This document discusses an analysis performed by Dodd Tool, a manufacturing company, to determine whether it should relax its credit standards. It evaluates the potential effects on additional profit from sales, cost of increased investment in accounts receivable due to longer collection periods, and cost of higher expected bad debts. Specifically, Dodd Tool calculates that relaxing standards could increase sales by 3,000 units, resulting in $12,000 in additional profit. However, it also estimates this would lengthen collection periods, increasing receivables investment by $17,159 with a cost of $2,574. Bad debts are projected to double from 1% to 2% of sales. Dodd Tool aims to determine if the added profit outweighs the higher costs.

1. SHEILA WAILAN FAYCAN
Accounts Receivable
Management

2. Objective:
• To collect accounts receivable as quickly as possible
without losing sales from high-pressure collection
techniques
Three Topics:
1. Credit Selection and Standards
2. Credit Terms
3. Credit Monitoring

3. Objective:
• To collect accounts receivable as quickly as possible
without losing sales from high-pressure collection
techniques
Three Topics:
1. Credit Selection and Standards
2. Credit Terms
3. Credit Monitoring

4. Credit Selection and Standards
Credit Selection
Involves evaluating the customer’s creditworthiness
and comparing it to the firm’s credit standards
Credit Standards
The firm’s minimum requirement for extending credit to
a customer

5. Credit Selection and Standards
Five C’s of Credit:
 Character
 Capacity
 Capital
 Collateral
 Conditions

6. Credit Selection and Standards
Five C’s of Credit:
 Character
 Capacity
 Capital
 Collateral
 Conditions
 The applicant’s record of meeting past obligations.

7. Credit Selection and Standards
Five C’s of Credit:
 Character
 Capacity
 Capital
 Collateral
 Conditions
 The applicant’s ability to repay the requested credit, as judged in
terms of financial statement analysis focused on cash flows available
to repay debt obligations.

8. Credit Selection and Standards
Five C’s of Credit:
 Character
 Capacity
 Capital
 Collateral
 Conditions
 The applicant’s debt relative to equity.

9. Credit Selection and Standards
Five C’s of Credit:
 Character
 Capacity
 Capital
 Collateral
 Conditions
 The amount of assets the applicant has available for use in
securing the credit.

10. Credit Selection and Standards
Five C’s of Credit:
 Character
 Capacity
 Capital
 Collateral
 Conditions
 Current general and industry-specific economic conditions, and
any unique conditions surrounding a specific transaction.

11. Credit Selection and Standards
Credit Scoring
A credit selection method commonly use with high volume or
small-dollar credit requests
relies on a credit score determined by applying statistically
derived weights to a credit applicant’s scores on key financial
and credit characteristics
FICO® Scores are the most widely used credit scores.
 The higher your FICO® Scores, the better.
 FICO® Scores generally range from 300 to 850, though industry
- specific FICO® Scores have a slightly broader 250 – 900 score
range

12. Credit Selection and Standards
Credit Scoring
The national average FICO® Score is 695.

13. Credit Selection and Standards
Changing Credit Standards

14. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10
per unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $6.
The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable, and
 the cost of marginal bad debts.

15. Credit Selection and Standards
Additional Profit Contribution from Sales
Profit Contribution Per Unit = Sales Price Per Unit – Variable Cost Per Unit

16. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10 per unit. Sales
(all on credit) for last year were 60,000 units.
The variable cost per unit is $6. The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable, and
 the cost of marginal bad debts.

17. Credit Selection and Standards
Additional Profit Contribution from Sales (APCS)
Profit Contribution Per Unit = Sales Price Per Unit – Variable Cost Per Unit
= $10 – $6
= $4
Total APCS = Expected Increase in Unit Sales * Profit Contribution Per Unit

18. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10 per unit. Sales
(all on credit) for last year were 60,000 units.
The variable cost per unit is $6. The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable, and
 the cost of marginal bad debts.

