Question

Tightening Credit Terms Maxwell Corp. distributes the "Smart" brand of electronic controller systems. The company currently has a credit policy of 1/10, net 40, though on average only 20% of customers pay in 10 days and take the discount, while another 30% pay on average in 15 days yet still take the unearned discount. The company's remaining customers pay on average in 50 days. Bad debt losses are 3% of sales. The company's sales are currently $600,000 per month, all on credit. Maxwell is thinking of restructuring its credit and collections department, with the goal of eliminating all unearned discounts and reducing bad debt losses to 1.5%. With this new policy, the company believes that sales will fall by 5%, that 40% of customers will pay in 10 days and obtain the discount, and that the remaining customers will pay in 40 days. Maxwell's variable costs are 60% of sales, its monthly collections department expense is expected to rise by $6,000 to $20,000, and its opportunity cost on funds is 12%. Maxwell's tax rate is 30%.

1. Should the company implement the new policy? Clearly explain your rationale (300 words minimum).

Answer

Current Policy:

New Policy:

2. What is the maximum percentage sales decline that the company could take and still proceed with the new policy?

Answer:

Cash Conversion Cycle Sterling Enterprises has an inventory conversion period of 50 days, an average collection period of 35 days, and a payables deferral period of 25 days. Assume that cost of goods sold is 80% of sales.

1. What is the length of the firm's cash conversion cycle?

2. If Sterling's annual sales are $4,380,000 and all sales are on credit, what is the firm's investment in accounts receivable?

3. How many times per year does Sterling Enterprises turn over its inventory?

4. What are some strategies to improve the cash conversion cycle? (100 words minimum).

Answer 1

Maxwell Corp should consider implementing the new policy as it would reduce bad debt losses and decrease unearned discounts, despite a small decline in sales and increased collections department expenses, which are likely offset by the savings from lower losses and opportunity costs.

Step-by-step explanation:

To decide whether Maxwell Corp should implement the new credit policy, we must evaluate the effects on sales revenue, costs, bad debt losses, and the opportunity cost of funds.

Current Policy: Maxwell's sales are $600,000 per month. With a bad debt loss of 3%, the actual revenue is reduced by $18,000. Unearned discounts of 30% (estimated at 1% of the total sales, due to the 1/10 term) cost another $1,800. Their monthly credit department expenses are $14,000 (inferred), and since the average collection period is beyond the net terms, funds are tied up longer, increasing the opportunity cost.

New Policy: With the sales expected to decline by 5%, new sales would be $570,000. Bad debt losses would decrease to 1.5%, saving $8,100. Also, with 40% of customers taking the discount and the rest paying in 40 days, the company would reduce unearned discounts and lower the opportunity cost. However, the credit department expenses would increase by $6,000 to $20,000.

By comparing the savings from reduced bad debt and unearned discounts with the increased costs and lost sales revenue, it appears the new policy may be financially beneficial due to the substantial decrease in costs associated with bad debt losses and opportunity costs. The increase in the collections department expense is outweighed by these savings.