Net sales= sales — discount

Discount=sales(1-bad dept rate)×percentage of customers

taking discount
Bad dept loss = sales × bad dept rate

DSO= discount period × % of customers taking

discount+ credit period × % of customers paying on
final due date × late period × % of customers paying
on late period
 Interest on receivable = sales × DSO×VCR×K
360

Receivables investment = average account receivables× variable cost

ratio
={ annual sales × DSO } × v
360
Receivables carrying cost = receivable investment× opportunity cost of
funds
={ annual sales × DSO × v}× K
360
particular Proposed Existing Effect of
policy (x) policy (y) change (x-y)
Sales
Less: discount Xx Xx Xx
Net sales Xx Xx Xx
Less: variable cost Xx Xx Xx
production
Profit before credit Xx Xx Xx
related costs and tax
Less:- credit related
costs:
Cost of carrying Xx
receivable Xx Xx
Bad debt loss Xx Xx Xx
Credit expenses Xx Xx Xx
Before tax profit Xx Xx Xx
Less: tax Xx Xx Xx
Net income after tax xx Xx Xx
 Credit Terms
The credit terms state the credit period,
size of the cash discount offered, the
discount period, and the beginning date
of credit period .
Invoice date Term Payment date
Cash dis taken Cash dis forgone

September 10 2/10 net30 Sep.20 Oct.10

September 10 2/10 net30 EOM Oct .10 Oct.30
September 10 2/10 net30 MOM Sep.25 Oct.15
September 20 2/10 net30 Sep.30 Oct.20
September 20 2/10 net30 EOM Oct.10 Oct.30
September 20 2/10 net30 MOM Oct.10 Oct.30
 Cost to Forgo a Discount
What is the approximate annual cost to
forgo the cash discount of “2/10, net 30”
after the first ten days?
Approximate annual interest cost =
% discount 365 days
X
(100% - % discount) (payment date -
discount period)
 Credit Terms “2/10,Net30”
ABC co. has been extended RS1500 OF Trade credit
from a supplier on terms of 2/10,net30.

• Beginning of Discounted Amount Full Amount

Credit period (1500 – 30 = 1470) (1500) due end of
credit period Time
(day )

0 10 20 30
Credit period
 Cost to Forgo a Discount
What is the approximate annual cost to forgo the
cash discount of “2/10, net 30,” and pay at the
end of the credit period?

Approximate annual interest cost =

2% 365 days
X
(100% - 2%) (30 days - 10 days)

= (2/98) x (365/20) = 37.2%

 Effective annual interest rate
Effective annual interest rate of not taking discount
365/(CP- DP )
( EAIR) = [1+
𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑝𝑒𝑟𝑐𝑒𝑛𝑡
100−𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑝𝑒𝑟𝑐𝑒𝑛𝑡
] - 1
2 365/(30- 10 )
= [ 1+ ] -1 = 1.4456 -1
100 −2
=0.4456 or 44.56%
 WBB 10-1
particular Before change After change
Credit terms 2/15,net30 3/10,net30
Discount taker customers 40% 50%
Non-discount customers who 30% 25%
pay on time
Non-discount who pay 10 30% 25%
days
Late 2% 2%
Bad debt loss ratio 2 million 2.6 million
Sales
Variable cost ratio (v) 75% or0.75 75% or0.75
Interest rate(k) 9% 9%
Tax rate(t) 40% 40%
a.DSO=?
We have
DSO=% of customers taking discount × discount period + % of
customers not taking discount × net period +%of customers paying in
late× late period
DSO0 =0.40×15 days+0.30×30days+0.30×40days=27 days
DSOn=0.50 × 10 days+0.25 ×30days+0.25 ×40days=22.5days
b.Discount costs=?
We have,
Discount costs=sales ×discount rate ×%of customers taking discount
Do=Rs.2,000,000 ×(1-0.02) ×0.02 ×0.40=Rs.15,680
Dn=Rs.2,6000,000 ×(1-0.02) ×0.03 ×0.50=Rs.38,220
Marginal discounts costs =new discount costs-current discount costs
= Rs.38,220 –Rs.15,680=Rs.22,540
c.Cost of carrying receivables =?
We have,
Cost of carrying receivables=?
Co =27days×Rs.2,000,000×0.75×0.09 =Rs.10,125
360days
Cn=22.5days×Rs.2,6000,000 ×0.75 ×0.06 =Rs.10,968.75
360days
Marginal carrying cost =new carrying costs-current carrying
cost
=Rs.10,968.75-Rs.10,125=Rs.843.75
d. Bad debt losses=?
We have,
Bad debt losses = sales ×bad debt ratio
Bo = Rs.2,000,000 ×0.02 =Rs.40,000
Bn = Rs.2,600,000 ×0.02 =Rs.52,000
Marginal bad debt costs =New bad debt costs-current bad
debt costs
=Rs.52,000-Rs.40,000 =Rs.12,000
e.Incremental profit( ∆ P)=?
We have,
∆P =[contribution margin × ∆ -marginal discount costs-
marginal costs of carrying receivables- marginal's bad debt
losses](1-T)
=[Rs.150,000-Rs.
.22,540-Rs.843.75-Rs.12,000] ×0.6
=Rs.114,616.25 ×0.60=Rs.68,770
8-9