19. Credit Selection and Standards
Additional Profit Contribution from Sales (APCS)
Profit Contribution Per Unit = Sales Price Per Unit – Variable Cost Per Unit
= $10 – $6
= $4
Total APCS = Expected Increase in Unit Sales * Profit Contribution Per Unit
= ($63,000 - $60,000) * $4
= $3,000 * $4
= $12,000

20. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10
per unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $6.
The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable, and
 the cost of marginal bad debts.

21. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable

22. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
where
Total variable cost of annual sales
Total Variable Cost of
= Variable Cost * Unit Sales
Annual Sales

23. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
where
Under Present Plan: ($6 x 60,000 units) = $360,000
Under Proposed Plan: ($6 x 63,000 units) = $378,000
Total variable cost of annual sales
Total Variable Cost of
= Variable Cost * Unit Sales
Annual Sales

24. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
where
Turnover of Accounts
=
365
Receivable Average Collection Period

25. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
where
Turnover of Accounts
=
365
Receivable Average Collection Period
Under Present Plan: 365
= 12.2
30
Under Proposed Plan: 365
= 8.1
45

26. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
where
Turnover of Accounts
=
365
Receivable Average Collection Period
Under Present Plan: 365
= 12.2
30
Under Proposed Plan: 365
= 8.1
45

27. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10 per unit. Sales
(all on credit) for last year were 60,000 units.
The variable cost per unit is $6. The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable, and
 the cost of marginal bad debts.

28. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
Under Present Plan:
=
Under Proposed Plan:
=

29. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
where
Under Present Plan: ($6 x 60,000 units) = $360,000
Under Proposed Plan: ($6 x 63,000 units) = $378,000
Total variable cost of annual sales
Total Variable Cost of
= Variable Cost * Unit Sales
Annual Sales

30. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
Under Present Plan: $360,000
=
Under Proposed Plan: $378,000
=

31. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
where
Turnover of Accounts
=
365
Receivable Average Collection Period
Under Present Plan: 365
= 12.2
30
Under Proposed Plan: 365
= 8.1
45

32. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
Under Present Plan: $360,000
=
12.2
Under Proposed Plan: $378,000
=
8.1

33. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
Under Present Plan: $360,000
= $29,508
12.2
Under Proposed Plan: $378,000
= $46,667
8.1

34. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment under Proposed Plan
- Average Investment under Present Plan
Marginal Investment in Accounts Receivable
X Cost of Funds Tied Up in Receivables
Cost of Marginal Investment in Accounts Receivable

35. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment under Proposed Plan
- Average Investment under Present Plan
Marginal Investment in Accounts Receivable
X Cost of Funds Tied Up in Receivables
Cost of Marginal Investment in Accounts Receivable

36. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
Under Present Plan: $360,000
= $29,508
12.2
Under Proposed Plan: $378,000
= $46,667
8.1

37. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment under Proposed Plan $46,667
- Average Investment under Present Plan 29,508
Marginal Investment in Accounts Receivable
X Cost of Funds Tied Up in Receivables
Cost of Marginal Investment in Accounts Receivable

38. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment under Proposed Plan $46,667
- Average Investment under Present Plan 29,508
Marginal Investment in Accounts Receivable $17,159
X Cost of Funds Tied Up in Receivables
Cost of Marginal Investment in Accounts Receivable

39. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10 per unit. Sales
(all on credit) for last year were 60,000 units.
The variable cost per unit is $6. The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable, and
 the cost of marginal bad debts.

40. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment under Proposed Plan $46,667
- Average Investment under Present Plan 29,508
Marginal Investment in Accounts Receivable $17,159
X Cost of Funds Tied Up in Receivables 0.15
Cost of Marginal Investment in Accounts Receivable

41. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment under Proposed Plan $46,667
- Average Investment under Present Plan 29,508
Marginal Investment in Accounts Receivable $17,159
X Cost of Funds Tied Up in Receivables 0.15
Cost of Marginal Investment in Accounts Receivable $2,574

42. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10
per unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $6.
The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable
 the cost of marginal bad debts

43. Credit Selection and Standards
Cost of Marginal Bad Debts
Level of Bad Debt x Selling Price Per Unit x
Total Unit Sales
Under Proposed Plan:
-Under Present Plan:
Cost of Marginal Bad
Debts

44. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10
per unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $6.
The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable, and
 the cost of marginal bad debts.

45. Credit Selection and Standards
Cost of Marginal Bad Debts
Level of Bad Debt x Selling Price Per Unit x
Total Unit Sales
Under Poposed Plan: (0.02 x $10/unit x 63,000 units) =$12,600
-Under Present Plan:
Cost of Marginal Bad
Debts

46. Credit Selection and Standards
Example:
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10
per unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $6.
The firm’s total fixed costs are $120,000.
The firm is currently contemplating a relaxation of credit standards that is
expected to result in the following:
 a 5% increase in unit sales to 63,000 units;
 an increase in the average collection period from 30 days (the current level) to 45 days;
 an increase in bad-debt expenses from 1% of sales (the current level) to 2%.
The firm determines that its cost of tying up funds in receivables is 15% before taxes.
To determine whether to relax its credit standards, Dodd Tool must calculate its effect on the
firm’s:
 additional profit contribution from sales,
 the cost of the marginal investment in accounts receivable, and
 the cost of marginal bad debts.

47. Credit Selection and Standards
Cost of Marginal Bad Debts
Level of Bad Debt x Selling Price Per Unit x
Total Unit Sales
Under Poposed Plan: (0.02 x $10/unit x 63,000 units) = $12,600
-Under Present Plan: (0.01 x $10/unit x 60,000 units) = $6,000
Cost of Marginal Bad
Debts

48. Credit Selection and Standards
Cost of Marginal Bad Debts
Level of Bad Debt x Selling Price Per Unit x
Total Unit Sales
Under Poposed Plan: (0.02 x $10/unit x 63,000 units) = $12,600
-Under Present Plan: (0.01 x $10/unit x 60,000 units) = $6,000
Cost of Marginal Bad
Debts
$6,600

49. Credit Selection and Standards
Making Credit Standard Decision
 additional profit contribution from sales
 the cost of the marginal investment in accounts receivable
 the cost of marginal bad debts

50. Credit Selection and Standards
Making Credit Standard Decision
 additional profit contribution from sales
 the cost of the marginal investment in accounts receivable
 the cost of marginal bad debts

51. Credit Selection and Standards
Making Credit Standard Decision
 additional profit contribution from sales = $12,000

52. Credit Selection and Standards
Making Credit Standard Decision
 additional profit contribution from sales
 the cost of the marginal investment in accounts receivable
 the cost of marginal bad debts

53. Credit Selection and Standards
Making Credit Standard Decision
 additional profit contribution from sales = $12,000
 the cost of the marginal investment in accounts receivable = $2,574

54. Credit Selection and Standards
Making Credit Standard Decision
 additional profit contribution from sales
 the cost of the marginal investment in accounts receivable
 the cost of marginal bad debts

55. Credit Selection and Standards
Making Credit Standard Decision
 additional profit contribution from sales = $12,000
 the cost of the marginal investment in accounts receivable = $2,574
 the cost of marginal bad debts = $6,600

56. Credit Selection and Standards
Making Credit Standard Decision
 additional profit contribution from sales = $12,000
 the cost of the marginal investment in accounts receivable = $2,574
 the cost of marginal bad debts = $6,600
Decision Rule:
If the additional profit contribution is greater than marginal costs, credit
standards should be relaxed.

