- 15 Marks
L2 – Q110 – Trade Receivables Management
Calculate the effect of reducing credit period on Entity N's annual profit, considering sales reduction, bad debts, and overdraft costs.
Question
Entity N is reviewing its credit policy. It is estimated that if the period of credit allowed to customers is reduced to 60 days, there will be a 25% reduction in annual sales, but bad debts would be reduced by GH¢30,000 each year. It would also be necessary to spend an extra GH¢20,000 each year on credit control. Entity N has cash flow difficulties and relies on overdraft finance, for which the interest rate is 9%.
Required
Calculate the effect of these changes on the annual profit. Base your answer on the level of sales in Year 3, and assume that purchases and inventory would be reduced in the same proportion as the reduction in sales.
| Entity N – Extracts from annual accounts | Year 3 |
|---|---|
| Inventory | GH¢ |
| Raw materials | 180,000 |
| Work in progress | 93,360 |
| Finished goods | 142,875 |
| Purchases | 720,000 |
| Cost of goods sold | 1,098,360 |
| Sales | 1,188,000 |
| Trade receivables | 297,000 |
| Trade payables | 126,000 |
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