SESSION 5

Overview
Overview of
of Working
Working
Capital
Capital Management
Management
 The Balance Sheet
ASSETS LIABILITIES AND
STOCKHOLDERS’
Current Assets EQUITY
Cash and Cash Equivalents Current Liabilities
Marketable Securities Trade and Other Payables
Trade and Other Receivables Accrued Expenses
Inventories Noncurrent Liabilities
Noncurrent Assets Bonds Payable
Long-term Investments Stockholders’ Equity
Property, Plant and Preference Shares
Equipment Ordinary Shares
Intangible Assets Share Premium
Prepayments Retained Earnings
Other Assets Total Liabilities and
Total Assets Stockholders’ Equity
 The Balance Sheet

LEVERAGED
Stockhold
ers’
Liabilit Equity
ies

ASSE
TS
Income Statement

Sales
Less: Cost of Sales
Gross Profit
Less: General and
Administrative
Expenses
Net Income before
tax
Income Tax
Net Income
 Cash Flow Statement

Cash Flows from Operating Activities

+
Cash Flows from Investing Activities
+
Cash Flows from Financing Activities
=
Net Increase (Decrease) of Cash
Add: Cash Balance, beginning of the
year
Cash Balance, end of the year
 Working Capital
Management
Balance
Sheet
Current Liabilities
Current Assets
Trade and Other Payables
Cash and Cash Equivalents
Accrued Expenses
Marketable Securities
Trade and Other Receivables Income
Inventories Statement
Sales
Cash Flow Statement Less: Cost of Sales
Gross Profit
Cash Flows from Operating Activities Less: General and
Administrative Expenses
Net Income before tax
Income Tax
Net Income
 Overview of
Working Capital
Management
 Working Capital Concepts
 Working Capital Issues

 Financing Current Assets:

Short-Term and Long-Term Mix

 Combining Liability Structure

and Current Asset Decisions

 Working Capital
Concepts
Net Working Capital
Current Assets - Current Liabilities.
Gross Working Capital
The firm’s investment in current assets.
Working Capital Management
The administration of the firm’s current assets
and the financing needed to support current
assets.
 Significance of
Working Capital
Management
 In a typical manufacturing firm, current
assets exceed one-half of total assets.
 Excessive levels can result in a
substandard Return on Investment (ROI).
 Current liabilities are the principal source
of external financing for small firms.
 Requires continuous, day-to-day
managerial supervision.
 Working capital management affects the
company’s risk, return, and share price.
 Working Capital
 Financial Analysts: Working Capital
equals current assets
 Accountants: Working Capital equals
current assets- current liabilities
 Current Assets
 Reasonably expected to be realized
in cash or consumed or sold during
the normal operating cycle of the
business. These include cash,
marketable securities, receivables
and inventory.
 Normal Operating Cycle is one year

(360 days).
 Working Capital
Management
 The administration and control of
the company’s working capital.

 The primary objective is to

achieve a balance between
return ( profitability) and risk.
 Current Liabilities
 Their liquidation requires the use
of current assets or incurrence of
other current liabilities. They
include trade accounts payable,
unearned revenues, accrued
expenses, short term debt, and
current portion of long term
debt.
 Current Assets
 Temporary  Permanent Current
Current Assets – Assets – the portion
of the company’s
current assets, assets required to
such as cash, that maintain the firm’s
fluctuate with the daily operations.
firm’s operational Minimum level of
needs assets required (e.g.
minimum inventory
level) if the firm is to
continue its
operations.
 Working Capital Financing Policies

