The Swink Company expects to have sales of $20 million this year under current operating policies. Its variable costs as a proportion of sales are 0.8, and its cost of receivables financing is 8%. Currently, the firm’s credit policy is net 25. However, its average collection period is 30 days, indicating that some customers are paying late, and its bad debt losses are 3% of sales.
Swink’s credit manager is considering the following alternative credit policy:
Proposal: Lengthen the credit period to net 40. If this were done, it is estimated that sales would increase to $20,500,000, that days sales outstanding would increase to 45 days, and that bad debt losses on the incremental sales would be 5%. Existing customer bad debt losses would remain at 3%.
Based on your calculation, should the manager adopt this new credit policy?