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Credit policies and profits

Case 7-3 Credit Policy Review

The president, vice president, and sales manager of Moorer Corporation were discussing the company's present credit policy. The sales manager suggested that potential sales were being lost to competitors because of Moorer Corporation's tight restrictions on granting credit to consumers. He stated that if credit policies were loosened, the current year's estimated credit sales of $3,000,000 could be increased by at least 20% next year with an increase in uncollectible accounts receivable of only $10,000 over this year's amount of $37,500. He argued that because the company's cost of sales is only 25% of revenues, the company would certainly come out ahead.

The vice president, however, suggested that a better alternative to easier credit terms would be to accept consumer credit cards such as VISA or MASTERCARD. She argued that this alternative could increase sales by 40%. The credit card finance charges to Moorer Corporation would be 4% of the additional sales.

At this point, the president interrupted by saying that he wasn't at all sure that increasing credit sales of any kind was a good thing. In fact, he suggested that the $37,500 of uncollectible accounts receivable was altogether too high. He wondered whether the company should discontinue offering sales on account.

With the information given, determine whether Moorer Corporation would be better off under the sales manager's proposal or the vice president's proposal. Also, address the president's suggestion that credit sales of all types be abolished.

Solution Preview

Sales manager proposal:
Increase of sales = $3,000,000 * 20% = $600,000
Subtract production cost = -25% * $600,000 = -$150,000
Uncollectable accounts loss = -$10,000
Net change in profits = $600,000 - $150,000 - $10,000 = + $440,000

Vice president proposal:
Increase of sales = $3,000,000 * 40% = ...

Solution Summary

This shows how to evaluate the effects of various credit policies on profits.