 Conservative ( Relaxed)
Policy
 Aggressive (Restricted) Policy

 Matching Policy

 Balanced Policy
 Conservative(Relaxed)
Policy
 Operations are conducted
with too much working
capital, involves financing
almost all asset
investments with long
term capital
 Conservative (Relaxed)
Policy
 Advantages  Disadvantage
› Reduces risk of › Less profitable
illiquidity because of
› Eliminates the higher financing
firm’s exposure costs
to fluctuating
loan rates and
potential
unavailability of
short term credit
 Aggressive (Restricted)
Policy
 Operations are conducted on a
minimum amount of working
capital; uses short-term liabilities
to finance, not only temporary,
but also part or all of the
permanent current asset
requirement
 Aggressive (Restricted)
Policy
 Advantage:  Disadvantages:
› Increases return on › Exposure to risk
equity(profitability) arising from low
by taking working capital
advantage of the position
cost differential › Puts too much
between long-term pressure on the
and short term firm’s short-term
borrowing capacity
debt.
so that it may have
› (i.e. STL - 6% vs difficulty in satisfying
LTL - 10%, 4% unexpected need for
difference) funds.
 Matching Policy
 Also called self liquidating or hedging
policy – matching the maturity of a
financing source with specific financing
needs
 Short term assets are financed with short
term liabilities
 Long term assets are funded by long term
liabilities

Client with a approved rate of 6% E.Y. long

term; funds of 3% E.Y. long term.
 Balanced Policy
 Balances the trade off
between risk and
profitability in a manner
consistent with its attitude
toward bearing risk.
 Deciding on an Appropriate Working
Capital Policy

 The amount of net working capital that a

company should have depends on the
amount of risk it is willing to take. The
primary consideration therefore is the trade
off between returns (profitability) and risk
(risks of illiquidity) associated with;
› Asset Mix decision – appropriate mix of current
and non current assets
› Financing Mix Decision – appropriate mix of
short term and long term liabilities to finance
current assets.
 Risk Return of trade off
 The greater the risk, the greater is the
potential for larger returns.
 More current assets lead to greater
liquidity but yield lower returns(profit)
 Fixed asset earn greater returns than
current assets
 Long term financing has less liquidity
risk than short- term debt, but has
higher explicit cost, hence lower return.
Cash
Cash and
and
Marketable
Marketable
Securities
Securities
Management
Management
 Cash and Marketable
Securities Management

 Motives for Holding Cash

 Speeding Up Cash Receipts
 S-l-o-w-i-n-g D-o-w-n
Cash Payouts
 Electronic Commerce
 Cash Management
 Involves the maintenance of the
appropriate level of cash and investment
in marketable securities to meet the firm’s
cash requirements and to maximize
income on idle funds
 Objective: to invest cash for a return
while retaining sufficient liquidity to
satisfy future needs
 Motives for Holding
Cash
Transactions Motive -- to meet payments
arising in the ordinary course of
business, that is to carry out its
purchases and sales activities
Speculative Motive -- to take advantage of
temporary opportunities, firm delays
purchases and store up cash for use
later to take advantage of possible
changes in prices of materials.
 Motives for Holding
Cash
Precautionary Motive -- to maintain a
cushion or buffer to meet
unexpected cash needs resulting
from unexpected slow down in
accounts receivable collection, strike
or increase in cash needs beyond
management’s original projections.
 Motives for Holding
Cash
Compensating Balance Requirement
A certain amount of cash that a firm must
leave in its checking account at all times
as part of a loan agreement
 Motives for Holding
Cash
Potential Investment opportunities
Excess cash reserves are allowed to build
up in anticipation of a future investment
opportunity such as a major capital
expenditure project.
 Cash Management
System
Collections Disbursements

Marketable securities
investment

Control through information reporting

= Funds Flow = Information Flow

 Speeding Up
Cash Receipts

Collections
 High standards on credit approval
 Shorter trade discount and credit period
 Efficient and effective billing system
 Speeding Up
Cash Receipts

Billing System
 Expedite preparing and mailing the
invoice
 Accelerate the mailing of payments from
customers
 Reduce the time during which payments
received by the firm remain uncollected
 Speeding Up
Cash Receipts

Cost-effective collection system

 Frequency of collection follow-up
 Visibility of collection personnel
 Use of specialized postal system (i.e., lockbox
system)
 Electronic fund transfer (EFT)
 Concentration banking
 Automatic debit/credit
 Depository check
 Concept of FLOAT in
Cash Management
 Float – difference between the bank’s
balance for a firm’s account and the
balance that the firm shows on its own
books.
 2 aspects of float
 The time it takes a company to

process its checks internally

 The time consumed in clearing the

check through the banking system

(this : 1 day)
 Concept of FLOAT in
Cash Management
 Types of Float
 Negative Float – book balance

exceeds the bank balance

 Positive float – the firm’s bank balance

exceeds its book balance ( Ex. Checks

written/ issued by the firm that have
not yet cleared)E
 Collection Float

Mail Processing Availability

Float Float Float

Deposit Float

Collection Float: total time between the mailing

of the check by the customer and the availability
of cash to the receiving firm.
 Mail Float

Customer Firm
mails check receives check

Mail Float: time the check is in the mail.

