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Credit Policy

If the company reduces its receivables without adversely affecting sales, what effect should this have on the company's cash position (1) in the short run and (2) in the long run?

Which ratios would explain whether a firm's customers pay more or less promptly than those of its competitors? Which ones would suggest that a firm should tighten or loosen its credit policy?

Is there any reason to think that a firm may be holding too much receivables? If so, how would that affect EVA and ROE?

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*** If the company reduces its receivables without adversely affecting sales, what effect should this have on the company's cash position (1) in the short run and (2) in the long run? ***

Short run: Cash will increase as inventory purchases decline as receivables are reducued.

Long run: Company is likely to take steps to reduce its cash holdings and increase its EVA.

*** Which ratios would explain whether a firm's customers pay more or less promptly than those of its competitors? ***

1) A/R Turnover which is:
Net Credit Sales/Average Net A/R

This measures the ability to collect cash from credit customers

2) Days' sales in receivables which is:
Average Net A/R / One Day's Sales

3) A measure of the average number of days that a company takes to collect revenue after a sale has been made. A low DSO number means that it takes a company fewer days to collect its accounts receivable. A high DSO number shows that a company is selling its product to customers on credit and taking longer to collect money.

Days sales outstanding is calculated as:
AR/Totalal Credit Sales (# of Days)

This shows how many days sales remain in A/R -- how many days it takes to collect the average level of receivables.

Due to the high importance of cash in running a business, it is in a company's best interest to collect outstanding receivables as quickly as possible. By quickly turning sales into cash, a company has the chance to put the cash to use again - ideally, to reinvest and make more sales. The DSO can be used to determine whether a company is trying to ...

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