the cash account.Select all that apply: (Points : 3)
Goods are sold on credit
An interest payment on a notes payable is made
Raw materials are purchased and paid for with credit
A new machine is purchased and paid for with the business line ofcredit

2. (TCO 2) Which one of the following will increase the operatingcycle? (Points : 3)
increasing the accounts payable period
decreasing the accounts payable turnover rate
decreasing the cash cycle
increasing the accounts receivable turnover rate
increasing the inventory period

3. (TCO 2) Assume Green Leaf Nursery anticipated sales of $500 inthe first quarter. Accounts receivable at the beginning of the yearwas $300. Assuming a collection period of 30 days, which is theapproximate beginning balance for the second quarter? (Points :3)
$550
$630
$250
$170
None of the above

4. (TCO 2) Best Environment Engineering wrote a check and mailed itto the Electric Co. When the Electric Co. went to deposit thecheck, it discovered that the bank was closed due to flooding inthe area. It was 5 days before the Electric Co. could deposit thecheck from Best Environment Engineering. Because the Electric Co.'sbank was closed: (Points : 3)
Best Environment's collection float decreased.
the Electric Co.'s collection float decreased.
Best Environmentâs disbursement float increased.
the Electric Co.'s disbursements float increased.
the ledger balance of Best Environment was less than it would havebeen otherwise.

5. (TCO 2) Which of the following statements is true? Select allthat apply: (Points : 3)
The optimal credit policy minimizes the total cost of grantingcredit.

There is an opportunity cost associated with not offeringcredit.

An increase in a firm's average collection period generallyindicates that at least some customers are taking longer topay.

The costs of the credit application process and the costs expendedin the collection process are not carrying costs of grantingcredit.

Character refers to the ability of a firm to meet its creditobligations out its operating cash flows.

The optimal credit policy is the policy that produces the largestamount of sales for a firm.

6. (TCO 2) You place an order for 100 units of inventory Part A ata unit price of $522. The supplier offers terms of 1/25, net 40.How much should you remit if you take the discount? (Points :3)
$52,200
$39,150
$51,678
None of the above

7. (TCO 2) Auto Parts sells 1,200 electric parts per week and thenreorders another 1,200 parts. If the relevant carrying cost perelectric part is $4 and the fixed order cost is $750, what is thetotal carrying cost and the restocking cost, respectively? (Points: 3)
$2,400 and $39,900
$3,200 and $33,800
$2,400 and $39,000
$3,400 and $30,000
None of the above

8. (TCO 2) Company ABC has expected sales of 12,000 units thisyear, an ordering cost of $6 per order and carrying costs of $1.60per unit. What is the EOQ? (Points : 3)
310 units
300 units
150 units
155 units
None of the above

9. (TCO 2) The operating cycle begins when _____ and endswhen_____. (Points : 3)
inventory is purchased; inventory is sold
inventory is purchased; payment is received for the sale of thatinventory
inventory is purchased; the supplier of the inventory is paid
the sale of inventory occurs; payment is received for the sale ofthat inventory
the sale of inventory occurs; the supplier of the inventory ispaid

10. (TCO 2) List three examples of short-term investments. (Points: 3)

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FINC-220 Lecture Notes - Lecture 13: Opportunity Cost, Financial Statement, Experian

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