Question Tag: Credit Period

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FM – Nov 2024 – L2 – Q5a – Management of Receivables

Evaluate the financial implications of different strategies for managing Abaa LTD's accounts receivable.

Abaa LTD, a company that manufactures and sells electronic appliances, has been facing challenges with its accounts receivable management. Currently, the company allows its customers 60 days of credit. Due to the highly competitive market, Abaa LTD has been experiencing an increasing amount of bad debts and delayed payments, which has adversely affected its cash flow and profitability. To address these issues, the company’s Finance Manager is considering several strategic changes:

  1. Reduction in Credit Period: Reducing the credit period from 60 days to 45 days. It is estimated that this change could reduce sales by 5% due to the stricter credit terms, but it would also decrease the bad debt ratio from 4% to 2% of sales.
  2. Offering Early Payment Discounts: Introducing a 2% discount for customers who pay within 30 days. The company anticipates that 30% of its customers will take advantage of this discount, which would improve cash flow and reduce the average collection period by 15 days.
  3. Engagement of a Factor: The company is also considering engaging a factoring company to manage its receivables. The factor would advance 80% of the invoice value upon the sale of goods at 200 basis points below the company’s cost of capital and charge a 3% fee on all sales. The factor is expected to reduce the bad debt ratio to 1% of sales and further reduce the average collection period by 20 days. Engaging the factor will lead to annual administrative savings of GH¢90,000.

Abaa LTD’s current annual sales are GH¢20 million, and the variable cost of sales is 60% of sales. The company’s cost of capital is 12% per annum.

Required:
Evaluate the financial implications of the following:
i) Reduction in Credit Period
ii) Offering Early Payment Discounts
iii) Engagement of a Factor
iv) Recommend the appropriate method to manage the credit sales

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  • 10 Marks

CSME – Nov 2015 – L2 – Q1a – Risk Management and Corporate Strategy

Explains credit risk management concepts, including exposure, losses, residual risk, and appetite.

The finance director of Basket Company is preparing a proposal to present to the board of directors. He believes that the company is much too cautious in its policy of giving credit to customers. At the moment all customers are given 30 days’ credit. He believes that by increasing its exposure to credit risk, and increasing credit terms to 60 days, the company will achieve an increase in annual sales of up to 20%. He also thinks that some improvements in debt collection procedures will reduce the level of bad debts, although some bad debts cannot be avoided. He thinks that the value of sales where there is a default will fall each year from 2% of sales to 1.8% of sales. He proposes that in order to increase annual sales and profits, the company should be willing to increase its risk appetite and accept the risk of higher bad debts.

Required:

  1. Using this example of managing credit risk, explain and illustrate the meaning of:
    i. Exposure to risk
    ii. Risk of losses
    iii. Residual risk
    iv. Risk appetite

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  • 10 Marks

FM – Nov 2024 – L2 – Q5a – Management of Receivables

Evaluate the financial implications of different strategies for managing Abaa LTD's accounts receivable.

Abaa LTD, a company that manufactures and sells electronic appliances, has been facing challenges with its accounts receivable management. Currently, the company allows its customers 60 days of credit. Due to the highly competitive market, Abaa LTD has been experiencing an increasing amount of bad debts and delayed payments, which has adversely affected its cash flow and profitability. To address these issues, the company’s Finance Manager is considering several strategic changes:

  1. Reduction in Credit Period: Reducing the credit period from 60 days to 45 days. It is estimated that this change could reduce sales by 5% due to the stricter credit terms, but it would also decrease the bad debt ratio from 4% to 2% of sales.
  2. Offering Early Payment Discounts: Introducing a 2% discount for customers who pay within 30 days. The company anticipates that 30% of its customers will take advantage of this discount, which would improve cash flow and reduce the average collection period by 15 days.
  3. Engagement of a Factor: The company is also considering engaging a factoring company to manage its receivables. The factor would advance 80% of the invoice value upon the sale of goods at 200 basis points below the company’s cost of capital and charge a 3% fee on all sales. The factor is expected to reduce the bad debt ratio to 1% of sales and further reduce the average collection period by 20 days. Engaging the factor will lead to annual administrative savings of GH¢90,000.

Abaa LTD’s current annual sales are GH¢20 million, and the variable cost of sales is 60% of sales. The company’s cost of capital is 12% per annum.

Required:
Evaluate the financial implications of the following:
i) Reduction in Credit Period
ii) Offering Early Payment Discounts
iii) Engagement of a Factor
iv) Recommend the appropriate method to manage the credit sales

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  • 10 Marks

CSME – Nov 2015 – L2 – Q1a – Risk Management and Corporate Strategy

Explains credit risk management concepts, including exposure, losses, residual risk, and appetite.

The finance director of Basket Company is preparing a proposal to present to the board of directors. He believes that the company is much too cautious in its policy of giving credit to customers. At the moment all customers are given 30 days’ credit. He believes that by increasing its exposure to credit risk, and increasing credit terms to 60 days, the company will achieve an increase in annual sales of up to 20%. He also thinks that some improvements in debt collection procedures will reduce the level of bad debts, although some bad debts cannot be avoided. He thinks that the value of sales where there is a default will fall each year from 2% of sales to 1.8% of sales. He proposes that in order to increase annual sales and profits, the company should be willing to increase its risk appetite and accept the risk of higher bad debts.

Required:

  1. Using this example of managing credit risk, explain and illustrate the meaning of:
    i. Exposure to risk
    ii. Risk of losses
    iii. Residual risk
    iv. Risk appetite

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