 Processing Float

Firm Firm
receives check deposits check

Processing Float: time it takes a company

to process the check internally.
 Availability Float

Firm Firm’s bank

deposits check account credited

Availability Float: time consumed in clearing

the check through the banking system.
 Deposit Float

Processing Float Availability Float

Deposit Float: time during which the check

received by the firm remains uncollected funds.
 Cash Management
Strategies – Earlier
Billing
Accelerate preparation and mailing of
invoices to customers
 computerized billing
 invoices included with shipment
 invoices are faxed
 advance payment requests
 preauthorized debits
 Cash Management
Strategies -Preauthorized
Payments

Preauthorized debit
The transfer of funds from a payor’s bank
account on a specified date to the payee’s
bank account; the transfer is initiated by
the payee with the payor’s advance
authorization.
 S-l-o-w-i-n-g D-o-
w-n Cash Payouts
 “Playing the Float”(Positive Float)
 Control of Disbursements
 Stretch Payables
 Payroll and Dividend
Disbursements
 Zero Balance Account (ZBA)
 Remote and Controlled Disbursing
 Some Effective Methods
of Cash Outflow
Management
 Use of checks and drafts
 Voucher system
 The 3:00 o’clock habit
 Thanks God it’s Friday (TGIF) Syndrome
 Payroll management
 The Optimum Cash Balance

Optimum

√
2 x Annual Cash Need x Cost per Transaction
Cash Balance = Carrying Cost Rate
The Optimum Cash Balance
Sample Problem:
Pure Gold Corporation expects to make even
monthly cash payments of P160,000 during the
year. The average return on money market
placements is 8% per annum and it expects to pay
P250 per cash transfer. Determine the following:
1. Optimum cash balance per transaction
2. Average cash balance
3. Number of transfer per year
4. Total relevant cost at the optimum cash balance
5. Total relevant cash cost at the following cash
transfers:
a. P50,000
b. P400,000
The Optimum Cash Balance

Optimum

√
2 x 1,920,000 x
Cash Balance = 250
8%
= P109,544

Average
Cash Balance = P109,544 / 2

= P54,772
The Optimum Cash Balance

Number of
Cash = P1,920,000 / P109,544
Transfers
= 17.53 or 18 times
Total Relevant Cost:

Transaction Cost : 17.53 x 250 = P4,382

Carrying Cost : P54,772 x 8% = P4,382
P8,764
 The Optimum Cash Balance

Total Relevant Cost: at P50,000 at

Transaction Cost P400,000
:
(P1,920,000 / P50,000) x P250
(P1,920,000 / P400,000) x P250 9,600
1,200

Carrying
(P50,000 / Cost
2) x 8%
:
(P400,000 / 2) x 8% 2,000
_____ 16,000
P11,600 P17,200
Lilly P. Corporation expects to make even
monthly cash payments of 500,000 during the
year. The average return of financial
investment is 6% per annum and it expects to
pay P500 transaction charges per cash
transfer. Determine the following
A.Optimum cash balance per transaction
B.Average cash balance
C.Number of cash transfer per year
D.Total Relevant Cost of the optimum cash
balance
E.Total Relevant Cash cost at the following
Accounts
Accounts Receivable
Receivable
Management
Management
Accounts Receivable
Are among a companies
most liquid assets. They
represent collectibles
from customers.
They represent potential
cash
 Accounts Receivable Management

Seeks an efficient trade off

between profits from
increased credit sales and
debts, collection expenses
and opportunity costs
arising from customer
credit
 Key factors affecting
Accounts Receivable

