Response to the following problem:
Your superior, the general manager of Plastics Manufacturers Limited, has recently been talking to the chief buyer of Plastic Toys Limited, which manufactures a wide range of toys for young children. At present, Plastic Toys is considering changing its supplier of plastic granules and has offered to buy its entire requirement of 2,000 kg a month from you at the going market rate, provided that you will grant it three months' credit on its purchases.
The following information is available:
1 Plastic granules sell for £10 a kilogram, variable costs are £7 a kilogram, and fixed costs £2 a kilogram.
2 Your own business is financially strong, and has sales revenue of £15m a year.
For the foreseeable future it will have surplus capacity, and it is actively looking for new outlets.
3 Extracts from Plastic Toys' financial statements:
|
|
Year 1
£000
|
Year 2
£000
|
Year 3
£000
|
|
Sales revenue
|
800
|
980
|
640
|
|
Profit before interest and tax
|
100
|
110
|
(150)
|
|
Capital employed
|
600
|
650
|
575
|
|
Current assets
|
|
|
|
|
Inventories
|
200
|
220
|
320
|
|
Trade receivables
|
140
|
160
|
160
|
|
|
340
|
380
|
480
|
|
Current liabilities
|
|
|
|
|
Trade payables
|
180
|
190
|
220
|
|
Short-term borrowings (overdraft)
|
100
|
150
|
310
|
|
|
280
|
340
|
530
|
Required:
(a) Write some short notes suggesting sources of information that you would use to assess the credit worthiness of potential customers who are unknown to you. You should critically evaluate each source of information.
(b) Describe the accounting controls that you would use to monitor the level of your business's trade receivables.
(c) Advise your general manager on the acceptability of the proposal. You should give your reasons and do any calculations you consider necessary.
(Hint: To answer this question you must weigh the costs of administration and cash discounts against the savings in bad debts and interest charges.)