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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:
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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Pee Ltd has been factoring its debtors for the past 5 years. The factor charges a fee of 2% and will lend up to 80% of the volume of debtors purchases for an additional ¾% per month. The firm typically has sales of GH¢500,000 per month, 70% of which are on credit. By using the factor, two savings are effected:
Pee Ltd’s bank has recently offered to lend it up to 80% of the face value of the debtors shown on the schedule of accounts. The bank would charge 8% per annum interest plus a 2% processing charge per GH¢1 of debtors lending. The firm extends terms of net 30, and all customers who pay their bills do so by the thirtieth of the month.
Required:
If the firm borrows on the average GH¢100,000 per month on its debtors, advise whether the firm should discontinue its factoring arrangement in favor of the bank’s offer.
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a) Factoring and Invoice Discounting are both financial services that can release the funds tied up in your unpaid invoices, involving a provider who agrees to advance money against outstanding debtor balances. However, factoring is not the same as invoice discounting.
Required:
Differentiate between factoring and invoice discounting.
(5 marks)
b) ATA Ghana Ltd is a company in Ghana engaged in the trading of commodities. The annual sales are GH¢24 million. The average age of debtors is one month, and the percentage of bad debts is 1%.
A new Marketing Director has been hired by the company to improve its sales. The new Marketing Director proposed that sales could be increased up to GH¢30 million if new customers were taken on. Taking on new customers will lengthen the average credit period to 2 months and increase bad debts to 1.5% of sales.
The Finance Manager provided that the variable cost is 70% of the selling price and the company’s cost of capital is 20%.
Required:
Advise whether the company should take on the new customers.
(10 marks)
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a) Wahala Ltd wants to employ more liberal credit standards to increase sales. The current annual sales figure is GH¢30 million. Currently, the firm has an average collection period of 30 days. Three alternative credit policies are on the table for evaluation and selection. The management team believes that the alternative credit policies will result in the following:
| Factor | Alternative Credit Policy A | Alternative Credit Policy B | Alternative Credit Policy C |
|---|---|---|---|
| Increase in sales from the current level | GH¢2.2 million | GH¢3.1 million | GH¢5.4 million |
| Average collection period for incremental sales (days) | 45 | 60 | 150 |
| Bad-debt losses on incremental sales | 1.50% | 3.50% | 8.50% |
The prices of its products average GH¢30.50 per unit and variable costs average GH¢21.35 per unit. The company’s pre-tax opportunity cost of funds is 35%.
Required:
i) Evaluate each of the three alternative liberal credit policies and advise the company on which credit policy it should pursue. (Assume a 360-day year). (12 marks)
ii) Suppose the company introduces a discount policy of 2/10 net 45. Compute the cost to a customer who forgoes the discount. (3 marks)
b) The treasury unit of a company performs various functions, including financial risk management.
Required:
Explain TWO (2) types of financial risks the treasury function manages. (5 marks)
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Kanzo Food Stores Plc (Kanzo) sells on credit terms of net 60 days. Kanzo’s new Chief Finance Officer (CFO) thinks that the company’s credit terms are too lengthy considering the industry average credit terms of net 45 days.
Kanzo’s annual credit sales revenue is GH¢500 million, and its receivables turnover days are 55 days. The CFO has proposed that the credit terms be revised to net 45 days. Although the tightening of the credit terms would cause annual sales revenue to drop by an estimated GH¢20 million, the CFO believes that the policy change would lower the receivables turnover days to 40 days, which would bring some savings on investment in accounts receivables.
Kanzo has a variable cost ratio of 65% and a cost of capital of 20%.
Required:
i) Compute the net benefit/cost associated with the proposed change in the credit terms and recommend whether the proposed change in the credit terms should be adopted. (10 marks)
ii) The CFO is considering investing funds that would be released from trade receivables in short-term marketable securities. Explain TWO (2) characteristics of marketable securities. (5 marks)
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Poh-Poh Electronics Ltd is a wholesale distributor of household electrical products of major electronic brands. The company currently sells on credit to all its customers. Although the credit term is net 20 days, the receivables turnover days have been 15 days. The company’s annual credit sales revenue is GH¢80 million, and its contribution margin ratio is 30%. Bad debt is 2% of sales revenue, and credit collection cost is GH¢50,000 per annum.