57. Credit Selection and Standards

58. Credit Selection and Standards
Additional Profit Contribution from Sales (APCS)
Profit Contribution Per Unit = Sales Price Per Unit – Variable Cost Per Unit
= $10 – $6
= $4
Total APCS = Increase in Unit Sales * Profit Contribution Per Unit
= ($63,000 - $6,000) * $4
= $3,000 * $4
= $12,000

59. Credit Selection and Standards

60. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
Under Present Plan: $360,000
= $29,508
12.2
Under Proposed Plan: $378,000
= $46,667
8.1

61. Credit Selection and Standards

62. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment in
=
Total Variable Cost of Annual Sales
Accounts Receivable Turnover of Accounts Receivable
Under Present Plan: $360,000
= $29,508
12.2
Under Proposed Plan: $378,000
= $46,667
8.1

63. Credit Selection and Standards

64. Credit Selection and Standards

65. Credit Selection and Standards
Cost of Marginal Investment in Accounts Receivable
Average Investment under Proposed Plan $46,667
- Average Investment under Present Plan 29,508
Marginal Investment in Accounts Receivable $17,159
X Cost of Funds Tied Up in Receivables 0.15
Cost of Marginal Investment in Accounts Receivable $2,574

66. Credit Selection and Standards

67. Credit Selection and Standards
Cost of Marginal Bad Debts
Level of Bad Debt x Selling Price Per Unit x
Total Unit Sales
Under Poposed Plan: (0.02 x $10/unit x 63,000 units) = $12,600
-Under Present Plan: (0.01 x $10/unit x 60,000 units) = $6,000
Cost of Marginal Bad
Debts
$6,600

68. Credit Selection and Standards
The net addition to total profits resulting from such an
action will be $2,826 per year. Therefore, the firm should
relax its credit standards as proposed.

69. Credit Selection and Standards
Marginal International Credit
International operations typically expose a firm to
exchange rate risk
Dangers and delays involved in shipping goods long
distances
Exports of finished goods are usually priced in the
currency of the importer’s local market

70. Objective:
• To collect accounts receivable as quickly as possible
without losing sales from high-pressure collection
techniques
Three Topics:
1. Credit Selection and Standards
2. Credit Terms
3. Credit Monitoring

71. Credit Terms
Credit Terms
the terms of sale for customers who have been
extended credit by the firm
Examples:
• Term Net 30 - full payment is expected within 30 days
• Term 2/10 Net 30 - 2% discount can be taken by the buyer
only if payment is received in full within 10 days of the date
of the invoice, and that full payment is expected within 30
days

72. Credit Terms
Credit Terms
the terms of sale for customers who have been
extended credit by the firm
Examples:
• Term Net 30 - full payment is expected within 30 days
 $1000 invoice has the terms "net 30", buyer must pay the
full $1000 within 30 days.
• Term 2/10 Net 30 - 2% discount can be taken by the buyer
only if payment is received in full within 10 days of the date
of the invoice, and that full payment is expected within 30
days

73. Credit Terms
Credit Terms
the terms of sale for customers who have been
extended credit by the firm
Examples:
• Term Net 30 - full payment is expected within 30 days
• Term 2/10 Net 30 - 2% discount can be taken by the buyer
only if payment is received in full within 10 days of the date
of the invoice, and that full payment is expected within 30
days
 the buyer can take a 2% discount ($1000 x .02 = $20)
and make a payment of $980 within 10 days or pay the
full $1000 within the remaining of the 30 days

74. Credit Terms
Cash Discount
a percentage deduction from the purchase price
available to the credit customer who pays its account
within a specified time
a popular way to speed up collections without putting
pressure on customers
provides an incentive for customers to pay sooner

75. Credit Terms
Example:
MAX Company has annual sales of $10 million and an average collection
period of 40 days (turnover ). In accordance with the firm’s credit terms of net 30,
this period is divided into 32 days until the customers place their payments in the
mail (not everyone pays within 30 days) and 8 days to receive, process, and
collect payments once they are mailed.
MAX is considering initiating a cash discount by changing its credit terms
from net 30 to 2/10 net 30.
The firm expects this change to reduce the amount of time until the payments are
placed in the mail, resulting in an average collection period of 25 days
(turnover ).

