KNOWLEDGE

ACADEMY

DEBTORS MANAGEMENT
Q.1 Credit Granting Decision - Decision Tree Analysis N11, M15

A New Customer has approached a Firm to establish new business connection.

The Customer require 1.5 month of credit. If the proposal is accepted, the Sales
of the Firm will go up by ₹2,40,000 per annum. The new customer is being
considered as a Member of 10% risk of non-payment group.
The Cost of Sales amounts to 80% of Sales. The Tax Rate is 30% and the
desired Rate of Return is 40% (after tax).
Should the Firm accept the offer? Give your opinion on the basis of
calculations.

Q.2 Debtors Decision - Interest on Average Debtors M 09, M 07, M11

A Company currently has an annual turnover of ₹50 Lakhs and an average

collection period of 30 days. The Company wants to experiment with a more
liberal credit policy on the ground that increase in collection period will
generate additional sales. From the following information, kindly indicate
which policy the Company should adopt:

Credit Policy Average Collection Annual Sales (₹in

Period Lakhs)

A 45 days 56

B 60 days 60

C 75 days 62

D 90 days 63

Variable Cost is 80% of Sales. Fixed Cost is ₹6 Lakhs per annum.

Required (pre-tax) Return on Investment is 20%. A year may be taken to
comprise of 360 days.
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ACADEMY
Q.3 Debtors Decision - Interest on Average Debtors

Vishnu Limited is considering the liberalisation of existing credit terms to three

of their large customers A, B and C. The credit period and likely quantity that
will be lifted by the customers are as follows -

Credit Period Quantity lifted (No. of units)

(Days)
A B C

0 1,000 1,000 -

30 1,000 1,500 -

60 1,000 2,000 1,000

90 1,000 2,500 1,500

The Selling Price per unit is ₹750. The expected contribution is 1/3rd of the
Selling Price. The cost of carrying Debtors averages 20% per annum. You are
required -
1. To determine the credit period to be allowed to each customer (Assume 1
year = 360 days).
2. To list other problems the Company might face in allowing the credit period
as determined in (1) above.

Q.4 Debtors Decision - Interest on Average Debtors, Bad Debts RTP

The current sales of Raja Ltd are ₹250 Lakhs. It sells on terms of net 30 days
and the average collection period (ACP) is 40
days. Bad Debt losses are 3% of Sales. The cost of funds blocked in receivables
is reckoned at 18%. The Variable Costs are
80% of Sales. Since the Company has excess capacity, it can expand its sales
substantially without additional Fixed Costs. The
Management is evaluating three alternative credit policies –
1. Policy A: This calls for relaxing the credit standards. It is expected to increase
sales by ₹40 Lakhs. On the new sales, ACP will be 50 days and the Bad Debt
Loss is 15%.
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ACADEMY
2. Policy B: This involves changing the terms of credit from net 30 to net 45.
This is expected to raise Sales by ₹15 Lakhs, lengthen the ACP to 60 days and
result in a Bad Debt Loss of 4% on the new sales.
3. Policy C: This calls for decreasing the rigours of collection effort. This is
expected to push sales up by ₹10 Lakhs, increase the ACP to 50 days and raise
the Bad Debt Loss to 4%.
Determine the most optimum policy for the Company. Take 1 year = 360 days.

Q.5 Working Capital Management – Debtors Decision M16

A Trader whose current Sale are ₹4,20,000 per annum and an Average
Collection Period of 30 days, wants to pursue a more liberal policy to improve
sales. A study made by a Management Consultant reveals the following
information:

Credit Policy Increase in Increase in Sales Present default

Collection Period anticipated

1 10 days ₹21,000 1.5%

II 30 days ₹52,500 3%

III 45 days ₹63,000 4%

The Selling Price per unit is ₹3. Average Cost per unit is ₹2.25 and Variable
Cost per unit is ₹2. The current Bad-Debts Loss is 1%. Required Return on
Additional Investment is 20%. Assume a 360 days year.

Which of the above policies would you recommend for adoption?