Management is considering extending the credit period to net 30 days. It is expected that the implementation of this proposal would attract new customers, and the annual revenue would increase by 20%. It is also expected that both the existing and the new customers will probably take the full 30 days credit. To mitigate the probable lengthening in the receivables turnover days, management proposes that the extension in the credit period be combined with the introduction of a cash discount policy of 2% on all payments made within the first 10 days of the credit period. It is expected that 30% of all customers will pay their accounts early to take the discount. Consequently, the receivables turnover days would increase to 24 days. While the bad debt will remain at 2% of sales revenue, the annual credit collection cost will increase to GH¢65,000.
The company’s cost of capital is 24%.
Required:
i) Evaluate the proposed change in the credit policy and recommend whether the proposed change should be implemented. (9 marks)
ii) Advise the management team on THREE (3) procedures for the collection of its receivables. (6 marks)
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Question:
Lisa-Joys Company has annual credit sales of GH¢1,000,000. Credit customers take 45 days to pay. Bad debts are 2% of sales. The company finances its trade receivables with a bank overdraft, on which interest is payable at an annual rate of 15%.
A factor has offered to take over administration of the receivables ledger and collections for a fee of 2.5% of the credit sales. This will be a non-recourse factoring service. It has also guaranteed to reduce the payment period to 30 days. It will provide finance for 80% of the trade receivables, at an interest cost of 8% per year.
Lisa-Joys Company estimates that by using the factor, it will save administration costs of GH¢8,000 per year.
Required:
What would be the effect on annual profits if Lisa-Joys Company decides to use the factor’s services? (Assume a 365-day year). (9 marks)
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Find Related Questions by Tags, levels, etc.
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:
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
Find Related Questions by Tags, levels, etc.
Pee Ltd has been factoring its debtors for the past 5 years. The factor charges a fee of 2% and will lend up to 80% of the volume of debtors purchases for an additional ¾% per month. The firm typically has sales of GH¢500,000 per month, 70% of which are on credit. By using the factor, two savings are effected:
Pee Ltd’s bank has recently offered to lend it up to 80% of the face value of the debtors shown on the schedule of accounts. The bank would charge 8% per annum interest plus a 2% processing charge per GH¢1 of debtors lending. The firm extends terms of net 30, and all customers who pay their bills do so by the thirtieth of the month.
Required:
If the firm borrows on the average GH¢100,000 per month on its debtors, advise whether the firm should discontinue its factoring arrangement in favor of the bank’s offer.
Find Related Questions by Tags, levels, etc.
a) Factoring and Invoice Discounting are both financial services that can release the funds tied up in your unpaid invoices, involving a provider who agrees to advance money against outstanding debtor balances. However, factoring is not the same as invoice discounting.
Required:
Differentiate between factoring and invoice discounting.
(5 marks)
b) ATA Ghana Ltd is a company in Ghana engaged in the trading of commodities. The annual sales are GH¢24 million. The average age of debtors is one month, and the percentage of bad debts is 1%.
A new Marketing Director has been hired by the company to improve its sales. The new Marketing Director proposed that sales could be increased up to GH¢30 million if new customers were taken on. Taking on new customers will lengthen the average credit period to 2 months and increase bad debts to 1.5% of sales.
The Finance Manager provided that the variable cost is 70% of the selling price and the company’s cost of capital is 20%.
Required:
Advise whether the company should take on the new customers.
(10 marks)
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a) Wahala Ltd wants to employ more liberal credit standards to increase sales. The current annual sales figure is GH¢30 million. Currently, the firm has an average collection period of 30 days. Three alternative credit policies are on the table for evaluation and selection. The management team believes that the alternative credit policies will result in the following:
| Factor | Alternative Credit Policy A | Alternative Credit Policy B | Alternative Credit Policy C |
|---|---|---|---|
| Increase in sales from the current level | GH¢2.2 million | GH¢3.1 million | GH¢5.4 million |
| Average collection period for incremental sales (days) | 45 | 60 | 150 |
| Bad-debt losses on incremental sales | 1.50% | 3.50% | 8.50% |
The prices of its products average GH¢30.50 per unit and variable costs average GH¢21.35 per unit. The company’s pre-tax opportunity cost of funds is 35%.