Sales
Credit Policy
Collection Efficiency
 Sales
If credit sales
increases, accounts
receivable also
increases
 Credit Policy
Includes the term
of credit, the cash
discount and credit
standards.
 Credit Terms
Include the period ( 30 days or
45 days) and any cash discounts
to encourage prompt payment
by the customers. Lengthening
the credit period increases sales
and profits, collection expenses
and investment in Accounts
receivable.
 Cash Discounts
Shortens the average collection
period of the company and
reduces the company’s
investment in accounts
receivable. It reduces
investments in A/R, reduces
collection period and may
increase sales. Cash discounts
reduce the gross margin rate of
 Cash Discounts
The bait is, the higher the
discount rate, the more
attractive it is for the buyer to
pay at an earlier date. However,
the cost-benefit trade-off should
be considered, that is, the cost
of offering the discount rate
should be compared with the
benefit of using the money
 Credit Standards
Are the criteria in
evaluating the
creditworthiness of a
customer.
The criteria may either
be financial or non
financial.
 Financial Criteria
1. Turnover of Inventory
2. Liquidity of the
Customer
Non financial Criteria
1. Quality of
management
2. Minimum Track
record of a Business
Credit Policies/Standards
Strict Credit Aggressive
Policy Credit Policy
1) Lower 1) Increase AR
investment in balance
AR 2) Increase the
2) Lower risk of risk of bad
Bad Debts debts
3) Lower 3) Bring about
collection more
expense collection
problems
 Credit Policies/Standards
A slack credit standard will increase sales but will also
increase receivables and bad debts as credit is extended
to marginally credit worthy customers.

A tight standard reduces accounts receivable and bad

debts but may prevent the company from achieving its
sales potential.

The finance manager should evaluate alternative credit

and collection policies by comparing incremental
benefits from higher sales with incremental costs from
credit processing, bad debts and opportunity cost of
incremental investment in receivables.
 The five (5) C’s of Credit

1. Character
2. Capacity
3. Conditions
4. Capital
5. Collateral
Are a simple guide to
analyzing creditworthiness
and getting information about
 1. Character
Refers to a borrower’s
commitment to pay
according to the terms
of the agreement.
 2. Capacity
Is the customer’s
capability to pay his debts.
It is assessed based on the
past and forecast financial
status and performance of
his business.
 3. Condition
Refers to industry and
economic factors that
may affect a company’s
ability to meet its
obligations.
 4. Capital
Refers to the net worth
of the customer.
Highly Exposure - 75(L)-
25(C)
 5. Collateral
Represents assets that
a customer pledges in
favor of a creditor to
secure the latter’s
delivery of goods.
Collection Efficiency
Collection efforts of the
company directly
influences customer
payments of their
accounts.
Collection Efficiency
Collection of AR is the
last step of converting
goods to cash. Failure at
this stage causes loss of
an asset and dissipation
of working capital.
 Kinds of Collection Letters

1. Discount Letter
2. Reminder Letter
3. Past Due Letter
4. Demand Letter
5. Ultimatum Letter
6. Legal Letter (thru lawyer)
 Indicators of Efficient Accounts
Receivable Management

1. Turnover of Accounts
Receivable
2. Average age of the
Receivable portfolio
3. Degree of bad debt
losses
 Turnover Ratios
Measures the efficiency
of management of
accounts Receivable.
Aging of Receivables
Reveals possible
problem of collection
and the proportion of
slow paying customers.
 Analysis of Bad Debts

Determines the causes

of bad debts and their
adverse effect on the
net worth of the
company.
 Problem 1

Metro technologies is considering its

credit terms from 2/15,net 30 to 3/10
net 30 in order to speed collections. At
present 40% of Metrotech’s customers
take the 2% discount. Under the new
term discount customers to take the
discount are expected to rise to 50%.
Regardless of the credit terms, half of
the customers who do not take the
discount are expected to pay on time,
whereas the remainder will pay 10
days late.
 Problem 1: (cont.)

The change does not involve a

relaxation of credit standards; therefore,
bad debt losses are not expected to rise
above their present 2% level. However,
the more generous cash discount terms
are expected to increase sales from
2million to 2.6 million per year.
Metrotech’s variable cost ratio is 75%,
the interest rate on funds invested in
accounts receivable is 9% and the
corporate tax is 40%
 Problem 1: (cont.)

Required:
1. What is the day’s sales outstanding
before and after the change?
2. Calculate the discount costs before
and after the change.
3. Calculate the peso cost of carrying
receivables before and after the
change.
 Problem 1: (cont.)

