Trade Credit and Receivables. A firm offers terms of 2/15, net 30.
Currently, two-thirds of all customers take advantage of the trade
discount; the remainder pay bills at the due date.

a. What will be the firm?s typical value for its accounts receivable period?

b. What is the average investment in accounts receivable if annual
sales are $20 million?

c. What would likely happen to the firm?s accounts receivable period
if it changed its terms to 3/15, net 30?

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Request for Question Clarification by omnivorous-ga on 03 May 2004 14:44 PDT

MMP --

You've just changed the imputed discount for prompt payment from 48.7%
(before compounding) to 73% (before compounding).  Such an impressive
discount SHOULD lead to a decline in days-sales-outstanding.

The simple answer to C is: "It will decline."  But there's no way to
judge by how much -- and cases where it might not change at all:
*  a country with hyper-inflationary environment
*  customers who structurally can't pay any faster.  For example, if
you bill the first of every month and your customers are primarily
state & local government agencies, their council or school board might
not meet in time to approve invoices and take a 15-day prompt payment
discount.

Best regards,

Omnivorous-GA

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Clarification of Question by missmallprincess-ga on 03 May 2004 15:57 PDT

I understand that a clear cut answer cannot be given for "C" but I
would like two seperate answers showing yout calculations for "A" and
"B" if possable.  I know that there are so many "what ifs" to this
question but in general, what do you think?

Missmallprincess --

A.	Value for AR period:
15 days x .66666 = 10 days
30 days x .33333 = 10 days

Total DSO (days sales outstanding) = 20 days

B.  Value of receivables:
15 days @ $20 million/year = 15/365 * $20M = $822,000
30 days @ $20 million/year = 30/365 * $20M = $1,644,000

But we have to weight these by the percentages each comprise in our AR total:
0.666 * $822,000 = $547,452
0.333 * $1,644,000 = $547,452

AVERAGE AR OUTSTANDING = $1,094,905

--

There's an alternate way to calculate this using the information in A.
 If you have, on average 20 days of receivables:
20/365 * $20M per year = $1,095,890

The differences here are only due to rounding and are not
statistically significant.


C.	 As said before: "it should decline," inasmuch as the discount rate
is drastically higher.  If we'd compounded the interest rate, it would
approach 100%.

You might wish to include the other comments on situations where it
wouldn't change.  It shows a better understanding of how the AR
function really works!

Best regards,

Omnivorous-GA