Generally speaking, the industry payable turnover is only 30 days. This means that the company is taking advantage of paying its creditors late. Although it is foregoing a 2.5% discount, it can make use of the money that they have in hand for almost 30 days (as they pay their creditors in almost 60 days). This money can be used to buy government securities or short term investments that would give a return of greater than 2.5% and hence the company is currently doing a great job. The advantages of this are an improvement in cash conversion cycles, investment opportunity and it can use the cash for profitable purposes.
The disadvantage is that it may lose its reputation in the market and it has to forego a 2.5% discount. However, the advantages of the policy outweigh the disadvantages and the company should continue with the current policy. The Company would rely more on overdraft after the new policy implementation because it is going to take more days for the company to create cash and hence it will meet any of its obligations falling between the cycle by using an overdraft and other credit lines provided by financial institutions and banks.
The company should think about increasing the bank overdraft facility or should apply for working capital loans, because the new policy implementation is likely to cause liquidity problems, because of the extended time needed to convert inventory into cash. (Brigham & Ehrhardt 2010) Between 2010 and 2011 the trade receivables payment period showed a marked increase, in spite of the generous discount on offer. Suggest other ways in which the company could improve its credit control.
Answer: The Company can improve its credit control by adopting effective collection policies or by restructuring the collection department. There should be aging of accounts receivable and the company should intimate its customers regularly when their debt is about to mature. Another way of improving the credit control policy is through assessment of the financial worth of customers before allowing them the leverage to pay later.
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