Receivables management, Financial Management

Assignment Help:

Receivables Management

The decision on whether to grant or not to grant credit to a particular customer can be taken if certain subjective probabilities of the payment pattern of the customer can be specified based on an analysis of the customer's financial viability, the nature of profession or employment or business he is engaged in, his relationship with other suppliers, his past record of payments to other suppliers, etc. has been carried out. The decision to grant credit or not to grant credit is usually based on expected value calculations.

Example 

A textile manufacturer must decide whether a credit of Rs.30 lakh can be extended to a new customer who manufactures dresses. The customer is expected to make a repeat purchase. The textile manufacturer on credit evaluation of the customer feels that the probability that the customer will pay is 0.85 and the probability that the customer will default is 0.15. If the customer pays for the first purchase, the probability that he will pay for the repeat purchase would increase to 0.95. The repeat purchase is also expected to be worth Rs.30 lakh. The cost of sales for both orders is 80 percent of sales value. Should the textile manufacturer grant credit?

The possibilities when credit is granted for the first order are as follows:

  1. The customer defaults and no repeat purchase is allowed.

  2. The customer pays and places a repeat purchase order.

The outcome of the repeat order could be that the customer pays or does not pay.

In the example, at the first decision node we have two choices: to allow credit or not to allow credit. If credit is allowed on the first order, the subsequent events are the customer will pay with a probability of 0.85 or he will not pay with a probability of 0.15. If the customer pays then at the second decision node he is expected to make a repeat purchase. The subsequent events on allowing credit for the second order are that the customer will pay with a probability of 0.95 or not pay with a probability of 0.05.

We can draw the following decision tree:

Figure 

663_recievables management.png

Evaluating expected pay-offs from right to left,

At node D2:

Decision - Go for 2nd order

 

prob.

x

pay-off

=

Exp. pay-off

Event: customer will pay

0.85

x

(6 + 4.5)

=

8.925

Event: customer will not pay

(+)0.15

x

0.8*(-)30

=

(-)3.6

 

Net Expected Pay-off

=

5.325

Therefore, by going for the 2nd order the net expected pay-off is Rs.4.5 lakh.

At node D1:

Decision - Allow Credit and go for 1st order

 

prob.

x

pay-off

=

Exp. pay-off


Event: customer will pay

0.85

x

(6 + 4.5)

=

8.925

Event: customer will not pay

(+)0.15

x

0.8*(-)30

=

(-)3.6

 

Net Expected Pay-off

=

5.325

* (Note that for the event, customer will pay, we consider the total expected pay-off i.e. 6 + 4.5. This is because if the customer pays for the 1st order he will make a profit of Rs.6 lakh on the 1st order as well as make a net expected pay-off of Rs.4.5 lakh on the 2nd order which takes place as a result of the customer paying for the 1st order.)

Decision - Do not allow credit

Here the pay-off is 0.

We find that if the decision of allowing credit is followed then a net expected pay-off of Rs.5.325 lakh can be made as opposed to no pay-off by not allowing credit. Hence the decision of allowing credit is followed.


Related Discussions:- Receivables management

Determine the proportion of debt and equity, Q. Determine the proportion of...

Q. Determine the proportion of debt and equity? Financing Decision: - This function is related to increasing of finance from different sources. For this reason the financial ma

Sensitivity analysis, Sensitivity Analysis A test of an organizations p...

Sensitivity Analysis A test of an organizations performance projections based on varying the key assumptions which is used for forecast performance.

Finance, Ask questiSuggestion regarding Credit limit. Should it be approved...

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

Audit opinion, Clean Opinion - AUDIT opinion not qualified for any material...

Clean Opinion - AUDIT opinion not qualified for any material scope restrictions nor departures from GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP). Also called UNQUALIFIED OPINION

Define mergers affect consumers, How do mergers affect consumers? A: Th...

How do mergers affect consumers? A: The impacts mergers have on consumers vary widely. There may be a few inconvenience and anxiety when a customer's bank or branch is obtained

Determine the name of some profit margin ratios, Determine the name of some...

Determine the name of some profit margin ratios Other profit margin ratios can also be computed: Gross profit/ turnover Profit after tax/ turnover Advertising co

Borrowing funds to purchase bonds, Borrowing Funds to Purchas...

Borrowing Funds to Purchase Bonds There are several sources available to borrow funds. When securities are purchased with borrowed funds then the mo

Case study on labour standars, describe the impact of different types of st...

describe the impact of different types of standards on motivation, and specifically , the likely effects on motivation of adopting the labor standards recommended for geeta & compa

Cash flow yield analysis, A cash-flow yield is the discount r...

A cash-flow yield is the discount rate that makes the price of a mortgage-backed or asset-backed security equal to the present value of its ca

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd