Financial management course

1. Tutorial 7
1-)Accounts receivable changes with bad debts A firm is evaluating an accounts receivable
change that would increase bad debts from 2% to 4% of sales. Sales are currently
50,000 units per month, the selling price is $20 per unit, and the variable cost per unit
is $15. As a result of the proposed change, sales are forecast to increase to 60,000 units.
If the cost of capital is 0.75% per month, should the firm change its credit policy?
a. Bad debts under proposed plan = $1,137,600  0.04 = $45,504
Bad debts under present plan = $948,000  0.02 = $18,960
b. Cost of marginal bad debts = $45,504  $18,960 = $26,544
c. No, as the bad debts are higher at $45,504 under the proposed plan.
d. If the cost of the marginal investment and the bad debts exceed the additional profit that will be
generated, then the proposed plan should be rejected.
2-)Explain the credit selection process and the quantitative procedure for evaluating changes in
credit standards.
Credit selection techniques determine which customers’ creditworthiness is consistent with the firm’s credit
standards. Two common credit selection techniques are the five C’s of credit and credit scoring. Changes in
credit standards can be evaluated mathematically by assessing the effects of a proposed change on profits
from sales, the cost of accounts receivable investment, and bad-debt costs.
3-)Review the procedures for quantitatively considering early payment Discount changes, other
aspects of credit terms, and credit monitoring.
Changes in credit terms—the discount, the discount period, and the credit period—can be quantified
similarly to changes in credit standards. Credit monitoring, the ongoing review of accounts receivable,
frequently involves use of the average collection period and an aging schedule.
4-) What is the role of the five C’s of credit in the credit selection activity?
A firm uses a credit selection process to determine if credit should be extended to a customer and if so, how
much. The credit manager may use the five Cs of credit to focus the analysis of a customer's creditworthiness:
1.Character
- the applicant's past record of meeting financial, contractual, and moral obligations.
2.Capacity
- the applicant's ability to repay the requested credit amount; this is evaluated through financial statement
analysis, particularly liquidity and debt ratios.
3.Capital
- the applicant's financial strength, measured by ownership position (percentage of equity) and profitability
ratios.
4.Collateral
- the assets available to secure the applicant's credit.
5.Conditions

2. - the current economic and business environment, as well as any special circumstances, affecting either party
to the credit transaction.
Character and capacity are the most important aspects in deciding whether to extend credit. Capital,
collateral, and conditions are considered when structuring the credit arrangement
5-)Explain why credit scoring is typically applied to consumer credit decisions rather than to
mercantile credit decisions.
Credit scoring is the ranking of an applicant's overall credit strength. It is derived as a weighted
average of scores on key financial and credit characteristics. Credit scoring is not generally used
in mercantile credit decisions because the necessary statistical characteristics are not available.
And the mercantile have a credit score by the credit rating firms .