The Receivables Policy That Grows Sales and Starves Cash
Jamuna Distributors has annual credit sales of BDT 120 crore, receivables days of 45, and a gross margin of 22%. It funds working capital with an overdraft at 13%. The new commercial manager proposes relaxing credit terms to 60 days, forecasting a 15% increase in sales, and simultaneously offering a 2% early-settlement discount for payment within 10 days, which she expects 40% of customers to take. Bad debts currently run at 1.5% of sales and are expected to rise to 2.5% on the incremental sales only. The finance manager warns that the overdraft facility has only BDT 8 crore of headroom and the company is already close to its limit. The CEO wants a decision this week.
1. Compute the incremental cost and benefit of the relaxed credit policy before the discount, and state whether it is worth doing.
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Incremental sales. 15% of BDT 120 crore = BDT 18 crore. Contribution at 22% gross margin = BDT 3.96 crore.
Incremental receivables. New total sales BDT 138 crore. At 60 days, receivables = 138 × 60/365 ≈ BDT 22.7 crore. Old receivables = 120 × 45/365 ≈ BDT 14.8 crore. Incremental investment in receivables ≈ BDT 7.9 crore.
Financing cost. At 13%, the carrying cost is about BDT 1.03 crore. Note the stricter approach: only the cost of the incremental receivables (78% of the balance) should be financed, since the margin is recovered at sale. On that basis the investment is 7.9 × 0.78 ≈ BDT 6.2 crore and the cost ≈ BDT 0.80 crore. Either way, state the convention.
Bad debts. 2.5% of the BDT 18 crore incremental sales = BDT 0.45 crore. Existing bad debts are unchanged under the stated assumption, so they are not incremental.
Net benefit. 3.96 − 1.03 − 0.45 ≈ BDT 2.48 crore (or BDT 2.71 crore on the margin-only convention). The policy is clearly positive on these numbers - the contribution dwarfs the carrying cost.
The catch. The facility headroom is BDT 8 crore and the incremental receivables are BDT 7.9 crore before the discount is layered on. The policy is profitable but unfundable as structured: it consumes essentially all remaining liquidity. The decision is not 'yes' or 'no' but 'yes, phased' - extend terms to 60 days for new customers only, or negotiate a facility increase before launch.
2. Now evaluate the 2% early-settlement discount and its interaction with the relaxation.
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Cost of the discount. If 40% of customers pay in 10 days, the discount applies to 40% of BDT 138 crore = BDT 55.2 crore. Cost = 2% × 55.2 = BDT 1.10 crore per year.
Benefit. Those customers' receivables fall from 60 days to 10 days, releasing 55.2 × 50/365 ≈ BDT 7.6 crore of funding at 13% = BDT 0.98 crore saved. Bad debts on that segment should also fall, but the setup does not quantify it; flag it as an unquantified upside rather than assuming it.
Net. 0.98 − 1.10 ≈ −BDT 0.12 crore, marginally negative before any bad-debt benefit. The annualised cost of the discount is 2% × 365/50 ≈ 14.6%, which exceeds the 13% overdraft rate - the company would be borrowing more cheaply from the bank than from its own customers. That is the decisive comparison, and it holds regardless of the precise mix.
Interaction with the relaxation. The two proposals pull in opposite directions. Relaxing to 60 days raises receivables by BDT 7.9 crore; the discount pulls BDT 7.6 crore back. Net incremental receivables are only about BDT 0.3 crore, which solves the facility headroom problem - but the discount costs BDT 1.10 crore to save BDT 0.98 crore. The combined package is therefore worse than the relaxation alone on profitability, though better on liquidity.
Recommendation. Do not offer the discount at 2%/10 days. If liquidity is the binding constraint, either negotiate the facility or offer a smaller discount (about 1.5%, which annualises to roughly 11%, below the overdraft rate). Present the board with the relaxation alone plus a facility request, and the discount only as a liquidity lever if the facility cannot be increased.