1. Chapter 6 Credit Policy and Collections
Order Order Sale Payment Sent Cash
Placed Received Received
Accounts Collection
< Inventory > < Receivable > < Float >
Time ==>
Accounts Disbursement
< Payable > < Float >
Invoice Received Payment Sent Cash Disbursed

2. Evaluate Changes in Credit Policy
Credit term change decision variables
effect on dollar profits
sales effect
receivables effect
return on investment effect
84% can estimate:
default probability
credit limits
opportunity cost of funds invested in receivables
company’s overall cost of capital

3. Changing Credit Terms, EQ 6.1 (P. 196)
NPV Average Daily Sales
= PV of Sales to discount-takers
+ PV of Sales to non-discount takers
- Variable Operating Costs
- PV of Variable Credit and Collection Costs

4. Changing Credit Terms, Equation 6.1
ZN =
[(1+g)SE](1-dN)PN(1-bN) / (1 + iDPN) PV discount payments
+ [(1+g)SE](1-PN)(1-bN) / (1 + iCPN) PV non-discount pmts
- VCR [(1+g)SE] PV variable cost pmts
- [EXPN[(1+g)SE] / (1 + iCPN) PV credit expense pmts

5. Existing Credit Terms, Equation 6.2
ZE =
SE(1-dE)PE(1-bE) / (1 + iDPE) PV discount pmts
+ SE(1-PE)(1-bE) / (1 + iCPE) PV non-discount pmts
- VCR (SE) PV variable cost pmts
EXPE SE / (1 + iCPE) PV credit expense pmts
(correct this in your textbook)

6. Changing Credit Terms, Equation 6.3, 6.4
Equation 6.3 Z = ZN - ZE
Decision Rule:
IF Z > 0 then Accept policy change
IF Z = 0 then Indifferent
IF Z < 0 then Reject policy change
Equation 6.4 NPV = Z / i

7. Assignment
AJ Group’s CEO Mr. Ananta Jalil asked you make a recommendation to the executive policy committee on whether the company should tighten its credit standards. The marketing department estimates that annual sales will drop by BDT 15 million from the present level of BDT 200 million. The VCR is 0.60 and it will not change, and the credit and collection expenses will increase from 1.25 percent to percent under the proposal. The bad debt expense rate on both existing and incremental sales is estimated to be 10 percent. The DSO of 30 days is not expected to change. The company’s annual cost of capital is 18 percent.
a. Calculate the decision’s 1-day change in value.
b. Calculate the decision’s NPV.
c. Do you recommend tightening the credit standards? Explain.

8. Monitoring Collections

9. Spreadsheet containing sales and A/C receivable data

10. Aging Schedule

11. Monitoring Collections
Receivables turnover
least favored technique
Days sales outstanding, DSO
ranked almost as high as aging schedules
Aging schedules
ranked as most favored technique

12. Problem All three traditional measures have a serious flaw
All three are influenced by sales trends
Choice of averaging period impact turnover and DSO
Increasing sales tends to:
improve aging schedules
worsen DSO and A/C Receivable turnover

13. Solution: Uncollected balance percentage/ Payment pattern approach

14. Collection Procedures
Typical collection effort
initial contact within 10 days of delinquency
then reminder letter followed by phone call
sales force notified
last resort, reference to collection agency/legal action
Collection agency
Phase 1 - computer generated collection letter, when accounts are 45 to 90 days past due
Phase 2 - commissioned collectors used
Companies tend to be more aggressive the larger the receivables balance
Companies understand the good-will tradeoff when selecting collection methods