22-6 Tightening Credit Terms

Kim Mitchell, the new credit manager of the Vinson Corporation, was alarmed to find that Vinson sells on credit terms of net 60 days while industry-wide terms have recently been lowered to net 20 days. On annual credit sales of $3.0 million, Vinson currently averages 75 days of sales in accounts receivable. Mitchell estimates that tightening the credit terms to 20 days would reduce annual sales to $3,250,000, but accounts receivable would drop to 25 days of sales and the savings on investment in them should more than overcome any loss in profit. Vinson's variable cost ratio is 80%, and taxes are 40%. If the interest rate on funds invested in receivables is 16% , should the change in credit terms be made?