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Grabbit Quick Co achieves current annual sales of $1,800,000. The cost of sales is 80% of this amount, but bad debts average 1% of total sales, and the annual profit is as follows.
| $000 | |
| Sales | 1,800 |
| Less COGS | (1,440) |
| Gross profit | $360 |
| Less bad debts | ($18) |
| Profit | $342 |
The current debt collection period is one month, and the management considers that, if credit terms were eased (Option A), the effects would be as follows.
| Current policy | Option A | |
| Additional sales % | - | 25% |
| Average collection period | 1 month | 2 months |
| Bad debt (% of sales) | 1% | 3% |
The company has 15% cost of financing working capital. The costs of sales are 75% variable and 25% fixed. Assume there would be no increase in fixed costs from the extra revenue and that there would be no increase in average inventories or accounts payable.
Requirements:
Analyze and comment whether company should stay with current policy or shift to the option A?
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