Q.6 Debtors Decision - Interest on Average Debtors, Bad Debts, Collection

Expenses M 06

A Company has Sales of ₹25,00,000. Average Collection Period is 50 days, Bad

Debt losses are 5% of Sales and Collection Expenses are ₹25,000. The cost of
funds is 15%. The Company has 2 alternative Collection Programmes:

Particulars Programme I Programme II

Average Collection Period reduced to 40 days 30 days

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ACADEMY
Bad Debt Losses reduced to 4% of Sales 3% of Sales

Collection Expenses ₹50,000 ₹80,000

Evaluate which Programme is viable.

Q.7 Debtors Decision - Interest on Average Debtors, Bad Debts N 13

PTX Limited is considering a change in its present credit policy. Currently it is

evaluating two policies. The Company is required to give a Return of 20% on
the Investment in new Accounts Receivables. The Company's Variable Costs
are 70% of the Selling Price. Information regarding present and proposed
policies are given below. Which option would you recommend?

Present Policy Policy Option 1 Policy Option

2

Annual Credit Sales ₹30,00,000 ₹42,00,000 ₹45,00,000

Debtors Turnover Ratio 4 times 3 times 2.4 times

Loss due to Bad Debts 3% of Sales 5% of Sales 6% of Sales

Note: Return on Investment in new Accounts Receivable is based on Cost of

Investment in Debtors.

Q.8 Debtors Decision - Interest on Average Debtors, Bad Debts N 19

XYZ Ltd is making a turnover of ₹ 70 Lakhs out of which 60% is made on credit.
The Company allows credit for 30 days. The Company is considering proposals
to liberalize the credit policy. Information regarding options available are as
under:

Proposal- A Proposal-B

Credit Period 45 days 60 days

Anticipated Credit Sales ₹ 65 Lakhs ₹ 80 Lakhs

The product yields an average contribution of 20%on Sales. Fixed Costs are ₹
6 Lakhs per annum. The Company expects a pre-tax return of 18% on Capital
Employed. At present, the Company makes a Provision for Bad Debts @ 0.5%
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ACADEMY
which is expected to go up to 1% for Proposal-A and to 2% for Proposal-B.
Assume 360 days in a year. Evaluate the proposals.

Q.9 Debtors Decision - Interest, Bad Debts, Collection Expenses M 19

HT Ltd has Sales of ₹ 960 Lakhs. Selling Price per unit is ₹ 80 and Variable
Operating Cost is 75% of Selling Price and Average Cost per unit is ₹ 70. The
cost of funds is 12%. Average Collection Period is 75 days, Bad Debt Losses
are 4% of Sales and Collection Expenses are ₹ 15.60 Lakhs. The Company is
considering whether collection policies should be made strict. Due to rigorous
collection procedures, Sales are expected to decline to ₹ 920 Lakhs. Average
Collection Period will reduce to 60 days and Bad Debts will reduce to 2.5% of
Sales. Annual Collection Expenses will increase to ₹ 22.50 Lakhs.
Should the Company carry out the proposal? (Assume 360 days pa and
Investment in Debtors are calculated on Total Cost)

Q.10 Credit Period Decision - with required Post-Tax Return N 03

A Firm has a current sale of ₹2,56,48,750. The Firm has unutilised capacity.
In order to boost its sales, it is considering the relaxation in its credit policy.
The proposed terms of credit will be 60 days credit against the present policy
of 45 days. As a result, the Bad Debts will increase from 1.5% to 2% of Sales.
The Firm's sales are expected to increase by 10%. The Variable Operating Costs
are 72% of the Sales. The Firm's Corporate Tax is 35% and it requires and
after-tax return of 15% on its investments. Should the Firm change its credit
period?

Q.11 Credit Period Decision-with required Post-Tax Return N 17

The current Credit Sales of a Firm is ₹ 15 Lakhs and the Firm still has an
unutilized capacity. In order to boost its sales, the Firm is willing to relax its
Credit Policy.
The Firm proposes a new Credit Policy of 2/10 net 60 days as against the
present policy of 1 /10 net 45 days. The Firm expects an increase in the Sales
by 12%. However, it is also expected that Bad Debts will go upto 2% of Sales
from 1.5%.
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ACADEMY
The Contribution to Sales Ratio of the Firm is 28%. The Firm’s Tax Rate is 30%
and Firm requires an after-tax return of 15% on its Investment. Should the
Firm change the Credit Policy?

