11.1 Lecture_21_Monday_5_October

11.1 Lecture_21_Monday_5_October - FINC 202 2009 Lecture...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: FINC 202 2009 Lecture 21: Managing Accounts Receivable 1 Reported in the the online newspaper: Reported thenewzealandweek.co.nz thenewzealandweek.co.nz 10th July 2009 A ‘relaxed attitude’ from firms to collecting debts is changing as pressure tightens on the bottom line, Dun & Bradstreet says. Overall, New Zealand businesses reported 127 percent more debts for collection in the March quarter this year than in the same period last year. “As a consequence, cash flow and receivables management have come to the fore as executives have realised the critical role they play in ensuring the sustainability of business.” Veda Advantage says that ‘a staggering increase’ in businesses not paying their bills suggests the economy might not recover until 2011. The credit reporting agency released data showing commercial defaults up 64.56 percent in the first six months of the year compared with last year. Commercial inquiries for credit fell 16.43 percent. 2 The Optimal Credit Policy What is the optimal credit policy? How do we evaluate a change in policy ? Firm can relax credit policy by: • • • ________________________________ reducing discount selling on credit ___________________ credit 3 Effects of relaxation in credit policy: • Rise in sales revenue • Rise in labour/materials costs • Fall/rise in discount expenses ??? More info needed • ____________________________ • Rise in “carrying costs” • Rise in collection costs Assuming ____________________ 4 The Optimal Credit Policy (2) Firm can tighten credit policy by: • shorten credit period • raising discount • Selling on credit ____________________ 5 Effects of tightening of credit policy: • Fall in sales revenue • Fall in labour/materials costs • Rise/fall in discount expenses Not clear which • Fall in % bad debts • ______________________________ • Fall in collection costs If fewer slow payers to chase If collection procedures not intensified 6 $ Optimal Credit Policy 0 M% CP* Strictness of credit policy (increasing ⇒ ) 0 Cost of credit policy (increasing ⇒ ) 7 Model for analysing changes in credit policy: Estimate ________________________ Estimate cost of carrying receivables (COCR) at new sales level credit sales COCR = DSO × ×VC ratio × cost of funds 360 Approve change in credit policy only if NPAT rises 8 Model for analysing changes in credit policy: ______________________________ ____________________________ ____________________________ credit sales COCR = DSO × ×VC ratio × cost of funds 360 9 Comments on the COCR Model This model works on how credit policy impacts on the Income Statement But we will extend beyond it in the JANUS Ltd example (coming up!) to consider: ________________________________ • How the same credit policy informs our choice of 10 Problem 1: Credit Policy Analysis for JANUS Ltd Determine Janus Ltd’s choice of policy given the following information: Variable cost Ratio Cost of Funds Tax rate 82% 16% 35% Current Policy: Credit Terms: Net 60 days (no discounts) DSO: 80 days Credit Sales $4,000,000 Alternative Policy Credit Terms: Net 30 days DSO: 40 days Credit Sales $4,212,000 11 Solution 1: JANUS Ltd COCRCurrent Therefore adopt new policy? Check other effects first! Credit Sales = ( DSO ) ( VC Ratio ) ( Cost of Funds ) 360 = = COCRNew = = . 12 JANUS Ltd Example continued The percentage improvement in cost of carrying receivables: But the effect on the bottom line of the Income statement will be somewhat less than this, as _________________________________________ 13 Sales Less Discounts Net Sales Less Production Cost Less COCR EBT tax @ 35% NPAT Current 4,000,000 4,000,000 3,280,000 720,000 116,622 603,378 211,182 392,196 New 4,212,000 4,212,000 3,453,840 758,160 61,402 696,758 243,865 452,893 ∆NPAT = NPATNEW − NPATCURRENT ...or = = NPATNEW − NPATCURRENT NPATCURRENT = = 14 JANUS Example Continued And are we only interested in NPAT? • What about ROA, ROE and other profitability ratios? To extend the JANUS example and still keep it workable: Assume: • Janus is an all­equity company (no debt) • All of _______________________________________ Therefore bottom line of the Balance Sheet is kept constant • ______________________________________ • Janus Ltd’s sales are all credit sales • No change in Inventory or Cash or Current Liabilities • Ignore the effect of depreciation expenses 15 JANUS Example Continued Let: • • • • Total AssetsCURRENT = $7,844,000 InventoryCURRENT = 855,000 CashCURRENT = 100,000 Current Liabilities = 737,556 What is the impact of the policy on Janus’ ROA? M? Du Pont Equation? Start by calculating the average Receivables balance (given that TA = Total Equity) 16 Choice of Current Asset Management policy? Credit Sales Average Receivables Balance = × DSO 360 ARBCURRENT = = ARBNEW = = ∆ARB = Reduction in TA = = ROA ROA Solution for JANUS (first step) (first TANEW = 17 Second step of ROA Solution for JANUS ROACURRENT NPATCURRENT = TA = = Therefore ∆ ROA = ROANEW = = NPATNEW = TA = 18 Du Pont Equation for JANUS Ltd The Du Pont Equation is: NPAT Sales TA ROE = × × Sales TA E Given TA = E, this changes to: NPAT Sales TA ROE = × × Sales TA TA ROE = ROA = NPAT Sales × Sales TA 19 = M × TATO M Solution for JANUS NPAT M= Sales M CURRENT = M NEW = ∆M = . 20 TATO Solution for JANUS Sales TATO = TA TATOCURRENT = TATONEW = ∆TATO = . 21 Liquidity Risk for JANUS CA Current Ratio = CL CRCURRENT ARB + Inv + Cash = CL = = CA − Inventory Quick Ratio = CL ARB + Cash QRCURRENT = CL = = QRNEW = = 22 CRNEW = = Liquidity risk _____________________ Lessons from Janus Lessons The alternative (new) policy: • Improves NPAT • Improves net profit margin • Improves TATO Adoption of the alternative (new) policy moves JANUS closer to: • _____________________________________________ • Should Janus do it? The answer depends on how the CEO and CFO view the liquidity risk Because ___________________________________ • Via the reduction of DSO • Therefore improves ROA and ROE • But increases the liquidity risk Via reductions in CR and QR 23 Practice Problem Please work through the Dingleby Ltd Accounts Receivable problem in LEARN • Dingleby restricts itself to covering the effect on the Income Statement • But it is comprehensive in that it brings in Discount Expenses Bad Debt losses as well. 24 ...
View Full Document

This note was uploaded on 12/23/2009 for the course BCOM FINC 202 taught by Professor Warwickanderson during the Spring '09 term at Canterbury.

Ask a homework question - tutors are online