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The Management of Accounts Receivable and Inventories

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The North Carolina Furniture Company (NCFC) manufactures upholstered furniture, which it sells to various small retailers in the Northeast and Midwest on credit terms of 2/10, net 60. The company currently does not grant credit to retailers with a 3 (fair) or 4 (limited) Dun & Bradstreet Composite Credit Appraisal. If NCFC were to extend credit to retailers in the fair category, an estimated additional $1.2 million per year in sales could be generated. The estimated average collection period for these customers is 90 days, and the expected bad-debt loss ratio is 6 percent. Approximately 20 percent of these customers are expected to take the cash discount. NCFC's variable cost ratio is 0.70, and its required pretax rate of return on current assets investments is 20 percent. The company also estimates that an additional investment in inventory of $350,000 is necessary for the anticipated sales increase.

Determine the net change in NCFC's pretax profits from extending credit to retailers in the fair category.

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The management of account receivable and inventories are examined in the solution.

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