76. Credit Terms
Example:
MAX has a raw material with current annual usage of 1,100 units. Each finished p
roduct produced requires one unit of this raw material at a variable cost of
$1,500 per unit, incurs another $800 of variable cost in the production process,
and sells for $3,000 on terms of net 30.
Variable costs therefore total $2,300 ($1,500 + $800). MAX estimates that 80% of
its customers will take the 2% discount and that offering the discount will increase
sales of the finished product by 50 units (from 1,100 to 1,150 units) per year
but will not alter its bad debt percentage.
MAX’s opportunity cost of funds invested in accounts receivable is 14%.
Should MAX offer the proposed cash discount?

77. Credit Terms
Example:

78. Credit Terms
Example:
MAX has a raw material with current annual usage of 1,100 units. Each finished p
roduct produced requires one unit of this raw material at a variable cost of
$1,500 per unit, incurs another $800 of variable cost in the production process,
and sells for $3,000 on terms of net 30.
Variable costs therefore total $2,300 ($1,500 + $800). MAX estimates that 80% of
its customers will take the 2% discount and that offering the discount will increase
sales of the finished product by 50 units (from 1,100 to 1,150 units) per year
but will not alter its bad debt percentage.
MAX’s opportunity cost of funds invested in accounts receivable is 14%.
Should MAX offer the proposed cash discount?

79. Credit Terms
Example:

80. Credit Terms
Example:
MAX has a raw material with current annual usage of 1,100 units. Each finished p
roduct produced requires one unit of this raw material at a variable cost of
$1,500 per unit, incurs another $800 of variable cost in the production process,
and sells for $3,000 on terms of net 30.
Variable costs therefore total $2,300 ($1,500 + $800). MAX estimates that 80% of
its customers will take the 2% discount and that offering the discount will increase
sales of the finished product by 50 units (from 1,100 to 1,150 units) per year
but will not alter its bad debt percentage.
MAX’s opportunity cost of funds invested in accounts receivable is 14%.
Should MAX offer the proposed cash discount?

81. Credit Terms
Example:
Turnover of A/R:
365/40 Days= 9.1
365/25 Days= 14.6

82. Credit Terms
Example:
MAX Company has annual sales of $10 million and an average collection
period of 40 days (turnover ). In accordance with the firm’s credit terms of net 30,
this period is divided into 32 days until the customers place their payments in the
mail (not everyone pays within 30 days) and 8 days to receive, process, and
collect payments once they are mailed.
MAX is considering initiating a cash discount by changing its credit terms
from net 30 to 2/10 net 30.
The firm expects this change to reduce the amount of time until the payments are
placed in the mail, resulting in an average collection period of 25 days
(turnover ).

83. Credit Terms
Example:
Turnover of A/R:
365/40 Days= 9.1
365/25 Days= 14.6

84. Credit Terms
Example:
Turnover of A/R:
365/40 Days= 9.1
365/25 Days= 14.6

85. Credit Terms
Example:
MAX has a raw material with current annual usage of 1,100 units. Each finished p
roduct produced requires one unit of this raw material at a variable cost of
$1,500 per unit, incurs another $800 of variable cost in the production process,
and sells for $3,000 on terms of net 30.
Variable costs therefore total $2,300 ($1,500 + $800). MAX estimates that 80% of
its customers will take the 2% discount and that offering the discount will increase
sales of the finished product by 50 units (from 1,100 to 1,150 units) per year
but will not alter its bad debt percentage.
MAX’s opportunity cost of funds invested in accounts receivable is 14%.
Should MAX offer the proposed cash discount?

