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CHAPTER 6

CHAPTER 6. Credit Management. Chapter Outline. Credit and Receivables Components of Credit Policy Investment in Receivables Credit Policy Evaluation Optimal Credit Policy. Credit. What is “ credit sale ”? Why do firms have “ credit sales ”?

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CHAPTER 6

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  1. CHAPTER 6 Credit Management

  2. Chapter Outline • CreditandReceivables • Components of CreditPolicy • Investment in Receivables • CreditPolicyEvaluation • Optimal CreditPolicy

  3. Credit • What is “creditsale”? • Why do firmshave “creditsales”? • Arethereanyrisksto “creditsales”? • What is thetrade-off of “creditsales”? • Accountsreceivable & tradecredit

  4. Components of CreditPolicy • Terms of sale (creditperiods, cashdiscounts & period) • Creditanalysis (probability of paymentanddefault) • Collectionpolicy (howtocollect)

  5. CashFlowfromGrantingCredit Speedupthecollectionfloat!

  6. Investment in Receivables • Whatwouldtheinvestmentdepend on? • Kıyılar Balıkçılık: Averagecollectionperiod = 30 days Creditsalesperday = 1,000,000 TL AccountsReceivablebalance?

  7. Terms of Sale • Creditperiod • Cashdiscount • Discountperiod • Type of creditinstrument • Withinindustry & accrossindustries

  8. TheBasic Form • 2/10 net 60 • Purchase of 1,000,000 TL by Uşak Tarım Whataretheoptions? • 5/10 net 45

  9. TheCreditPeriod • CreditPeriod: length of time forwhichcredit is granted • Industryvariation 30-120 days • Cashdiscount: - net creditperiod - cashdiscountperiod

  10. TheCreditPeriod • Invoice: A billforgoodsorsevicesprovidedbythe seller tothepurchaser • Invoicedate: beginning of thecreditperiod • Billingorshippingdate • Receipt of goods • End of month (constantpurchases)

  11. Length of CreditPeriod • AffectingFactors: -buyer’sinventoryperiod -operatingcycle of thebuyer -perishability: moreperishable=>shorter -consumerdemand: establishedproducts => shorter newproducts=> longer

  12. Length of CreditPeriod -cost: lower => shorter -credit risk: higher=>shorter -size of theacocunt: smaller=>shorter -competition: higher=>longer -customertype: customerdifferentiation

  13. Cost of theCredit • 2/10 net 30? Is the 2 % highenoughto pay early? • Çelik Üretim: Buysworth 1,000,000 on credit If not paidearly? Cost? • CreditInstrument: Evidence of Indebtedness

  14. Evaluating a CreditPolicy • LocalProducer: -currentlysellsforcashonly -considering net 30 sales -Price = 49 TL Variablecost = 20 TL -Currentquantitysold (Q) = 100 units/month -Futurequantitytosell (Q*) = 110 u/month -No discounts/no taxes/no default risk -Shouldtheyswitch?

  15. Evaluating a CreditPolicy • Currentmonthlysales = Variablecost = Total cashflow = Fixedcosts? Futuremonthlysales = Total cashflow = Monthlychange =

  16. Evaluating a CreditPolicy • Interest rate = 2 % monthly • PV of monthly 290 = • Costs? • Extravariablecost = Uncollectedamount = Total cost of thismonth = Whyonlythismonth? SWITCH or NOT?

  17. Optimal CreditPolicy • Cashflow of increasedsale = Carryingcosts of credit • Carryingcosts: * requiredreturn on receivables * lossesfrombaddebt * costs of creditmanagement & collection • Opportunitycosts (forgonesales)

  18. Optimal CreditPolicy • Creditcostcurve = (carryingcosts, opp. costs of forgonesales) • Below optimal => ??? Over optimal => ???

  19. Optimal CreditPolicy

  20. CustomerCreditAnalysis • ONE TIME SALE: Customerwantsto buy 1 unit on credit at P. No credit => no sale Credit => pay in 1 monthordefault Defaultprobability => π One time sale Requiredreturn on acc. rec. => R Variablecost => v GRANT CREDIT?

  21. CustomerCreditAnalysis • ONE TIME SALE: Ifcreditgranted: Cashoutflow? When? Cashinflow? When? v=20 P=49 R=%2 π=20 % NPV? GRANT CREDIT? BREAK EVEN DEFUALT PROBABILITY?

  22. CustomerCreditAnalysis • REPEAT BUSINESS: Ifnewcustomerdoes not default at first => neverdefaults (assumption) cost v thismonth if no default=> P nextmonth Ifcustomerpays=>cyclegoes on forever

  23. CustomerCreditAnalysis • REPEAT BUSINESS: PV of everymonth’ssale? Firstmonth’scost? NPV of extendingcredit? GRANT CREDIT?

  24. Customer’s 5 C’s • Character • Capacity • Capital • Collateral • Conditions

  25. PolicyChangeExample • EGE Chemicals: • R=25 % • Variblecost=70 % of sales • Allsalesare on credit • ADOPT A NEW POLICY???

  26. PolicyChangeExample • EGE Chemicals: • Comparemarginalcosts vs. benefits • Ignorefixedcosts?

  27. PolicyChangeExample • Policy I • NET BENEFIT???

  28. PolicyChangeExample • Policy II • NET BENEFIT??? ANY POLICY CHANGES???

  29. END OF CHAPTER

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