Required:
4. Calculate the bad debts losses

before and after the change.

5. What is the incremental profit from

the change in credit terms? Should

Metrotech change its credit terms?
 Problem 1: (cont.)
Summary
from 2/15; n/30 to 3/10; n/30
40% takes 2% disc to 50% expected to take
3%
Metro technologies is
considering
30% pays on 30 its credit
25% pays on 30 terms
30% pays 10 days late 25% pays 10 days late
from 2/15,net
Sales of P2.0 Mn
30 to 3/10 net
Sales Increase to P2.6 Mn
Variable30
Cost in order to 75%speed
(same)
Tax Rate collections.
40% (same)
Cost of AR 9% (for both)
 Problem 1: (cont.)
Summary
from 2/15; n/30 to 3/10; n/30
40% takes 2% disc to 50% expected to take
3%
At present 40% of Metrotech’s
customers
30% pays on 30 take
25% pays the
on 30 2%
30% pays 10 days late 25% pays 10 days late
discount. Under the new term
Sales of P2.0 Mn Sales Increase to P2.6 Mn
discount
Variable Cost
customers to take
75% (same)
the
discount
Tax Rate are expected
40% (same) to rise to
Cost of AR 50%.
9% (for both)
 Problem 1: (cont.)
Summary
from 2/15; n/30 to 3/10; n/30
40% takes 2% disc to 50% expected to take
3%

Regardless
30% pays on 30 of the credit
25% pays on 30 terms,
half of 10
30% pays thedayscustomers
late 25% pays 10who do
days late
Sales of P2.0 Mn Sales Increase to P2.6 Mn
not take the discount are
Variable Cost 75% (same)
expected to pay on time,
Tax Rate 40% (same)
whereas
Cost of AR
the remainder
9% (for both)
will pay
10 days late.
 Problem 1: (cont.)
Summary
from 2/15; n/30 to 3/10; n/30
40% takes 2% disc to 50% expected to take
3%

30% pays on 30 25% pays on 30

Regardless
30% pays 10 days of
late the credit
25% pays terms,
10 days late
half ofP2.0
Sales of theMn customers who
Sales Increase do
to P2.6 Mn
not take
Variable Cost the discount are
75% (same)
expected
Tax Rate to pay 40%on time,
(same)
whereas
Cost of AR the remainder
9% (for both) will pay
 Problem 1: (cont.)
Summary
from 2/15; n/30 to 3/10; n/30
40% takes 2% disc to 50% expected to take
3%

30% pays on 30 25% pays on 30

30% pays 10 days late 25% pays 10 days late
However,
Sales of P2.0 Mnthe more generous
Sales Increase to P2.6 Mn
cash
Variablediscount
Cost terms 75%are
(same)
Tax Rate 40% (same)
expected to increase sales from
Cost of AR 9% (for both)
2million to 2.6 million per year.
 Problem 1: (cont.)
Summary
from 2/15; n/30 to 3/10; n/30
40% takes 2% disc to 50% expected to take
3%

30% pays on 30 25% pays on 30

30% pays 10 days late 25% pays 10 days late
Sales of P2.0 Mn Sales Increase to P2.6 Mn
Variable Cost 75% (same)
Metrotech’s
Tax Rate variable
40% (same) cost ratio
is 75%
Cost of AR 9% (for both)
> the interest rate on funds invested in
Problem
accounts receivable
corporate tax is 40%,
is 1:
9% (cont.)
and the

> bad debt losses are not expected to rise

Summary
above their present 2% level
from 2/15; n/30 to 3/10; n/30
40% takes 2% disc to 50% expected to take
3%

30% pays on 30 25% pays on 30

30% pays 10 days late 25% pays 10 days late
Sales of P2.0 Mn Sales Increase to P2.6 Mn
Variable Cost 75% (same)
Tax Rate 40% (same)
Cost of AR 9% (for both)
 Problem 1: Answer

1. What is the day’s sales

outstanding (DSO) before and
after the change?

