Lesson 2 Flashcards
What are the benefits of credit
management?
- Reducing the number of late payments
- Cash flow protection
- Increasing available business liquidity
- Executing faster and more complete debt recovery
- Improving your company’s Days Sales Outstanding (DSO)
- Identifying opportunities and freeing up your company’s working capital
- Helping you plan and analyse performance
- Reassuring potential lenders
Cost Element
a. non-payment
- Bad debt losses
- cost of the credit period
- late payment cost
Time Delay between Funds expended by seller from:
- Acquiring raw materials
- paying wages and other overhead costs
- production
- delivery of the goods or services to recipt of funds from the buyer
allows an element of certainty in forward planning and can dictate strategies on investment, marketing, employment and so on.
Interest Rates Stability
Assume a seller’s borrowing cost is 12% annually, because it is easily converted to 1% of the amount of unpaid invoices or debt every 30 days (monthly).
all five firms have a 5% profit level before credit cost and cost of credit is 12% annually. Here the direct impact of credit cost on Net Profit is clearly illustrated.
Found in laptop (figure 2.1)
If _______________ is to be factored in, it should be added to the cost of money to get the true cost of credit.
rate of inflation
if annual inflation is 6% if the firm e has 90 days collection
found in laptop (BELOW 2.1)
Free credit offers
- 0% finance/interes
- Three years interest fee
is as something (money) which is bought from a supplier (bank) at a price, in just the same way as any other goods or services are bought.
Credit
The ________________ has to establish and operate a credit department, which involves all usual costs associated with any working office department such as staff salaries.
credit grantor
Company A has a 5% profit level where credit is not allowed, and cost of credit is 12% annually. In its normal terms of 60 days, it achieves sales of £12,000,000 annually, and a net profit of £360,000.
In an attempt to increase sales, credit terms are increased to 90 days, to increase sales by one-third to £16,000,000. It’s notable that net profit drops to £320,000 as
credit cost increases.
When actual sales only increased by a quarter to £15,000,000, net profit achieved is only £300,000, a decrease of £60,000 on increased sales of £3,000,000.
In desperation, the company extends credit to 120 days and sales grew 50% higher from £12,000,000 to £18,000,000. But net profit shrinks 50% to £180,000 due to increased credit cost.
Alternatively, what can be achieved by reducing debtors if sales of £12,000,000 with debtors of £3,000,000 (90 days) cut to £2,000,000 (60 days) saves £120,000 annually – more than enough to cover the salary of a good credit manager!
found in fugure 2.2 laptop
True or False
By preventing a bad debt loss, or at least reducing the loss by the time the customer fails, a credit manager avoids the impact of cancelling out previously booked profits on very large sales values.
True
Find the effect of bad debts on sales
Bad Debt
- 50
- 500
- 5,000
- 10,000
- 50,000
Pre-tax profit percentage
- 5%
- %
- 10%
-12%
Found in figure 2.3
Cost of borrowings annually
- 5%
- 6%
- 8%
- 10%
- 12%
- 15%
Net profit on sales
- 10%
- 8%
- 6%
- 4%
- 2%
Found in figure 2%
high margins and cheap money allow a _________,
soft impact
high interest rates combined with poor margins require very _____________ processes.
strict collection
______________________ may have a favorable effect on the creditworthiness of an individual or a company because the supplier or lender can is assured assets can be sold off to pay off debts.
Ownership of valuable fixed assets
have little or no impact on credit ability
Fixed Assets
the ability of the buyer or borrower to pay bills when due
Credit ability
The cash needed to run a business comes from somewhere, and the two contributors are:
- Borrowing
- Owner’s capital and reserves
comes in the form of capital and loan financing
Borrowing
relates to the amount put into the business by its owners – proprietors, shareholders
Owner’s Capital
are basically cash retained in the business not distributed to business owners
Reserves
also known as retained earnings, and capital reserves
Reserves
Most credit managers recognize a third source of finance, which even though it may be unofficial is quite often seen as the most readily available
trade suppliers
means that there will be a credit period that will require funding
granting credit
The company’s working capital, which includes the owners’ capital and reserves, and borrowings, is further supplemented by ________________________.
operational cash flow
The movement of money into and out of a business.
Cash Flow
Net profits before tax plus depreciation added back.