Since the net credit period is 30 days, we have pay in 30

days from the billing date before the account is overdue.
If we take the full period we have to pay the full invoice
price of Rs.60× 200 units =Rs.12,000

b. The discount offered is 3 percent on Rs.12,000 that is 0.03

× 12,000 that is 0.03 ×12,000 =Rs.360 we must pay within
the 10th day from billing date to get this discount. If we take
the discount we have to remit Rs.12,000-Rs.360 =Rs.11,640

c. If we do not take discount, we can use 97 percent the

invoice price for additional 20 days by foregoing 3 percent
cash discount. Here, the cost for 20 days is 3/97 = 0.0309 or
3.09%. Its effective annual rate is.
 365/20
EAR=(1+0.0309) -1 =0.7426 or 74.26%
Thus we are paying effective annual interest rate of
74.26%implicity for 20 days of credit.
 8-10
Credit terms= 2 Net 30
10
Total sales =Rs.1,00,0000
Customers taking discount=50%
Customers not taking discount and pay on 60 days =50%
a. DSO= % of customers taking discount × discount period + % of
customers paying late × late period
=0.5 × 10days + 0.5 × 60 days
= 35days
b. Average amount of receivable= sales/360 ×DSO
= 1,00,0000/360 ×35days
=97,222.22
c. If all 50% non- discount customers paid on 30th days
DSO=0.5 ×10+0.5 ×30
= 20 days
Average amount of receivable =sales  DSO
360
=Rs.10,000,00/360 × 20 days
= 55,555.55
If butwal spinning mills toughened up its collection
policy with the result that all non-discount Customers
paid on the 30th day, the average investment in account
receivable will reduce by 41,666.67 (Rs.97,222.22 -
55,555.55)
 8-11

Since the cost of production is given we use

cost to determine the average investment in
receivable. First we solve for average daily
cost as follows:
Average daily costs(ADC)=(Rs.20,000 × 0.8) ×
1/7 =Rs.2,285.71
Now, the average balance sheet amount of
account receivable is
Average receivable=ADC × ACP =Rs.2,285.71
× 35 days =Rs.80,000
 8-12

a. Since 60 percent customers are discount takers, they pay in 10 days

and remaining 40 percent pay on 30 days. Thus, the average
collection period is:
ACP=0.6×10 days + 0.4×30 days =18 days
b. First we work out average daily sales of the firm as follows.
average daily sales(ADS)=1,200×Rs.2,200×1/30 =Rs.88,000
now the average balance sheet amount of account receivables is
average receivables=ADS×ACP =Rs.88,000×18 =Rs.1,584,000.
 8-13
With 2/10, net 30 terms, if 50 percent customers
take discount, they pay in 10 days and
Remaining 50 percent pay in 30 days. So average
collection period of the firm is
ACP=0.5×10days+0.5×30days = 20 days
Firm has annual credit sales of 3,000×Rs.400
=Rs.1,200,000. we work out average daily sales as
follows
DS= annual credit sales×1/365 =Rs.1,200,000×1/365
=Rs.3,287.67
Now, the average amount of firm’s account
receivables is determined as follows.
Average account receivables =ADS×ACP
= Rs.3,287.67×
20days =Rs.65,753.4
Further, if the firm changes its credit terms to
4/10, net 30 the discount takers will naturally
increases with the increases in discount rate in
the terms. When proportion discount takers
increases, the average collection period
declines resulting into a decline in average
amount of accounts receivables.
8-14
With net 20 terms, if customers are 12 days overdue
in the average, its average collection period
is 32 days.
Firm has annual credit sales of Rs.6,000,000. we
work out average daily sales as follows:
ADS=annual credit sales× 1/365
=Rs.6,000,000×1/365 =Rs.16,438.36
Now, the average amount of the firm’s accounts
receivables is determined as follows:
Average account receivables=ADS×ACP
= Rs.16,438.36×32 days
=Rs.526,027.52
 8-15
Old credit policy New credit policy
Variable cost 70% 70%
ratio(V) 10% 10%
Cost of capital (K) Rs.10,000 Rs.12,000
Annual sales Net 30 Net 45
Credit period Rs.1,500 Rs.2,500
Accounts 360 days 360 days
receivables
Annual working
days
 Cost of carrying receivables(CCR)=Receivable balance× V ×K

