Fundamentals of Managing Finance Chap 12

Today motorola saves much more in reduced

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Unformatted text preview: ils. Vendors were told they had to perform at high quality levels to keep Motorola as a customer. In return, Motorola started paying those vendors by attaching a check to the purchase order and now pays by electronic transfer. Today, Motorola saves much more in reduced administrative costs than the value of the payables float. 10 Observation: Of course, virtually all large retailers also accept these credit cards. 298 Part IV Adding Value Figure 12.4 is a cash flow spreadsheet for permanent accounts receivable decisions. It is an expanded version of Figure 12.2, listing the investment and operating cash flows common to accounts receivable decisions. There are three potential changes to the amount the firm has invested in its accounts receivable process, four potential changes to annual operating cash flow, and a potential change to income taxes. Where the numbers may be calculated by a formula, the relationship is given in the cash flow columns. The potential changes in investment are: The change in the money invested in accounts receivable itself, calculated by taking the projected change in accounts receivable and multiplying it by a variable cost percentage to remove the profit portion. The changed value from receiving profits earlier or later, calculated as the daily profit flow (sales/day contribution percentage) multiplied by the change, if any, in the collection period. The change in other working capital, such as inventory and cash, which is not calculated by a standard formula. The potential changes in operating cash flows are: The change in profits, calculated as the change in sales multiplied by the firm’s contribution percentage. The change in bad debt losses, calculated as the change in sales multiplied by the percent that become bad debts. The change in discounts granted, calculated as the discount percentage multiplied by the sales affected by the discount. The change in administrative costs, which is not calculated by a standard formula. The change in taxes is the net change to operating cash flows multiplied by the firm’s marginal tax rate. FIGURE 12.4 Cash flow spreadsheet for permanent accounts receivable decisions. The spreadsheet organizes the data into three changes to the level of investment, four changes to operating cash flows, and the change to taxes. Year 0 Investment Accounts receivable Changed collection period Other working capital Operating cash flows Contribution from sales Bad debts Discounts Administrative costs Tax—changed income Net cash flows AR (sales/day variable cost % contribution %) Years 1– CP sales contribution % sales % bad debts discount % affected sales Tax on above Chapter 12 Investing in Permanent Working Capital Assets 299 A firm that extends credit to its customers must make three decisions that define its credit policy: (1) credit standards—who is an acceptable credit customer, (2) payment date—when is the customer expected to pay, and (3) price changes— what discounts may be taken for early payment and what finance charges will be added if payments are late. Each variable affects the level of the firm’s permanent accounts receivable. We look at each in turn. 1. Credit Standards NET Present Value A discussion of credit scoring systems can be found at the Federal Trade Commission website: http://www.ftc.gov/bcp/ menus/consumer/credit/ reports.shtm To qualify acceptable credit customers, companies create scoring systems based on data about the customer’s financial condition, stability, and past payment performance. Business customers are asked to provide financial statements and supporting data which are used for ratio and other financial analysis. Individuals are asked to fill out a form in which they report their income and their financial, employment, and family status. When available, information is obtained from credit reporting agencies, such as Dun & Bradstreet for businesses and Experian for individuals. A common system is to divide credit applicants into three groups. Those with the highest scores receive credit immediately, those with the lowest scores are rejected for credit, and those in the middle are investigated further before a decision is made. Extending credit to riskier customers increases sales, and hence profits, but adds to administrative costs and exposes the firm to additional bad debts. Contracting credit reduces these costs but also reduces sales and profits. Example Credit Standards Marie Kaye’s company currently extends credit to applicants scoring 150 or more points on its credit qualification scale. Marie is interested in the value of extending credit to applicants who score 145–149 points. She has prepared the following forecasts: a. Sales to the new customers will total $20,000,000 per year b. The new customers will pay in 90 days on average (assume a 360-day year for convenience) c. 5% of the new sales will become bad debts and will not be collected d. No discounts will be offered to the new customers e. Administering th...
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This note was uploaded on 03/15/2013 for the course FIN 250 taught by Professor Kim during the Spring '13 term at Medgar Evers College.

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