Horngren’s Cost Accounting A Managerial Emphasis, Canadian 9th edition soluti...
3 salima paul commercial
1. Professor Salima Y. Paul
Plymouth University
CCR 2015
salima.paul@plymouth.ac.uk
2. Trade Credit (TC) can provide a means of
financing working capital across supply chains,
especially where bank finance is restricted or
more costly
It can also be a useful means of utilising
otherwise idle working capital, so reducing the
costs of financing for both suppliers and
buyers
SMEs, which are likely to encounter greater
problems with accessing external finance, use
more TC
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3. TC is an implicit short-term loan from non-
financial suppliers to their clients and is tied to
purchases
TC is one of the most important forms of
credit available to (some) businesses
BUT TC is the riskiest asset in the balance
sheet
So why do companies offer it?
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4. Finance: inventory financed by supplier,
‘helping hand’
Supplier/Customer relationship:
establishing/enhancing supplier/customer
relations
Quality of Product/Service: communication of
product information, information about
customers’ creditworthiness
Others reasons include: Transaction Cost,
Specific Investment, Firm’s Business
Environment etc.
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5. The extensive use of TC, however, brings with it
serious risk of:
late-payment (increased cost of credit)
default (increased risk of insolvency)
cash-flow problems (increased cost of
borrowing)
This begs the question as to why any firm would
grant TC. Such questioning prompts both
reactive and proactive categorical explanations
as to whether there is an optimum level of
Accounts Receivable (AR) for which firms can aim
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6. If yes, can TC be:
◦ used strategically to gain competitive
advantage?
◦ used to reduce costs related to granting
credit and improving profit?
◦ used by all companies to achieve this
desired level?
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7. To identify and examine:
◦ possible relationship between TC and profitability
and an optimum level of AR (we look at the effect of
TC on profit growth and AR to Total Assets)
◦ extent to which AR might be managed to achieve
competitive advantage (as opposed to being
prudently handled as a ‘necessary evil’)
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8. Standard approaches are used for testing
hypotheses
regression analysis to examine the
relationship between TC and profit
cumulative percentage change over 4 years in
Profit, Sales, Accounts Receivable
level and duration of TC
combined volume and maturity of TC
AR relative to the firm’s total assets (ARTA)
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9. One of the many hypotheses
predicts:
Profit and Accounts Receivable
are related by a hump-shaped
function, increasing up to a
certain level of trade credit but
decreasing thereafter
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10. • Randomly selected sample from broad
range of firm size, industry type and
location
• Postal questionnaire sent to 1500
companies (results based on 196
companies so far)
• Company accounts across 4 years
(2010-2014) obtained from FAME
Database
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11. The predicted hump-shaped pattern was
found to be statistically significant and
economically meaningful
According to this pattern, TC is beneficial only
up to a point. Roughly speaking, increasing TC
increases profit as long as AR does not exceed
42% of the total assets
Beyond this point, the effect becomes
counter-productive, leading to an actual
reduction in profitability of firms
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12. When used strategically to enhance
competitive advantage, firms have a
discernible optimal level of Accounts
Receivable
Our model demonstrates a viable methodology
that, despite data limitations, could be applied
usefully to an extended data set
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13. Co-operative supply chains are critical to
maximising the advantages of TC finance
Other key factors may restrict either the
provision or the benefits of TC to a wide range
of businesses:
◦ Market power
◦ Risk management
◦ Supply chain management
◦ Information asymmetries
◦ Lack of awareness-raising/training measures
◦
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14. Effective strategic management of Accounts
Receivable to achieve competitive advantage
requires:
◦ technical understanding and skills
◦ organisational competences
◦ business acumen
in the utilisation of credit information.
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