- 15 Marks
FM – L2 – Q113 – Management of receivables and payables
Question
The summarised budget of Kofi Oil Mill Limited for the year to 31 December 20X8 is as follows:
| GH¢’000 | GH¢’000 | |
|---|---|---|
| Budgeted sales | 20,000 | |
| Budgeted variable costs | 18,400 | |
| Budgeted fixed costs | 800 | |
| 19,200 | ||
| Budgeted profit | 800 |
The sales manager has proposed that the period of credit allowed to customers should be increased from one month to two months. It is believed that this would increase sales by 15%. All sales are on credit and the cost of capital is 13%. Assume fixed costs will remain constant.
Required
(a) Briefly outline for management the implications of the sales manager’s proposal.
(b) List FOUR factors which should be taken into consideration in determining a policy for the control of credit extended by a company.
(c) Explain FOUR points which should be taken into consideration when granting credit to a particular customer.
Answer
(a) Let us assume that fixed costs will remain constant. The increased contribution (profit) from the extension of the credit period will be:
| GH¢’000 | |
|---|---|
| Increase in Budgeted sales (15% of GH¢20,000) | 3,000 |
| Increase in Budgeted variable costs (15% of 18,400) | 2,760 |
| Additional contribution | 240 |
GH¢240,000
Computation of Additional Investment in working capital
(i) Based on Variable Costs:
| GH¢ | |
|---|---|
| Average debtors in respect of the old policy will be 18,400,000 × 4/52 = | 1,415,385 |
| Average debtors in respect of the new policy will be (18,400,000 + 2,760,000) × 8/52 = | 3,255,385 |
| Additional investment in working capital | 1,840,000 |
| GH¢ | |
|---|---|
| Required returns = cost of capital × additional Investment = 13% × GH¢1,840,000 | 239,200 |
(ii) Based on Sales Value:
| GH¢ | |
|---|---|
| Average debtors in respect of the old policy will be 20,000,000 × 4/52 = | 1,538,462 |
| Average debtors in respect of the new policy will be (20,000,000 + 3,000,000) × 8/52 = | 3,538,462 |
| Additional investment in working capital | 2,000,000 |
| GH¢ | |
|---|---|
| Required returns = cost of capital × additional investment = 13% × 2,000,000 | 260,000 |
Valued at variable cost of finance (required return), the investment is basically the same as increase in professional investment. Sales value, the cost of the additional investment.
(b) Factors to consider in determining a credit control policy:
- Creditworthiness of customers: Assess the financial stability and payment history of customers to minimize bad debts.
- Industry standards: Align credit terms with competitors to remain competitive while managing risk.
- Cash flow requirements: Ensure credit policies support liquidity needs to avoid reliance on costly overdrafts.
- Cost of credit administration: Balance the costs of credit control measures with the benefits of reduced bad debts.
(c) Points to consider when granting credit to a particular customer:
- Credit history: Review the customer’s past payment behavior to assess reliability and likelihood of timely payments.
- Financial position: Analyze the customer’s financial statements to ensure they have the capacity to meet credit obligations.
- References: Obtain trade or bank references to verify the customer’s creditworthiness and business reputation.
- Economic conditions: Consider the broader economic environment, as it may impact the customer’s ability to pay during downturns.
- Tags: Credit Policy, Customer Credit, Financial Risk, Receivables Management
- Level: Level 2
- Uploader: Samuel Duah