86. Credit Terms
Example:
Turnover of A/R:
365/40 Days= 9.1
365/25 Days= 14.6

87. Credit Terms
Example:
MAX has a raw material with current annual usage of 1,100 units. Each finished
product produced requires one unit of this raw material at a variable cost of
$1,500 per unit, incurs another $800 of variable cost in the production process,
and sells for $3,000 on terms of net 30.
Variable costs therefore total $2,300 ($1,500 + $800). MAX estimates that 80% of
its customers will take the 2% discount and that offering the discount will increase
sales of the finished product by 50 units (from 1,100 to 1,150 units) per year
but will not alter its bad debt percentage.
MAX’s opportunity cost of funds invested in accounts receivable is 14%.
Should MAX offer the proposed cash discount?

88. Credit Terms
Example:
Turnover of A/R:
365/40 Days= 9.1
365/25 Days= 14.6

89. Credit Terms
Example:
Turnover of A/R:
365/40 Days= 9.1
365/25 Days= 14.6
Should MAX offer the proposed cash discount?
MAX should not initiate
the proposed cash
discount. However,
other discounts may be
advantageous.

90. Credit Terms
Cash Discount Period
the number of days after the beginning of the credit
period during which the cash discount is available
Example:
Increasing Cash Discount Period by 10 days:
- changing its credit terms from 2/10 net 30 to 2/20 net 30
- the following changes would be expected to occur:
(1) Sales would increase
(2) Bad-debt expenses would decrease
(3) The profit per unit would decrease

91. Credit Terms
However, the investment in accounts receivable will increase for
two reasons:
(1) Discount takers will still get the discount but will pay
later
(2) New customers attracted by the new policy will result
in new accounts receivable.
If the firm were to decrease the cash discount period,
the effects would be the opposite of those just described.

92. Credit Terms
Cash Period
the number of days after the beginning of the credit period
until full payment of the account is due
Example:
Increasing Cash Period by from Net 30 to Net 45 Days
- the following changes would be expected to occur:
(1) Sales would increase
(2) Bad-debt expenses would increase
(3) Investment in Accounts Receivable would increase
A decrease in the length of the credit period is likely to
have the opposite effects.

93. Objective:
• To collect accounts receivable as quickly as possible
without losing sales from high-pressure collection
techniques
Three Topics:
1. Credit Selection and Standards
2. Credit Terms
3. Credit Monitoring

94. Credit Monitoring
an ongoing review of the firm’s accounts receivable to
determine whether customers are paying according to the
stated credit terms
Two Frequently Used Techniques in Credit Monitoring:
1. Average Collection Period
2. Aging of Accounts Receivable
Credit Monitoring

95. Credit Monitoring
the average number of days that credit sales are outstanding
Example:
A firm that has credit terms of net 30 would expect its average
collection period (minus receipt, processing, and collection time) to equal
about 30 days.
Average Collection Period
Average Collection Period =
Accounts Receivable
Average Sales Per Day
Actual Collection Period is greater (>) than 30 - the firm has
reason to review its credit operations.
Average Collection Period is increasing over time - cause
for concern about its accounts receivable management.

96. Credit Monitoring
Aging Schedule
a credit-monitoring technique that breaks down accounts receivable
into groups on the basis of their time of origin
typically made on a month-by-month basis, going back 3 or 4 months
Example:
The accounts receivable balance on the books of Dodd Tool on
December 31, 2012, was $200,000. The firm extends net 30-day credit
terms to its customers. To gain insight into the firm’s relatively lengthy
51.3-day—average collection period, Dodd prepared the following
aging schedule:
Aging of Accounts Receivable

97. Credit Monitoring
Example:
Aging of Accounts Receivable

98. Credit Monitoring
Aging of Accounts Receivable
Current

99. Credit Monitoring
Aging of Accounts Receivable
Current Current
Overdue

100. Credit Monitoring
Aging of Accounts Receivable
Current Current
Overdue
Investigation on 61–90 days ago:
- the hiring of a new credit manager
- made a large credit purchase
- ineffective collection policy

101. Credit Monitoring
Popular Collection Techniques

102. SHEILA WAILAN FAYCAN