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Doria's Corporation makes sales of $2,160,000 per annum. The average age of accounts recievable is 30 days. Management considers shortening credit terms by 10 days. Cost of money is 18%
how much will the company save from financing charges?(assume 360-day per year)
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If they are paid 10 days sooner on the annual sales of $2,160,000 per annum, their bank (or bond) financing interest costs are reduced by (10/360)*0.18*$2,160,000 per annum = $10,800. This shows up as a saving.
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To calculate how much the company will save from financing charges, we need to determine the amount of accounts receivable that will be reduced by shortening the credit terms and then calculate the financing charges for the reduced amount.
Step 1: Calculate the average daily credit sales
Divide the annual sales by the number of days in a year (360 in this case) to find the average daily credit sales.
Average daily credit sales = $2,160,000 / 360 = $6,000
Step 2: Calculate the reduction in accounts receivable
Multiply the average daily credit sales by the number of days the credit terms are being shortened (10 days).
Reduction in accounts receivable = $6,000 * 10 = $60,000
Step 3: Calculate the financing charges for the reduced accounts receivable
Multiply the reduction in accounts receivable by the cost of money rate (18%) and the number of days in a year (360).
Financing charges = $60,000 * 0.18 * 360/100 = $388,800
Therefore, the company will save $388,800 from financing charges by shortening the credit terms by 10 days.