• Before change in credit • After change in credit

term term
Carrying cost of receivable(CCR) CCR= Rs.2500 × 0.70 × 0.10
=Rs.1500 × 0.70 × 0.10
=Rs.175
=Rs.105

Thus, the cost of carrying receivables increase under new

credit policy by Rs.70[Rs.175 –Rs.105]
8-16
Current credit term Change credit term
Credit term 2/15 ,net 30 3/10,net 30
Annual credit sales Rs.2,000,000 Rs.2,600,000
Discount taker customer 40% 50%
Non-discount customer 30 % 25%
[net period ]
Non-discount customer 30% 25%
[pay 10day late ]

Bad debt losses 2% 2%

DSO 30days 45days
Cost of funds(K) 9% 9%
Variable cost ratio(V) 75% 75%
Tax rate(T) 40% 40%
particular Current credit Change credit Effect of
change
Gross sales Rs.2,000,00 Rs.2,600,000 Rs.2,220,000
Less: discount 15680 38220 22540
Net sales Rs.1,984,320 Rs.2,561,780 Rs.577,460
Less: production cost (75%) 1,500,000 1,950,000 450,000
Profit before credit costs taxes Rs.484,320 Rs.611,780 Rs.127,460
Less: credit related costs:
bad debt losses 40,000 52,000 12,000
cost of carrying receivable 10,125 10,969 844
Profit before taxes Rs.434,195 Rs.548,811 114,616
Less: tax (40%) 173,678 219,524 45,846
Net income Rs.249,000 Rs.262,350 Rs.13,350

BTE should change the credit terms from 2/15, net 30 to 3/10 net 30 because change in
profit is positive i.e.Rs.68,770.
Before After
change change
CCR = CCR = 2,60,000/360
2,000,000/360 ×27 ×27 × 0.75 ×0.09 =
×0.75 ×0.09 = 10,125 10,968.75 or 10969

Bad debt losses = Bad debt losses

2000,000 × 0.02 = = 2600,000 ×
40000 0.02 = 52,000
a. DSO=?
We have,
Dso before change= 0.04×15 days+0.03 ×30days+0.30
×40days
= 27 days
Dso after change = 0.50×10 days+0.25×30days+0.25
×40days
= 22.5 days
B. Discount costs=?
We have,
Before change
Discount costs = Rs.2,000,000(1-0.02)(0.02)(0.40)
=Rs.15,680
After change
Discount costs= Rs.2,600,000×(1-0.02)(0.03)(0.50)
=Rs.38,220
 8-17
particular Present policy Proposed policy
Credit terms 2/15,net30 3/10,net30
Discount taker 60% 70%
customers 25Days 22 Days
ACP 1% 2%
Bad debt loss 8,00,000 1 Million
ratio 80% 80%
Annual credit 15% 15%
sales
Variable cost ratio
(v)
Cost of funds (k)
 particular Present policy Proposed
policy
Sales revenue Rs.8,00,00 Rs.1,000,000
Less: Variable cost (.80× sales) 640,000 800,000
Profit before credit costs taxes RS.1,60,000 Rs.200,000
Less: credit related costs: 1,650,000
bad debt losses 8,000 Rs.550,000
cost of carrying receivable 6,667
cash discount 9,504 20,580
Net Profit before taxes 135829 152087

