How would you judge the potential profit

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Reference no: EM131525210

This case has been framed in order to test the skills in evaluating a credit request and reaching a correct decision. Perluence International is large manufacturer of petroleum and rubber-based products used in a variety of commercial applications in the fields of transportation, electronics, and heavy manufacturing.

In the northwestern United States, many of the Perluence products are marketed by a wholly-owned subsidiary, Bajaj Electronics Company. Operating from a headquarters and warehouse facility in San Antonio, Strand Electronics has 950 employees and handles a volume of $85 million in sales annually. About $6 million of the sales represents items manufactured by Perluence.

Gupta is the credit manager at Bajaj electronics. He supervises five employees who handle credit application and collections on 4,600 accounts. The accounts range in size from $120 to $85,000. The firm sells on varied terms, with 2/10, net 30 mostly. Sales fluctuate seasonally and the average collection period tends to run 40 days. Bad-debt losses are less than 0.6 per cent of sales. Gupta is evaluating a credit application from Booth Plastics, Inc., a wholesale supply dealer serving the oil industry. The company was founded in 1977 by Neck A. Booth and has grown steadily since that time. Bajaj Electronics is not selling any products to Booth Plastics and had no previous contact with Neck Booth. Bajaj Electronics purchased goods from Perluence International under the same terms and conditions as Perluence used when it sold to independent customers. Although Bajaj Electronics generally followed Perluence in setting its prices, the subsidiary operated independently and could adjust price levels to meet its own marketing strategies.

The Perluence's cost-accounting department estimated a 24 per cent mark up as the average for items sold to Pucca Electronics. Bajaj Electronics, in turn, resold the items to yield a 17 per cent mark up. It appeared that these percentages would hold on any sales to Booth Plastics. Bajaj Electronics incurred out-of pocket expenses that were not considered in calculating the 17 per cent mark up on its items. For example, the contact with Booth Plastics had been made by James, the salesman who handled the Glaveston area. James would receive a 3 per cent commission on all sales made Booth Plastics, a commission that would be paid whether or not the receivable was collected. James would, of course, be willing to assist in collecting any accounts that he had sold. In addition to the sales commission, the company would incur variable costs as a result of handling the merchandise for the new account. As a general guideline, warehousing and other administrative variable costs would run 3 per cent sales.

Gupta Holmstead approached all credit decisions in basically the same manner. First of all, he considered the potential profit from the account. James had estimated first-year sales to Booth Plastics of $65,000. Assuming that Neck Booth took the, 3 per cent discount. Bajaj Electronics would realize a 17 per cent mark up on these sales since the average mark up was calculated on the basis of the customer taking the discount. If Neck Booth did not take the discount, the mark up would be slightly higher, as would the cost of financing the receivable for the additional period of time. In addition to the potential profit from the account, Gupta was concerned about his company's exposure. He knew that weak customers could become bad debts at any time and therefore, required a vigorous collection effort whenever their accounts were overdue.

His department probably spent three times as much money and effort managing a marginal account as compared to a strong account. He also figured that overdue and uncollected funds had to be financed by Bajaj Electronics at a rate of 18 percent.

All in all, slow - paying or marginal accounts were very costly to Bajaj Electronics. With these considerations in mind, Gupta began to review the credit application for Booth Plastics.

QUESTION

1. How would you judge the potential profit of Bajaj Electronics on the first year of sales to Booth Plastics and give your views to increase the profit?

2. Suggestion regarding Credit limit. Should it be approved or not, what should be the amount of credit limit that electronics give to Booth Plastics.

Reference no: EM131525210

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