Suggestion concerning Credit Limit. Should It Be Approved or Not, W, Finance
This case has been framed in order to test skills in evaluating a credit request and reaching a correct decision. Perluence International is large manufacturer of petroleum and rubber-based products used in a variety of commercial applications in fields of transportation, electronics, and heavy manufacturing. In the north-western United States, many of the Perluence products are marketed by a wholly-owned subsidiary, Bajaj Electronics Company. Operating from a headquarters and warehouse facility in the San Antonio, Strand Electronics has 950 employees and handles a volume of $85 million in sales yearly. About $6 million of sales represents items manufactured by the Perluence. Gupta is the credit manager at Bajaj electronics. He supervises five employees who manage credit application and collections on 4,600 accounts. The accounts range in size from $120 to $85,000. The firm sells on varied terms, with 2/10, net 30 mostly. Sales change seasonally and the average collection period tends to run 40 days. Bad-debt losses are less than 0.6 per cent of sales. Gupta is evaluating a credit application from the Booth Plastics, Inc., a wholesale supply dealer serving oil industry. The company was founded in 1977 by Neck A. Booth and has grown steadily since that time. Bajaj Electronics is not selling any products to Booth Plastics and had no preceding contact with Neck Booth. Bajaj Electronics purchased goods from Perluence International under the same terms and conditions as Perluence employed when it sold to independent customers. Though Bajaj Electronics usually followed Perluence in setting its prices, the subsidiary operated independently and could adjust price levels to meet its own marketing strategies. The Perluence's cost-accounting department estimated a 24 per cent mark-up as the average for items sold to Pucca Electronics. Bajaj Electronics, in turn, resold the items to yield a 17 per cent markup. It appeared that these percentages would grasp on any sales to Booth Plastics. Bajaj Electronics incurred out-of pocket expenses that were not considered in calculating the 17 per cent mark-up on its items. For example, the contact with Booth Plastics had been made by James, the salesman who managed the Glaveston area. Examination Paper Semester I: Financial Management IIBM Institute of Business Management James would receive a 3 per cent commission on all sales made Booth Plastics, a commission which would be paid whether or not the receivable was collected. James would, of course, be willing to assist in collecting any accounts that he had sold. In addition to the sales commission, the company would acquire variable costs as a result of managing the merchandise for the new account. As a common guideline, warehousing and other administrative variable costs would run 3 per cent sales. Gupta Holmstead approached all credit decisions in essentially the same way Plastics of $65,000. Supposing that Neck Booth took the, 3 per cent of discount. Bajaj Electronics would realize a 17 per cent mark-up on these sales since the average mark-up was computed on the basis of the customer taking the discount. If Neck Booth did not take the discount, the mark-up would be slightly higher, as would the cost of financing the receivable for the additional period of time. In addition to the potential profit from the account, Gupta was concerned regarding his company's exposure. He knew that weak customers could become bad debts at any time and therefore, needed a vigorous collection effort when ever their accounts were over-due. His department probably spent three times as much money and effort managing a marginal account as compared to a strong account. He also figured that over-due and uncollected funds had to be financed by the Bajaj Electronics at a rate of 18 per cent. All in all, slow -paying or marginal accounts were extremely costly to Bajaj Electronics. With these considerations in mind, Gupta began to reassess the credit application for the Booth Plastics.