Chapter 20, Problem 2M

Summary Introduction

Case study:

Person SW, thepresident of H industries, has been exploring many ways to increase the financial performance of the company. The sales of H industries were slow. However due to the expansion in the economy, the sales might increase in the future. Person SW has asked Person AP to examine the credit policy of H industries and bring about changes to increase the profitability.

Characters in the case:

• H industries: The manufacturing industry of office equipment
• Person SW: The president of H industries
• Person AP: The company’s treasurer

To discuss: Whether it is plausible when the default rate and administrative cost are higher in option 3 compared to option 2.

Introduction:

Credit policy refers to a set of procedures that include terms and conditions for providing goods on credit and principles for making collections.

Adequate information:

The company has a policy of net 30. The default rate on credit is 1.6%. Person AP came with 3 available options. H industries’ variable cost of production are 45% of sales, the interest rate is 6% of effective annual rate. The options are as follows:

• Option 1: To relax the decision of the company to grant credit.

Option 1 has the following items: The annual sales of $140, default rate of 2.5%, administrative costs of 3.2% and the receivables period of 38 days.

• Option 2: To increase the credit period to net 45

Option 2 has the following items: The annual sales of $137, default rate of 1.8%, administrative costs of 2.4% and the receivables period of 41 days.

• Option 3: Combination of relaxed policy and extension of credit period.

Option 3 has the following items: The annual sales of $150, default rate of 2.2%, administrative costs of 3.0% and the receivables period of 49 days.