Milwaukee Surgical Supplies, Inc, sells on terms of 3/10, net 30. Gross sales for the year are $1,200,000 and the collections department estimates that 30 percent of the customers pay on the tenth day and take discounts, 40 percent pay on the thirtieth day, and the remaining 30 percent pay, on average, 40 days after the purchase (Assume 360 days per year)
a. What is the firm's average collection period?
b. What is the firm's current receivables balance?
c. What would be the firm's new receivables balance if Milwaukee Surgical toughened up on its collection policy, with the result that all nondiscount customers paid on the 3oth day?
d. Suppose that the firm's cost of carrying receivables was 8 percent annually. How much would the toughened credit policy save the firm in annual receivables carrying expense? (Assume that the entire receivables had to be financed).
a.27 days
b.90000
c.80000
90,000
a. To calculate the average collection period, we need to determine the weighted average of the collection periods for each group of customers.
The collection period for customers who take the discount on the tenth day is 10 days.
The collection period for customers who pay on the thirtieth day is 30 days.
The collection period for customers who pay, on average, 40 days after the purchase is 40 days.
Now, we can calculate the average collection period:
Average collection period = (30% * 10 days) + (40% * 30 days) + (30% * 40 days)
Average collection period = (0.30 * 10 days) + (0.40 * 30 days) + (0.30 * 40 days)
Average collection period = 3 days + 12 days + 12 days
Average collection period = 27 days
Therefore, the firm's average collection period is 27 days.
b. To calculate the current receivables balance, we need to find the amount of gross sales that is not collected on the tenth day, considering the discount, and the amount of gross sales that is collected on the thirtieth day.
Amount collected with discount = 30% of $1,200,000 = $360,000
Amount collected on the thirtieth day = 40% of $1,200,000 = $480,000
Current receivables balance = Gross sales - Amount collected with discount - Amount collected on the thirtieth day
Current receivables balance = $1,200,000 - $360,000 - $480,000
Current receivables balance = $360,000
Therefore, the firm's current receivables balance is $360,000.
c. If Milwaukee Surgical toughened up its collection policy and all nondiscount customers paid on the thirtieth day, then the new receivables balance would only include the sales to customers who take the discount.
New receivables balance = Amount collected with discount
New receivables balance = $360,000
Therefore, the firm's new receivables balance would be $360,000.
d. The cost of carrying receivables is 8 percent annually, and if the firm toughens up its credit policy, they will reduce the average collection period from 27 days to 30 days.
Using the formula to calculate the carrying cost of receivables:
Carrying cost of receivables = Average receivables balance * Cost of carrying receivables
Current carrying cost of receivables = $360,000 * 0.08 = $28,800
New carrying cost of receivables = New receivables balance * Cost of carrying receivables
New carrying cost of receivables = $360,000 * 0.08 = $28,800
The toughened credit policy does not save the firm in annual receivables carrying expense as the new carrying cost of receivables is the same as the current carrying cost of receivables.
Therefore, the toughened credit policy does not save the firm in annual receivables carrying expense.
To answer these questions, we need to calculate the following:
a. Average Collection Period:
Average Collection Period is the average number of days it takes for a company to collect payment on its credit sales. To calculate the average collection period, we need to determine the weighted-average number of days it takes for customers to pay.
The calculation is as follows:
(Percentage of customers who pay on the 10th day x 10) + (Percentage of customers who pay on the 30th day x 30) + (Percentage of customers who pay after 40 days x 40)
b. Current Receivables Balance:
The current receivables balance is the total amount of money owed to the company by its customers. We can calculate it by multiplying the gross sales by the percentage of customers who have not paid yet.
Receivables Balance = Gross Sales x (1 - Percentage of customers who have paid)
c. New Receivables Balance with Toughened Collection Policy:
If all non-discount customers pay on the 30th day, we need to calculate the new receivables balance. This can be done similarly to the current receivables balance calculation.
New Receivables Balance = Gross Sales x (1 - Percentage of customers who have paid on the 10th day)
d. Savings in Annual Receivables Carrying Expense:
The savings in annual receivables carrying expense can be calculated by multiplying the reduction in receivables balance from the toughened credit policy by the cost of carrying receivables.
Savings = (Current Receivables Balance - New Receivables Balance) x Cost of Carrying Receivables
Let's calculate each of these:
a. Average Collection Period:
(0.30 x 10) + (0.40 x 30) + (0.30 x 40) = Average Collection Period
b. Current Receivables Balance:
Receivables Balance = $1,200,000 x (1 - (0.30 + 0.40)) = Current Receivables Balance
c. New Receivables Balance with Toughened Collection Policy:
New Receivables Balance = $1,200,000 x (1 - 0.30) = New Receivables Balance
d. Savings in Annual Receivables Carrying Expense:
Savings = (Current Receivables Balance - New Receivables Balance) x 0.08 = Savings in Annual Receivables Carrying Expense
By carrying out these calculations, you will be able to find the answers to the questions posed.