Required:
i) Evaluate each of the three alternative liberal credit policies and advise the company on which credit policy it should pursue. (Assume a 360-day year). (12 marks)
ii) Suppose the company introduces a discount policy of 2/10 net 45. Compute the cost to a customer who forgoes the discount. (3 marks)
b) The treasury unit of a company performs various functions, including financial risk management.
Required:
Explain TWO (2) types of financial risks the treasury function manages. (5 marks)
Find Related Questions by Tags, levels, etc.
Kanzo Food Stores Plc (Kanzo) sells on credit terms of net 60 days. Kanzo’s new Chief Finance Officer (CFO) thinks that the company’s credit terms are too lengthy considering the industry average credit terms of net 45 days.
Kanzo’s annual credit sales revenue is GH¢500 million, and its receivables turnover days are 55 days. The CFO has proposed that the credit terms be revised to net 45 days. Although the tightening of the credit terms would cause annual sales revenue to drop by an estimated GH¢20 million, the CFO believes that the policy change would lower the receivables turnover days to 40 days, which would bring some savings on investment in accounts receivables.
Kanzo has a variable cost ratio of 65% and a cost of capital of 20%.
Required:
i) Compute the net benefit/cost associated with the proposed change in the credit terms and recommend whether the proposed change in the credit terms should be adopted. (10 marks)
ii) The CFO is considering investing funds that would be released from trade receivables in short-term marketable securities. Explain TWO (2) characteristics of marketable securities. (5 marks)
Find Related Questions by Tags, levels, etc.
Poh-Poh Electronics Ltd is a wholesale distributor of household electrical products of major electronic brands. The company currently sells on credit to all its customers. Although the credit term is net 20 days, the receivables turnover days have been 15 days. The company’s annual credit sales revenue is GH¢80 million, and its contribution margin ratio is 30%. Bad debt is 2% of sales revenue, and credit collection cost is GH¢50,000 per annum.
Management is considering extending the credit period to net 30 days. It is expected that the implementation of this proposal would attract new customers, and the annual revenue would increase by 20%. It is also expected that both the existing and the new customers will probably take the full 30 days credit. To mitigate the probable lengthening in the receivables turnover days, management proposes that the extension in the credit period be combined with the introduction of a cash discount policy of 2% on all payments made within the first 10 days of the credit period. It is expected that 30% of all customers will pay their accounts early to take the discount. Consequently, the receivables turnover days would increase to 24 days. While the bad debt will remain at 2% of sales revenue, the annual credit collection cost will increase to GH¢65,000.
The company’s cost of capital is 24%.
Required:
i) Evaluate the proposed change in the credit policy and recommend whether the proposed change should be implemented. (9 marks)
ii) Advise the management team on THREE (3) procedures for the collection of its receivables. (6 marks)
Find Related Questions by Tags, levels, etc.
Question:
Lisa-Joys Company has annual credit sales of GH¢1,000,000. Credit customers take 45 days to pay. Bad debts are 2% of sales. The company finances its trade receivables with a bank overdraft, on which interest is payable at an annual rate of 15%.
A factor has offered to take over administration of the receivables ledger and collections for a fee of 2.5% of the credit sales. This will be a non-recourse factoring service. It has also guaranteed to reduce the payment period to 30 days. It will provide finance for 80% of the trade receivables, at an interest cost of 8% per year.
Lisa-Joys Company estimates that by using the factor, it will save administration costs of GH¢8,000 per year.
Required:
What would be the effect on annual profits if Lisa-Joys Company decides to use the factor’s services? (Assume a 365-day year). (9 marks)
Find Related Questions by Tags, levels, etc.
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