DSO = The days the Credit Sales

still Outstanding until it is
collected in cash. (% * Number of
Day)
 Problem 1: Answer

1. DSO (old)
40% x 15 days = 6 days
30% x 30 days = 9 days
30% x 40 days = 12 days
Days Sales Outstanding 27 days
 Problem 1: Answer

1. DSO (old)
50% x 10 days = 5 days
25% x 30 days =7.5 days
25% x 40 days = 10 days
Days Sales Outstanding 22.5 days
 Problem 1: Answer

2. Calculate the discount costs

before and after the change.
 Problem 1: Answer

2. Old Discounts:
Sales 2,000,000
Less: Probable Loss
(2,000,000 x 2%) 40,000
Total Net Receivable 1,960,000
% of Client to avail the
discount period 40%
Net Receivable 784,000
x Discount Rate 2%
Total Discount Cost 15,680
 Problem 1: Answer

2. New Discounts:
Sales 2,600,000
Less: Probable Loss
(2,600,000 x 2%) 52,000
Total Net Receivable 2,548,000
% of Client to avail the
discount period 50%
Net Receivable 1,274,000
x Discount Rate (NEW) 3%
Total Discount Cost 38,220
 Problem 1: Answer

2. Old Discounts:

.4x.02x2,000,000x.98 = P
15,680.00

New Discounts:

.5x.03x2,600,000x.98 = P
 Problem 1: (cont.)

Required:
3. Calculate the peso cost of carrying
receivables before and after the
change.
 Problem 1: Answer
3. Cost of Carrying Receivables =

Day Sales Outstanding (DSO)

XX
x Sales per day (Annual Sales / 360 days)
XX
x Variable cost ratio
XX%
 Problem 1: Answer
3. Old Cost of Carrying Receivables
=
27
Day Sales Outstanding
2,000,000 (DSO) 5,555.56
XX 75%
x Sales per day (Annual Sales / 360 days) 9%
XX
P10,125
x Variable cost ratio
XX%
 Problem 1: Answer
3. New Cost of Carrying
Receivables =
22.5
Day Sales Outstanding
2,600,000 (DSO) 7,222.22
XX 75%
x Sales per day (Annual Sales / 360 days) 9%
XX
P10,968.75
x Variable cost ratio
XX%
 Problem 1: (cont.)

Required:
4. Calculate the bad debts losses before

and after the change.

Accounts Receivable x Bad Debts Rate = Bad

Debts
or Probable
Loss
 Problem 1: Answer

4. Bad debt loss (old)

= .02 ( 2,000,000.00)
= P 40,000.00
 Problem 1: Answer

4. Bad debt loss (old)

= .02 ( 2,000,000.00)
= P 40,000.00

Bad debt loss (new)

