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Subunit 5: Receivables Management

  • 1.  Subunit 5: Receivables Management

    Posted 09-06-2020 01:25 PM
    why did he use 60 and 30 days in calculating costs of A.R

    A financial manager for a jewelry distributor is analyzing the cost of offering a cash discount to its credit policy. Currently, the firm's sales terms are net 60 and virtually all of its customers pay at the end of the 60 days. The manager estimates that if the firm offers a 2/10 net 60 discount, the average collection time on its $5,000,000 annual credit sales will drop to one month with 60% of its customers taking advantage of the discount. The distributor currently finances working capital with a revolving credit agreement at 12%. Calculate the firm's net cost of adding the cash discount to its credit terms.
    Answer (D) is correct.
    To calculate the firm's net cost of adding the cash discount to its credit terms, find both the total cash lost to discounts and the offsetting savings which arise from earlier customer payments. The calculations are as follows:

    Cash to be discounted = $5,000,000 × 60% = $3,000,000

    Cost of discount = $3,000,000 × 2% = $60,000

    Average daily sales = $5,000,000 ÷ 365 days = $13,698.63 per day

    Cost of A/R for 60 days = $13,698.63 × 60 days × 12% = $98,630.14

    Cost of A/R for 30 days = $13,698.63 × 30 days × 12% = $49,315.07

    Savings from discount = $98,630.14 – $49,315.07 = $49,315.07

    Net cost of discount = $60,000 (cost) – $49,315 (savings) = $10,685


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    Tayba Al-Mehdar
    Analyst
    Khobar
    Saudi Arabia
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