Managing Cash Flow

58 Managing Cash Flow—Receipts and Disbursements
moves, thus leaving everyone—except the customers—worse off. Sales could easily
return to the old levels, resulting in no gain, but with an increase in accounts
receivable investment and the resulting increase in expenses.
An analysis of Jack B. Nimble Company’s situation disclosed the following
for the future of the company, based on sales information provided by Jack’s sales
manager (and using a 360-day year):
10-Day Terms 20-Day Terms 30-Day Terms
Expected sales volume (annual) $ 18,000,000 $ 23,400,000 $ 28,800,000
Accounts receivable balance $ 500,000 $ 1,300,000 $ 2,400,000
Operating profit (20% of sales) $ 3,600,000 $ 4,680,000 $ 5,760,000
A/R carrying costs (4%) ____________ 20,000 ____________ 52,000 ____________ 96,000
Operating profit after carrying
costs ____________ $ 3,580,000 ____________ $ 4,628,000 ____________
$ 5,664,000
Adjusted operating profit
% of sales _______
19.89% _______
19.78% _______
19.67%
Based on assumptions that longer credit terms will result in increased sales
volume as shown and that customers will normally take the longer payment
terms, it is clear that each projected increase in the credit period results in higher
earnings (even after the carrying costs) because of the increase in sales volume.
Return on sales, however, reduces marginally because of the carrying
costs. This type of analysis should be done for all businesses, since every situation
will be different. In too many instances a business will adopt a net 30-day
credit policy without the benefit of analysis and will thereby have little or no
idea of its cost.
The company should also take into account the fact that longer credit terms
can easily lead to increased bad debt write-offs, and customers gained through
more lenient credit policies may be financially weaker and less likely to pay on
time—or at all. Remember, the goal is to convert sales into cash, not into accounts
receivable— receivables are merely a way station. Before easing credit terms, consider
all aspects of the situation, and keep in mind that it will be extremely difficult
to tighten these policies once the more lenient ones have been in effect.
CASH DISBURSEMENTS
NO PAY BEFORE ITS TIME.
We have just discussed how to manage the collection and control of cash receipts
more effectively, but it is also necessary to look at methods for disbursing cash so