=.02 ( 2,600,000.00)
= P 52,000.00
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales
Less: Discounts
Net Sales
Production
Costs
Profit B4 CC/tax
Cost of Carrying
Bad debt losses
Profit b4 tax
Taxes (40%)
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts
Net Sales
Production
Costs
Profit B4 CC/tax
Cost of Carrying
Bad debt losses
Profit b4 tax
Taxes (40%)
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts 15,680.00 38,220.00
Net Sales
Production
Costs
Profit B4 CC/tax
Cost of Carrying
Bad debt losses
Profit b4 tax
Taxes (40%)
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts 15,680.00 38,220.00
Net Sales P 1,984,320.00 P 2,561,780.00
Production
Costs
Profit B4 CC/tax
Cost of Carrying
Bad debt losses
Profit b4 tax
Taxes (40%)
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts 15,680.00 38,220.00
Net Sales P 1,984,320.00 P 2,561,780.00
Production 1,500,000.00 1,950,000.00
Costs (75%)
Profit B4 CC/tax
Cost of Carrying
Bad debt losses
Profit b4 tax
Taxes (40%)
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts 15,680.00 38,220.00
Net Sales P 1,984,320.00 P 2,561,780.00
Production 1,500,000.00 1,950,000.00
Costs (75%)
Profit B4 CC/tax P 484,320.00 P 611,780.00
Cost of Carrying
Bad debt losses
Profit b4 tax
Taxes (40%)
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts 15,680.00 38,220.00
Net Sales P 1,984,320.00 P 2,561,780.00
Production 1,500,000.00 1,950,000.00
Costs (75%)
Profit B4 CC/tax P 484,320.00 P 611,780.00
Cost of Carrying 10,125.00 10,969.00
Bad debt losses 40,000.00 52,000.00
Profit b4 tax
Taxes (40%)
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts 15,680.00 38,220.00
Net Sales P 1,984,320.00 P 2,561,780.00
Production 1,500,000.00 1,950,000.00
Costs (75%)
Profit B4 CC/tax P 484,320.00 P 611,780.00
Cost of Carrying 10,125.00 10,969.00
Bad debt losses 40,000.00 52,000.00
Profit b4 tax P 434,195.00 P 548,811.00
Taxes (40%)
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts 15,680.00 38,220.00
Net Sales P 1,984,320.00 P 2,561,780.00
Production 1,500,000.00 1,950,000.00
Costs (75%)
Profit B4 CC/tax P 484,320.00 P 611,780.00
Cost of Carrying 10,125.00 10,969.00
Bad debt losses 40,000.00 52,000.00
Profit b4 tax P 434,195.00 P 548,811.00
Taxes (40%) 173,678.00 219,524.00
Net income
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 2,600,000.00
Less: Discounts 15,680.00 38,220.00
Net Sales P 1,984,320.00 P 2,561,780.00
Production 1,500,000.00 1,950,000.00
Costs (75%)
Profit B4 CC/tax P 484,320.00 P 611,780.00
Cost of Carrying 10,125.00 10,969.00
Bad debt losses 40,000.00 52,000.00
Profit b4 tax P 434,195.00 P 548,811.00
Taxes (40%) 173,678.00 219,524.00
Net income 260,517.00 P 329,287.00
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 600,000.00 P 2,600,000.00
Less: Discounts 15,680.00 22,450.00 38,220.00
Net Sales P 1,984,320.00 P 577,460.00 P 2,561,780.00
Production 1,500,000.00 450,000.00 1,950,000.00
Costs (75%)
Profit B4 CC/tax P 484,320.00 P 127,460.00 P 611,780.00
Cost of Carrying 10,125.00 844.00 10,969.00
Bad debt losses 40,000.00 12,000.00 52,000.00
Profit b4 tax P 434,195.00 P 114,616.00 P 548,811.00
Taxes (40%) 173,678.00 45,846.00 219,524.00
Net income 260,517.00 P 68,770.00 P 329,287.00
 Problem 1: Answer (E)
What is the incremental profit
from the change in credit terms?
Should Metrotech change its
credit YES
terms?
IS - Current Effect of IS – New Policy
Policy Change
Gross Sales P 2,000,000.00 P 600,000.00 P 2,600,000.00
Less: Discounts 15,680.00 22,450.00 38,220.00
Net Sales P 1,984,320.00 P 577,460.00 P 2,561,780.00
Production 1,500,000.00 450,000.00 1,950,000.00
Costs (75%)
Profit B4 CC/tax P 484,320.00 P 127,460.00 P 611,780.00
Cost of Carrying 10,125.00 844.00 10,969.00
Bad debt losses 40,000.00 12,000.00 52,000.00
Profit b4 tax P 434,195.00 P 114,616.00 P 548,811.00
Taxes (40%) 173,678.00 45,846.00 219,524.00
Net income 260,517.00 P 68,770.00 P 329,287.00
INVENTORY MANAGEMENT
Separate Slide
 Problem 2
Golden Corporation is studying a proposed
collection system that will decrease
collection period from 45 days to 30 days.
To do this, administrative costs in relation
to collection activities are expected to
increase by .30% of net sales, which is
projected to remain at P30,000,000. The
effective rate of return prevailing in the
market with the same type of investment
risk is 12%.

Should Golden Corporation institute the

 Problem 2: Answer
Before After Change

Collection Period
45 days 30 days 15 days
Receivable turnover (360
days / Collection period)
8 times 12 times 4 times
Net Sales P30,000,000 P30,000,000 None
Accounts Receivable
balance (Net sales / P3,750,000 P2,500,000 (1,250,000)
Receivable turnover)
Increase in collection costs
(.30% of sales) 90,000
 Problem 2: Answer
Income from released
balance of Accounts Receivable
(1,250,000 x 12%) P150,000
Less: Increase in collection costs
90,000
Net advantage of
new collection policy P
60,000