The Receivables Squeeze at Meridian Traders
Meridian Traders has annual credit sales of ₹6 crore and average receivables of ₹1.1 crore. Its gross margin is 22% and net margin 3.5%. The firm has a cash credit limit of ₹80 lakh from its bank, currently drawn to ₹74 lakh at 11.5% interest. A large customer, representing 28% of sales, has moved from 45-day to 90-day payment and now owes ₹62 lakh. Two suppliers have shifted Meridian to cash-on-delivery because of delayed payments. The accountant records sales when goods are dispatched and makes no provision for doubtful debts. The owner wants to offer a 2% early-payment discount to all customers to pull cash forward, and to stretch supplier payments further to fund it.
1. Compute the receivables position, assess the owner's proposal, and recommend a working-capital plan.
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Position. Average collection period = receivables ÷ credit sales × 365 = 1.1 crore ÷ 6 crore × 365 ≈ 67 days. The dominant customer at 90 days owes ₹62 lakh, which is 56% of total receivables and 28% of sales. Cash credit is 92.5% utilised, leaving only ₹6 lakh headroom. Net margin of 3.5% on ₹6 crore is ₹21 lakh, so interest at 11.5% on ₹74 lakh (about ₹8.5 lakh) consumes 40% of net profit. No provision for doubtful debts overstates profit and assets.
Owner's proposal. A 2% discount to all customers costs 2% of sales, i.e. ₹12 lakh if all take it, against a maximum interest saving far smaller; the discount is only worth it if it shortens collection materially, and the problem customer is unlikely to pay early. Stretching suppliers further has already caused cash-on-delivery, which threatens supply and may raise prices. Both moves treat symptoms.
Recommendation. (1) Put the large customer on a written payment plan with staged dates and a credit limit; escalate to the owner. (2) Offer the discount selectively to reliable customers, not the problem account. (3) Create a provision for doubtful debts, say 2% of receivables (₹2.2 lakh), to reflect reality. (4) Negotiate a temporary enhancement of the cash credit limit or a bill-discounting facility against confirmed orders. (5) Introduce credit checks and ageing reports reviewed weekly.
2. Prepare a simple cash-flow reasoning showing why a profitable firm can still face a liquidity crisis here, and state three warning indicators the owner should monitor.
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Why profit and cash diverge. Meridian earns ₹21 lakh net profit on ₹6 crore of sales, but profit is recorded when goods are dispatched, not when cash arrives. If the large customer's ₹62 lakh is delayed from 45 to 90 days, roughly ₹62 lakh of cash is locked up for an extra 45 days. Meanwhile suppliers demand cash on delivery, so outflows accelerate while inflows slow. The bank limit is nearly exhausted (₹74 lakh of ₹80 lakh), so there is only ₹6 lakh of buffer. A firm can therefore report profit while being unable to pay wages or suppliers.
Warning indicators. (1) Collection period trend: rising from 67 days toward 90 signals worsening cash conversion. (2) Limit utilisation: cash credit above 90% leaves no headroom for shocks. (3) Customer concentration: 28% of sales in one account means its behaviour drives the whole cash cycle.
Additional useful measures: ageing of receivables (share over 60 days), supplier terms (share of purchases on cash-on-delivery), and the ratio of interest cost to net profit, currently about 40%. The owner should review these monthly alongside the profit and loss account, because the profit figure alone conceals the liquidity risk.