Incremental net income before ___ 16258

tax

Decision: the Siddhartha soft auto parts should change its credit
term from 2/15 net 3o 3/10 net 30 as it results into an
incremental profit of Rs.16,258.
Present
purpose
Bad debt
losses=800,000×0.01=R 1000,000×0.02=Rs.20,000
s.8000
[Rs.800,000×22/360]×0.15
=Rs.7,333
CCR=[Rs.640,000×25/3
60]×0.15
Cash discount = ( 1000,000 -
=Rs.6,667 20,000 ) × 0.70 × 0.03 =
25580
Cash discount = (800000-
8000 )× 0.60 × 0.02
= 9504
 8-18
Credit terms =2/10net 30 Variable cost ratio(V)=70%
Average tax rate =40% Cost of funds(K)=12%

particular Customers Customers Customers

category (3) category (4) category (5)
gross sales Rs.3,75,000 Rs.190,000 220,000
Less: Discount 0 0 0
Net sales Rs.375,000 Rs.190,000 220,000
Less: production cost(70%) Rs.262,500 1,33,000 154,000
profit before credit costs and 112,500 Rs.57,000 66,000
taxes
less: credit related cost 11,250 17100 35,200
bad debt losses 1,750 2660 4620
cost of carrying receivables 99500 37240 26180
profit before taxes 39,800 16258 10,472
Less: tax (40%) 59,700 22,344 15,708
Net income
It unlimited credit is extended to customers category no.3 to
5 the net income will decrease. It is due to the increase in
average collection period and bad debt losses
Working notes
CCR=sales/360×DSO ×V ×K
Caterogy1:
CCR=Rs.375,000/360 ×20 ×0.70 ×0.12
=Rs.1,750
Caterogy2:
CCR=Rs.190,000/360 ×60 ×0.70 ×0.12
=Rs.2,660
Caterogy3:
CCR=Rs.220,000/360 ×90 ×0.70 ×0.12
=Rs.4,620
Bad debt losses= sales × bad debt percentage

Caterogy1:
Bad debt losses=Rs.375,000×0.03=Rs.11,250
Caterogy2:
Bad debt losses=Rs.190,000×0.09=Rs.17,100
Caterogy3:
Bad debt losses=Rs.220,000×0.16=Rs.35.200
 8-19
Incremental cash inflow =
Additional sales ( Price per unit – cost per unit)
= 120unit ( 750 – 400 ) = Rs 42000
If we treat this cash flow as perpetuity, the present value of cash
inflow is calculated as follows. Using 1.5 percent discount rate
PV=Rs.42,000/0.015 =Rs.2,800,000
Cost of switching= current revenue foregone + cost of additional sales
= (Rs.750× 11,000)+(120 ×400)
= Rs.825,000 + Rs.48,000
= Rs.873,000
Now, we can determine NPV as follows
NPV=PV-cost of switching
=Rs.2,800,000 – Rs.873,000
= Rs.1,927,000
The NPV of switching is positive, therefore, the firm should proceed to
extend credit for one months.
8-20
Profit under new policy =3,000(Rs.315 – Rs.240)=Rs.225,000
Profit under cash policy =3,100(Rs.320 – Rs.245) =Rs.232,500
Incremental cash inflows= Profit under new policy - Profit
under cash policy
= Rs.232,500 - Rs.225,000 =Rs.7,500
If we treat this cash flows as perpetuity, the present value of
cash inflows is calculated as follows. Using 2percent
discount rate
PV=Rs.7,500/0.02 =Rs.375,000
Cost of switching= current revenue foregone + cost of
additional sales
= (3,000×315)+(100×245)
= Rs.945,000+24,500
= Rs.969,500
 Now, we can determine NPV as follows

NPV=PV – cost of switching

=Rs.375,000 – Rs.969,500
= -Rs.594,500
The NPV of switching is negative, therefore ,the firm should
Not proceed to extend credit for 30 days.
Solution:
a. 1st quarter
receivable(march)=Rs.120,000(0.8)+Rs.100,000(0.5)
=Rs.146,000
b. 2nd quarter receivable (June)= Rs.160,000(0.8)+Rs.140,
000(0.5)=Rs.198,000
1st quarter
ADS=(Rs.50,000 + Rs.100,000 + 120,000) / 90=Rs.3,000
DSO=Rs.146,000/Rs.3000 =48.7 days
2nd quarter
ADS=Rs.105,000 +Rs.140,000+Rs.160,000)/90
=Rs.4,500
DSO=Rs.198,000/4500 =44 days
cumulative ADS=Rs.3000+Rs.4500 =Rs.3,750
2
 DSO=Rs.198,000
Rs.3,750
= 52.8 days
Age of accounts Rupee value % of total
0-30 Rs.0 65%
31-60 70,000 35
61-90 0 0
198,000 100%

Month Sales Receivables Receivables/sales

April Rs.105,000 Rs.0 0%
May 140,000 70,000 50%
June 160,000 128,000 80%
198,000 130%