CHAPTER 1

Credit ManagementCHAPTER 6Chapter OutlineCredit and Receivables

Components of Credit Policy

Investment in Receivables

Credit Policy Evaluation

Optimal Credit PolicyCreditWhat is credit sale?

Why do firms have credit sales?

Are there any risks to credit sales?

What is the trade-off of credit sales?

Accounts receivable & trade creditComponents of Credit PolicyTerms of sale(credit periods, cash discounts & period)

Credit analysis(probability of payment and default)

Collection policy(how to collect)Cash Flow from Granting CreditSpeed up the collection float!

Investment in ReceivablesWhat would the investment depend on?

Kylar Balklk:Average collection period = 30 daysCredit sales per day = 1,000,000 TLAccounts Receivable balance?Terms of SaleCredit period

Cash discount

Discount period

Type of credit instrument

Within industry & accross industriesThe Basic Form2/10 net 60

Purchase of 1,000,000 TL by Uak TarmWhat are the options?

5/10 net 45The Credit PeriodCredit Period: length of time for which credit is granted

Industry variation30-120 days

Cash discount:- net credit period- cash discount periodThe Credit PeriodInvoice: A bill for goods or sevices provided by the seller to the purchaser

Invoice date: beginning of the credit period

Billing or shipping dateReceipt of goodsEnd of month (constant purchases)Length of Credit PeriodAffecting Factors:-buyers inventory period

-operating cycle of the buyer

-perishability: more perishable=>shorter

-consumer demand: established products => shorter new products=> longerLength of Credit Period-cost: lower => shorter

-credit risk: higher=>shorter

-size of the acocunt: smaller=>shorter

-competition: higher=>longer

-customer type: customer differentiationCost of the Credit2/10 net 30?Is the 2 % high enough to pay early?

elik retim:Buys worth 1,000,000 on creditIf not paid early?Cost?

Credit Instrument: Evidence of IndebtednessEvaluating a Credit PolicyLocal Producer:-currently sells for cash only-considering net 30 sales-Price = 49 TL Variable cost = 20 TL-Current quantity sold (Q) = 100 units/month-Future quantity to sell (Q*) = 110 u/month-No discounts/no taxes/no default risk

-Should they switch?Evaluating a Credit PolicyCurrent monthly sales = Variable cost =Total cash flow =

Fixed costs?

Future monthly sales = Total cash flow =

Monthly change =Evaluating a Credit PolicyInterest rate = 2 % monthlyPV of monthly 290 =

Costs?

Extra variable cost =Uncollected amount = Total cost of this month =Why only this month?

SWITCH or NOT?Optimal Credit PolicyCashflow of increased sale = Carrying costs of credit

Carrying costs:* required return on receivables* losses from bad debt* costs of credit management & collection

Opportunity costs (forgone sales)Optimal Credit PolicyCredit cost curve = (carrying costs, opp. costs of forgone sales)

Below optimal => ???Over optimal => ???Optimal Credit Policy

Customer Credit AnalysisONE TIME SALE:Customer wants to buy 1 unit on credit at P.No credit => no saleCredit => pay in 1 month or defaultDefault probability => One time saleRequired return on acc. rec. => RVariable cost => v

GRANT CREDIT?Customer Credit AnalysisONE TIME SALE:If credit granted:Cash outflow? When?Cash inflow? When?

v=20 P=49 R=%2 =20 % NPV?GRANT CREDIT?BREAK EVEN DEFUALT PROBABILITY?Customer Credit AnalysisREPEAT BUSINESS:If new customer does not default at first=> never defaults (assumption)

cost v this monthif no default=> P next monthIf customer pays=>cycle goes on foreverCustomer Credit AnalysisREPEAT BUSINESS:PV of every months sale?First months cost?NPV of extending credit?

GRANT CREDIT?Customers 5 CsCharacter

Capacity

Capital

Collateral

ConditionsPolicy Change ExampleEGE Chemicals:

R=25 %Varible cost=70 % of salesAll sales are on creditADOPT A NEW POLICY???Current PolicyPolicy IPolicy IIAnnual Sales5,000,0006,000,0006,750,000Receivable Turnover432.4Doubtful Rec.450,000600,000750,000Policy Change ExampleEGE Chemicals:

Compare marginal costs vs. benefits

Ignore fixed costs?Current PolicyPolicy IPolicy IIAnnual Sales5,000,0006,000,0006,750,000Receivable Turnover432.4Doubtful Rec.450,000600,000750,000Average Receivables???Policy Change ExamplePolicy I

NET BENEFIT???Marginal BenefitSales increaseProfit increaseDoubtful sale inc.Net profit increaseMarginal CostAcc. rec. increaseInvest. in acc. rec.Cost of marginal inc.Policy Change ExamplePolicy II

NET BENEFIT??? ANY POLICY CHANGES???Marginal BenefitSales increaseProfit increaseDoubtful sale inc.Net profit increaseMarginal CostAcc. rec. increaseInvest. in acc. rec.Cost of marginal inc.END OF CHAPTER