PLease elaborate where possible, thanks in advance BLC Ltd. has revenue of £500

Question

PLease elaborate where possible, thanks in advance

BLC Ltd. has revenue of £500 million and sells all of its goods on credit to a variety of different wholesale customers. At the moment the company offers a standard credit period of 30 days. However, 70% of its customers (by revenue) take an average of 70 days to pay, while the other 30% of customers (by revenue) pay within 30 days. The company is considering offering a 2% discount for payment within 30 days and estimates that 80% of customers (by revenue) will take up this offer (including those that already pay within 30 days).

The Managing Director has asked the credit controller if the cost of this new policy would be worth offering. The company has a £80 million overdraft facility that it regularly uses to the full limit due to the lateness of payment and the cost of this overdraft facility is 15% per annum.

The credit controller also estimates that bad debt level of 2% of revenue would be halved to 1% of revenue as a result of this new policy.

Required

Calculate the approximate equivalent annual percentage cost of a discount of 2%, which reduces the time taken by credit customers to pay from 70 days to 30 days.

Calculate the value of trade receivables under the existing scheme and the proposed scheme at the year-end.

Evaluate the benefits and costs of the scheme and explain with reasons whether the company should go ahead and offer the discount. You should also consider other factors in this decision. (Hint: You need to work out the cost of the discount compared to the interest on the overdraft saved and bad debt reduction.)

Explanation / Answer

Current Average Collection period = 70*0.7 + 30*0.30

= 58 days

..

Average collection period under proposed scheme = 30*0.8 + 70*0.2

= 38 days

..

Reduction in average collection period = 20 days

,

Trade receivable under the existing scheme at the year-end. = 500m*(58/365)

= 79.45

Trade receivable under the proposed scheme at the year-end. = 500m(38/365)

= 52.05

..

..

Benefit from the proposed scheme

1)Savings in Interest Cost (79.45-52.05)*15% = 4.11 m

2)Reduction in Bad Debt (1% of 500) = 5,

Less:-Cost of Proposed Scheme - Discount of 2% (2% of 500) = 10m

..

Net Loss form the sceme = 0.89 m

..

The proposed sceme is not viable

..

..

the approximate equivalent annual percentage cost of a discount of 2%, which reduces the time taken by credit customers to pay from 70 days to 30 days. = 0.89/10 * 100

= 8.9%

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