Evaluation of credit Policies
Example :
-Current Sales 10 lakh, shall increase by 200000 in option 1 , by 300000 in option 2 . —Variable cost are 35% of Sales. Fixed cost are Rs 200000 .
-Existing credit period is 2 mth, option 1 is 2.5 mth. and option 2  is  3 mth.
-Credit Sales are 80% of total Sales.
-Required rate of return is 12%.
-Existing Bad debt  loss is 2% , option 1 is 3% and option 2  is  4%.
-Collection cost is 3%Â of debtors .
| Particulars | Present Policy | Option 1 | Option 2 |
| Credit Period |
2 mth. |
2.5 mth. |
3 mth |
| Sales |
10,00,000 |
12,00,000 |
13,00,000 |
| Less:Variable Cost |
 3,50,000 |
4,20,000 |
4,55,000 |
| Contribution(S-V) |
 6,50,000 |
7,80,000 |
8,45,000 |
| Less: Fixed Cost |
 2,00,000 |
2,00,000 |
2,00,000 |
| PROFIT(BENEFIT) |
 4,50,000 |
5,80,000 |
6,45,000 |
| Â |
 |
 |
 |
| TotalCost=FC+VC |
5,50,000 |
6,20,000 |
6,55,000 |
| Average Invt.in Debtors= Total Cost X Creditsales  X
   Total Sales Debtor Period mth  12 mths  |
5,50,000 X 80% X 2/12mth =73333 | 6,20,000 X 80% X 2.5/12mth =103333 | 6,55,000 X 80% X 3/12 mth. = 131000 |
| COST | Â | Â | Â |
| a) Opportunity cost of capital= eg. 12% x Avg.Invt.in Debtor | 73333Â XÂ 12%Â = 8800 | 103333Â XÂ 12%Â = 12400 | 131000 X 12%Â = 15720 |
| b) Bad debt cost= eg.Bad debt % x Sales | 10,00,000 X 2% =20,000 | 12,00,000Â X 3% = 36,000 | 13,00,000Â X 4% = 52,000 |
| c) Collection Cost = Â 3% x Debtors | (10,00,000 X 2/12mth)Â X 3%
=Â 5000 |
(12,00,000Â X
2.5 /12 mth)X 3% = 7500 |
(13,00,000Â XÂ
 3/12mth)  X 3% = 9,750 |
| TOTAL COST |
33,800 |
55,900 |
77,470 |
| NET BENEFITS(Profit – Total Cost) |
4,16,200 |
5,24,100 |
5,67,530 |
| RATING |
III |
II |
I |
 Formulae
a) If P/V  Ratio  is given  find            — Contribution = Sales X  P/V ratio.
b) If Debtors Turnover ratio is given — Debtors = Credit sales
Debtors Turnover ratio
c) Debtors  Velocity    =             12 mths.
Debtors Turnover ratio
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