Evaluation of credit Policies
Example :
-Current Sales 10 lakh, shall increase by 200000 in option 1 , by 300000 in option 2 . —Variable cost are 35% of Sales. Fixed cost are Rs 200000 .
-Existing credit period is 2 mth, option 1 is 2.5 mth. and option 2 is 3 mth.
-Credit Sales are 80% of total Sales.
-Required rate of return is 12%.
-Existing Bad debt loss is 2% , option 1 is 3% and option 2 is 4%.
-Collection cost is 3% of debtors .
| Particulars | Present Policy | Option 1 | Option 2 |
| Credit Period |
2 mth. |
2.5 mth. |
3 mth |
| Sales |
10,00,000 |
12,00,000 |
13,00,000 |
| Less:Variable Cost |
3,50,000 |
4,20,000 |
4,55,000 |
| Contribution(S-V) |
6,50,000 |
7,80,000 |
8,45,000 |
| Less: Fixed Cost |
2,00,000 |
2,00,000 |
2,00,000 |
| PROFIT(BENEFIT) |
4,50,000 |
5,80,000 |
6,45,000 |
|
|
|
|
|
| TotalCost=FC+VC |
5,50,000 |
6,20,000 |
6,55,000 |
| Average Invt.in Debtors= Total Cost X Creditsales X
Total Sales Debtor Period mth 12 mths
|
5,50,000 X 80% X 2/12mth =73333 | 6,20,000 X 80% X 2.5/12mth =103333 | 6,55,000 X 80% X 3/12 mth. = 131000 |
| COST | |||
| a) Opportunity cost of capital= eg. 12% x Avg.Invt.in Debtor | 73333 X 12% = 8800 | 103333 X 12% = 12400 | 131000 X 12% = 15720 |
| b) Bad debt cost= eg.Bad debt % x Sales | 10,00,000 X 2% =20,000 | 12,00,000 X 3% = 36,000 | 13,00,000 X 4% = 52,000 |
| c) Collection Cost = 3% x Debtors | (10,00,000 X 2/12mth) X 3%
= 5000 |
(12,00,000 X
2.5 /12 mth)X 3% = 7500 |
(13,00,000 X
3/12mth) X 3% = 9,750 |
| TOTAL COST |
33,800 |
55,900 |
77,470 |
| NET BENEFITS(Profit – Total Cost) |
4,16,200 |
5,24,100 |
5,67,530 |
| RATING |
III |
II |
I |
Formulae
a) If P/V Ratio is given find — Contribution = Sales X P/V ratio.
b) If Debtors Turnover ratio is given — Debtors = Credit sales
Debtors Turnover ratio
c) Debtors Velocity = 12 mths.
Debtors Turnover ratio
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