Changing Credit Terms, EQ 5.1
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Transcript Changing Credit Terms, EQ 5.1
Chapter 6
Credit Policy and Collections
Order
Placed
Order
Received
< Inventory >
Sale
Payment Sent Cash
Received
Accounts
Collection
< Receivable > < Float >
Time ==>
Accounts
< Payable >
Invoice Received
Disbursement
<
Float
>
Payment Sent
Cash Disbursed
Copyright 2005 by Thomson Learning, Inc.
Objectives
Specify advantages of NPV in evaluating credit
policy alternatives.
Calculate the NPV of alternative credit policies and
select the best policy.
Identify the 3 major traditional measures of
collection patterns, calculate them, and understand
their flaws.
Calculate and interpret uncollected balance
percentages and relate to traditional measures.
Describe present corporate credit policy practices.
List and explain the major differences encountered
when extending credit internationally.
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Evaluate Changes in Credit Policy
Credit term change decision variables
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effect on dollar profits
sales effect
receivables effect
return on investment effect
84% can estimate:
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default probability
credit limits
opportunity cost of funds invested in receivables
company’s overall cost of capital
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Incremental Profit vs NPV
Financial statement approach
NPV approach
Copyright 2005 by Thomson Learning, Inc.
Changing Credit Terms, EQ 6.1
ZN =
[(1+g)SE](1-dN)PN(1-bN) / (1 + iDPN)
PV discount pmts
+ [(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
Copyright 2005 by Thomson Learning, Inc.
Changing Credit Terms, EQ 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
Copyright 2005 by Thomson Learning, Inc.
Changing Credit Terms, EQ 6.3, 6.4
EQ 6.3 Z = ZN - ZE
Decision Rule:
IF Z > 0 then Accept policy change
IF Z < 0 then Reject policy change
EQ 6.4 NPV = Z / i
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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
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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 turnover
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Solution
Uncollected Balance Percentage
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Collection Procedures
Typical collection effort
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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
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Evaluating the Credit Department
Reducing investment in receivables
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reduce invoice float
fine-tune credit administration and credit policy
outsourcing and automating
reduce discrepancies and deductions
improve monitoring and collections using benchmark data
Organizational integration and key account
management
– develop better understanding of needs and wants of key
accounts
– prioritize accounts by potential value
– make credit terms and policies integral part of well designed
sales and marketing offering
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International Credit Management
Credit policy analysis
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lengthening terms increases exchange rate risk
also increases default risk
harder to get D&B reports
harder to get bank credit information
Modifying monitoring and collections
– legal remedies for late payment or nonpayment differ by
country
Copyright 2005 by Thomson Learning, Inc.
Summary
This chapter developed the framework for
applying the NPV model to credit policy decisions.
The NPV approach was applied to changes in
credit standards, the credit period, cash discounts.
Traditional monitoring tools include aging, DSO
and receivables turnover.
Improved monitoring measure
– uncollected balance percentage
– a reliable and unbiased measure of customer payment behavior
Collection procedures were reviewed.
The chapter concluded with a look at
benchmarking and the impact of foreign sales.
Copyright 2005 by Thomson Learning, Inc.