Topic 15: Short-term Credit Management (Sem 2)

Question 1

Terms of sale

Answer 1

The conditions under which a firms sells its good’s and services for cash or credit.

Question 2

Credit Period

Answer 2

The length of time over which credit is granted (Typically 30,60 or even 90 days).

It begins on invoice cate
The invoice is a bill for goods or services provided by the seller to the purchaser.

Question 3

What determines the credit period?

Answer 3

Buyers operating cyle - Credit shortens the buyers cash cycle which may be important if their customers also pay on credit.
Some factors are specific to particular industries, customers and even products.

Question 4

Discount and Cash Discounts

Answer 4

The cash discount and the discount period

Note: Look at example of Cash discounts on notes

Question 5

Credit Instrument

Answer 5

Evidence of indebtedness

Question 6

Credit Policy (Revenue Effects)

Answer 6

If credit is granted, payment will be delayed by the period of credit

This may attract more customers and may mean the company can charge a higher price

Total revenues may increase

Question 7

Credit Policy (Cost Effects)

Answer 7

Granting credit will delay payment receipts, but the company will still need to pay it’s suppliers.

Question 8

Credit policy (Cost of Debt effects)

Answer 8

Granting credit means that the payment delay has to be financed.

Question 9

Credit Policy (The profitability of non-payment)

Answer 9

If a firm grants credit, some percentage of the credit buyers will not pay what they owe (default on the debt). This cannot happen with cash only sales.

Question 10

Credit policy (The cash discount)

Answer 10

When a firm offers a cash discount as part of it’s credit terms, some customers will choose to pay early to take advantage of the discount.

Question 11

Evaluating a proposed credit policy (FORMULAS)

Answer 11

Cash Flow = contribution * Quantity sold
Cash Flow = (P - v)Q
Cash Flow with new policy: (P - v)Q’
Incremental Cash inflow = (P - v)(Q’ - Q)

Therefor present value of the future incremental cash flow is:

PV of new credit policy = [(P - v)(Q’ - Q)] / R

Where:
P = Price per unit
v = variable cost
Q = Current quantity sold per month
Q’ = Quantity sold under new policy
R = Monthly required return

NOTE: CHECK EXAMPLE IN NOTES

Question 12

Cost of new credit policy (Formula)

Answer 12

Cost of switching = P * Q + v * (Q’ - Q)

Where:
P = Price per unit
v = variable cost
Q = Current quantity sold per month
Q’ = Quantity sold under new policy

NOTE: CHECK EXAMPLE IN NOTES

Question 13

Optimal Credit Policy

Answer 13

Carrying costs:
The costs that must be incurred when credit is granted i.e; interest cost of deferred payment, bad debts and credit management costs.

Opportunity costs:
Lost sales from refusing credit. They include lost sales and a potentially higher price. These costs drop when credit is granted

Credit cost curve:
A graphical representation of the sum of carrying costs and the opportunity costs of a credit policy.

NOTE: CHECK EXAMPLE IN NOTES

Question 14

One-off Credit sale (NPV of granting credit to a one time customer Formula)

Answer 14

NPV = (- V + (1 - π)*P) / (1 + R)

Where:
v = variable cost per unit
π = probability of Default (Not paying direct)
R = Required return on receivables over the period of credit
P = Price on credit

NOTE: CHECK EXAMPLE IN NOTES

Question 15

NPV of granting credit to a repeat customer (Formula)

Answer 15

NPV = - V + (1 - π) * ((P - v)/R)

Where:
v = variable cost per unit
π = probability of Default (Not paying direct)
R = Required return on receivables over the period of credit
P = Price on credit

Question 16

Repeat customer without defaulting (PV Formula)

Answer 16

PV = (P - v) / R

R = Required return on receivables over the period of credit
P = Price on credit
v = variable cost per unit

NOTE: CHECK EXAMPLE IN NOTES

Question 17

Aging Schedule

Answer 17

A tool for monitoring recievables. It is. a compilation of trade recievables by the age of each account

NOTE: CHECK EXAMPLE IN NOTES