Q.12 Credit Period Decision - Effect of Bad Debts, etc. N 18 (New)

MN Ltd has a current turnover of ₹ 30,00,000 p.a. Cost of Sales is 80% of

Turnover and Bad Debts are 2% of Turnover. Cost of Sales includes 70%
Variable Cost and 30% Fixed Cost, while Company’s required Rate of Return
is 15%. MN Ltd currently allows 15 days credit to its customers, but it is
considering increase this to 45 days credit in order to increase turnover.
It has been estimated that this change in policy will increase turnover by 20%,
while Bad Debts will increase by 1%. It is not expected that the policy change
will result in an increase in Fixed Cost and Creditors and Stock will be
unchanged.
Should MN Ltd introduce the proposed Policy? (Assume a 360 days Year).

Q.13 Debtors Decision - Interest on Average Debtors, Bad Debts, Discount

Allowed M12

A Company is presently having a Credit Sales of ₹12 Lakh. The existing credit
terms are 1/10 net 45 days, and average collection period is 30 days. The
current Bad Debts Loss is 1.5%. In order to accelerate the collection process
further as also to increase Sales, the Company is contemplating liberalization
of its existing credit terms to 2/10 net 45 days. It is expected that Sales are
likely to increase 1/3rd of existing Sales, Bad Debts increase to 2% of Sales and
average collection period to decline to 20 days. The Contribution to Sales Ratio
of the Company is 22% and Opportunity Cost of Investment in Receivables is
15% (pre-tax). 50% and 80% of Customers in term of Sales Revenue are
expected to avail Cash Discount under existing and liberalization scheme
respectively. Tax Rate is 30%. Should the Company change its credit terms?
(Assume 360 days in a year).
KNOWLEDGE
ACADEMY
Q.14 Debtors Decision - Interest on Average Debtors, Discount Allowed -
Weighted Average Collection Period

Aakash Ltd sells on credit terms "2/15 net 45". Its present Sales are ₹100
Lakhs per annum, Variable Costs are 70% of Sales and Fixed Costs are ₹12
Lakhs per annum. The Company's cost of funds is 24% and it is observed that
40% of the customers avail the discount, while the rest pay on the due date.
The Company is considering relaxing its credit terms to "3/18 net 45". This
relaxation is expected to increase Sales by 25% and Fixed Costs by ₹3 Lakhs
per annum. Due to economy of operations, Variable Costs will be reduced to
68% on all Sales. It is expected that 80% of the customers will avail the
discount, the rest paying on the due date.
Advise whether the relaxation in credit terms is worthwhile.

Q.15 Working Capital – Debtors Management - Credit Period Decision N14

PQR Ltd having an Annual Sales of ₹30 Lakhs, is re-considering its present
collection policy. At present, the Average Collection Period is 50 days and the
Bad Debts Losses are 5% of Sales, The Company is incurring an expenditure
of ₹30,000 on account of collection of receivables.

The alternative policies are given below. Evaluate them based on incremental
approach and state which is more beneficial.

Particulars Alternative I Alternative II

Average Collection Period 40 days 30 days

Bad Debt Losses 4% of Sales 3% of Sales

Collection Expenses ₹60,000 ₹95,000

Q.16 Computation of Average Age of Receivables RTP

From the following details, calculate the Average Age of Receivables and
comment upon the results.

Month Sales for the first 3 quarte₹ of the year

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ACADEMY
Quarter 1 Quarter 2 Quarter 3

First 15,000 7,500 22,500

Second 15,000 15,000 15,000

Third 15,000 22,500 7,500

Total 45,000 45,000 45,000

Working days 90 90 90

The Company's collection pattern is as follows -

• 10% of the Sales in the same month,
• 20% of the Sales in the 2nd month,
• 30% of the Sales in the 3rd month,
• 40% of the Sales in the 4th month.

Q.17 Factoring Decision - Basics M 18

A Company is considering to engage a Factor. The following data is given.

Advise if the Factoring Agreement is worthwhile.
• The current Average Collection Period for the Company’s Debtors is 90 days
and ½% of Debtors default. The Factor has agreed to pay money due after 60
days and will take the responsibility of any loss on account of bad debts.
• The annual charge for Factoring is 2% of Turnover. Administration Cost
Saving is likely to be ₹ 1,00,000 per annum.
• Annual Credit Sales are ₹ 1,20,00,000. Variable Cost is 80% of Sales Price.
The Company’s Cost of Borrowing is 15% per annum. Assume 360 days in a
year.

