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Unformatted text preview: e receivables balance must
be financed? What would the firm’s balance sheet figures for accounts receivable, notes
payable, and retained earnings be at the end of 1 year if notes payable are used to finance the
investment in receivables? Assume that the cost of carrying receivables had been deducted
when the 25 percent profit margin was calculated. (5) If bank loans have a cost of 12 percent, what is the annual dollar cost of carrying the receivables? c. What are some factors that influence (1) a firm’s receivables level and (2) the dollar cost of carrying
d. Assuming that the monthly sales forecasts given previously are accurate, and that customers pay
exactly as was predicted, what would the receivables level be at the end of each month? To reduce
calculations, assume that 30 percent of the firm’s customers pay in the month of sale, 50 percent pay
in the month following the sale, and the remaining 20 percent pay in the second month following the
sale. Note that this is a different assumption than was made earlier. Also assume there are 91 days
in each quarter. Use the following format to answer parts d and e:
Month Sales End-of-Month Receivables January $100 $ 70 February 200 160 March 300 250 April 300 May 200 June Sales Ads $600 DSO $6.67 (A/R)(ADS) 100 37.5 e. What is the firm’s forecasted average daily sales for the first 3 months? For the entire half-year? The
days sales outstanding is commonly used to measure receivables performance. What DSO is
expected at the end of March? At the end of June? What does the DSO indicate about customers’
payments? Is DSO a good management tool in this situation? If not, why not?
f. Construct aging schedules for the end of March and the end of June (use the format given below).
Do these schedules properly measure customers’ payment patterns? If not, why not?
Age of Account (Days) JUNE A/R %
84% 0–30 $210 31–60 40
0 % 16 61–90 A/R 0 $250 100% g. Construct the uncollected balances schedules for the end of March and the end of June. Use the format given below. Do these schedules properly measure customers’ payment patterns?
to A/R JUNE
A/R-toSales Ratio Month Sales January $100 February 200 40 20 May March 300 210 70 June $ 0 0% Month
April Sales Contribution
to A/R A/R-toSales Ratio 27-30 Chapter 27 Providing and Obtaining Credit h. Assume that it is now July of Year 1, and the brothers are developing pro forma financial statements
for the following year. Further, assume that sales and collections in the first half-year matched the
predicted levels. Using the Year 2 sales forecasts as shown next, what are next year’s pro forma
receivables levels for the end of March and for the end of June?
March Predicted Sales
500 Predicted A/R-toSales Ratio Predicted Contribution
to Receivables 0%
Projected March 31 A/R balance April
Projected June 30 A/R balance i. Assume now that it is several years later. The brothers are concerned about the firm’s current credit
terms, which are now net 30, which means that contractors buying building products from the firm
are not offered a discount, and they are supposed to pay the full amount in 30 days. Gross sales are
now running $1,000,000 a year, and 80 percent (by dollar volume) of the firm’s paying customers generally pay the full amount on Day 30, while the other 20 percent pay, on average, on Day 40. Two
percent of the firm’s gross sales end up as bad debt losses.
The brothers are now considering a change in the firm’s credit policy. The change would entail
(1) changing the credit terms to 2/10, net 20, (2) employing stricter credit standards before granting
credit, and (3) enforcing collections with greater vigor than in the past. Thus, cash customers and
those paying within 10 days would receive a 2 percent discount, but all others would have to pay
the full amount after only 20 days. The brothers believe that the discount would both attract additional customers and encourage some existing customers to purchase more from the firm—after all,
the discount amounts to a price reduction. Of course, these customers would take the discount and,
hence, would pay in only 10 days. The net expected result is for sales to increase to $1,100,000; for
60 percent of the paying customers to take the discount and pay on the 10th day; for 30 percent to
pay the full amount on Day 20; for 10 percent to pay late on Day 30; and for bad debt losses to fall from
2 percent to 1 percent of gross sales. The firm’s operating cost ratio will remain unchanged at 75 percent, and its cost of carrying receivables will remain unchanged at 12 percent.
To begin the analysis, describe the four variables that make up a firm’s credit policy, and explain
how each of them affects sales and collections. Then use the information given in part h to answer
parts i through q.
j. Under the current credit policy, what is the firm’s days sales outstanding (DSO)? What would the
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