Cash Flow
Money comes in from paid ________ and goes out in ________ to achieve those sales, mainly to creditors for supplies and in salaries and operating costs.
sales; expenses
is not the same nor will translate to financial success
Sales Volume
In the Profit and Loss Statement, ‘_________________’ is the last cost before ‘Net Profit Before Tax (NPBT)
Interest Expense
The interest item results from how the net assets have been managed, that is,:
a) stock control,
b) credit control on debtors and
c) the credit taken from suppliers.
above the 50% level is even concerning for banks which is why they then appoint an __________________ to protect their own interests
Administrative Receiver
Four key items progressive and successful companies tightly manage:
- annual profit growth rate, to equal or exceed sales growth rate;
- cash flow effectiveness, to minimize external debt;
- efficient use of assets, i.e.,as slim as possible to a chieve sales;
- interest cost avoidance since it drains on profits.
is the ratio that indicates cash flow efficiency and effectiveness
Return On Capital Employed (ROCE)
Formula of ROCE
(𝑅𝑒𝑡𝑢𝑟𝑛 (𝑁𝑃𝐵𝑇) / 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 (𝑖𝑛𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑏𝑜𝑟𝑟𝑜𝑤𝑖𝑛𝑔)) 𝑥 100
Faster cash collections improve the ROCE ratio by
a) reducing interest expense, which in turn increase profit,
and b) reducing borrowings (borrower accounts).
The calculation of DSO is done at
1) month-end, taking total debtors (current, overdue, and disputed),
2) deducting total monthly sales from the debtors figure, and
3) going back to months prior until the debtors figure is zeroed.
The DSO can be used to show how an improvement in DSO performance can also give some degree of competitive edge. For example: You sell £14.6 million a year = £40,000 per day on average. Debtors run at about £2.4 million, that is, 60 DSO. Your competitor has similar sales but debtors of 70 DSO. So, you have £400,000 more cash to use (10 days × £40,000) Your competitor must borrow an extra £400,000 at, say, 10% per annum,
Example 1
is simply arithmetical, but achieving it needs specific approaches to larger customers.
Cash target setting
for prompt payment have a cost to the seller which can quite easily be calculated and is best thought of in terms of the per annum, or annualized, rate of interest.
Discounts
Formula of Discounts
(𝑅𝑎𝑡𝑒 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 / 𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
𝑙𝑒𝑠𝑠 𝑡h𝑒 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑) x 100
solve the figure 2.7 found in excel
figure 2. 7
Age
Current, that is, within terms
60 days overdue
180 days overdue
12 months overdue
Worth %
100%
80%
50%
10%
epresent cash and cash is the lifeblood of any business – knowing a) what we have, b) what we are expecting to have and when will enable us to know what we can spend, and when.
Debtors
is controlling the ledger directly on a daily basis
credit manager
has an overview as/when required;
finance director
are kept informed by regular reports for action as needed.
the board of directors
Company A has annual sales of 12M and net profit level before credit cost of 5% on a cash basis, while the cost of credit is at 12% yearly. The firm is changing its strategy and giving 2% discount to increase their annual sales by at least 50%. If they indeed achieve their goal with this discounting strategy, determine their cost of discounting, net profit after discount cost, and positive/negative rate change in net profit level. (Show your solution with tabular illustration. 20 points)
Found in SOUL
Company B has annual sales of 4M and net profit level before credit cost of 5% on a 30 days net credit term with 1M debtors, while the cost of credit is at 12% yearly. The firm was able to triple their annual sales by extending the credit term 60 days more. Given that their total debtors also tripled along with their cost of credit, determine their cost of credit, net profit after credit cost, and positive/negative rate change in net profit level if inflation rate of 6% yearly is also factored in.
Found in SOUL
Suppose firm A offers a 60-day net credit term, with annual sales of $14M, 16% profit level, debtor of $3M, how much is their cost of credit if the rate is 10.56% a year, and the rate of their actual net profit?
Found in SOUL
In item no. 1 above, if inflation rate of 6% a year is factored in, how much is their cost of inflation, and the rate of their actual net profit with inflation?
found in SOUL
CDB company’s debtor accounts totaled $1.25M as of June 30 2024, and monthly sales for June, May, and April are $660,000, $490,000, and $600,000 respectively, how many days is their Days Sales Outstanding (DSO) for that period?
Found inSOUL
Suppose a company with sales of $24M makes profit before interest at 14% on sales, debtor account of $4.6M, interest expense at 10% p.a., and sales outstanding of 72 DSO was 6 days faster in cash collection, how much would their net profit after interest expense be after adjustment and change in borrowings?
Found inSOUL