Q.18 Effective Cost of Factoring

Under an advance factoring arrangement, Super Factors Ltd (SFL) has

advanced a sum of ₹ 14 Lakhs against the Book Debts of Ramesh Ltd. The
agreement provides for 80% advance (maintaining a Reserve of 20% to provide
for disputes, allowances, returns and other deductions) of the value of Factored
Book Debts. The Advance carries an interest of 20% p.a. compounded
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ACADEMY
quarterly. Factoring Commission is 1.5% of the value of Factored Book Debts.
Both Interest & Commission are collected upfront.

From the above data, answer the following questions -

1. What is the amount of advance payable? What is the effective cost of funds
made available to Ramesh Ltd?

2. Suppose SFL collects the Commission upfront but Interest is collected in

arrears, what is the effective cost of funds made available to Ramesh Ltd?

Q.19 Working Capital Management - Debtors- Factoring vs Bank Finance

M 09, N15

A Firm has a total sale of ₹200 Lakhs of which 80% is on credit. It is offering
credit terms of 2/40, net 120. Of the total, 50% of customers avail of discount
and the balance pay in 120 days. Past experience indicates that Bad Debt
losses are around 1% of Credit Sales. The Firm spends about ₹2,40,000 per
annum to administer its credit sales. These are avoidable as a Factor is
prepared to buy the Firm's Receivables. He will charge 2% Commission. He will
pay Advance against Receivables to the Firm at an Interest Rate of 18% after
withholding 10% as Reserve.
• What is the Effective Cost of Factoring? Consider year as 360 days.
• If Bank Finance for Working Capital is available at 14% Interest, should the
Firm avail of factoring service?

Q.20 Own Collection System vs Factoring RTP

Jaidev Ltd has total credit sales of ₹40 Lakhs p.a. and its average collection
period is 90 days. The past experience indicates that the Bad Debt losses are
around 3% of credit sales. Jaidev spends about ₹1,00,000 per annum on
administrating its credit sales. It is considering availing the services of a
Factoring Firm. It has received offer from Uday Ltd, which agrees to buy the
receivables of Company. Uday will charge Commission of 3% and also agrees
to pay advance against receivables at an Interest Rate of 18% p.a after
withholding 10% as Reserve. Should Jaidev accept Uday's offer if the former's
ROI is 15%? Assume 360 days in a year.
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ACADEMY
Q.21 Own Financing vs Non-Recourse Factoring RTP

Ramana Ltd sells on credit terms 2/10 net 30. It has an annual credit sale of
₹900 Lakhs, with a Variable Cost of 80% and Bad Debts of 0.75%. Past
experience shows that 50% of the customers avail cash discount and the
remaining customers pay 50 days after the date of sale. Presently the
Company's investment in receivables are financed in the ratio of 2 :1 by a mix
of Bank Borrowings and Own Funds, which cost 24% and 27% p.a.
respectively. The Company also incurs ₹16 Lakhs on Credit Collection Costs.
The Company is considering a "Non-Recourse Factoring" arrangement with T-
Facto₹ Ltd on the following terms - (a) 15% Factor Reserve, (b) Guaranteed
Payment date = 24 days after the date of purchase, (c) 22% Interest / Discount,
(d) 4% Factoring Commission. Evaluate whether the factoring proposal is
worthwhile, with suitable assumptions, wherever applicable.

Q.22 Factoring v Bank Facility

The turnover of Raghav Ltd is ₹60 Lakhs of which 80% is on credit. Debtors
are allowed one month to clear off the dues. A Factoring Institution is willing
to advance 90% of the bills raised on credit for a Fee of 2% per month plus a
Commission of 4% on the total amount of debts. Raghav Ltd, as a result of this
arrangement, is likely to save ₹21,600 annually in management costs and
avoid Bad Debts at 1% on the credit sales.
A Scheduled Bank has come forward to make an advance equal to 90% of the
Debts at an Interest Rate of 18% p.a. However, its Processing Fee will be at 2%
on the Debts. Would you accept Factoring or the offer from the Bank?