Kaluba Ltd achieves current annual sales of K1,800,000. The cost of sales is 80% of this amount but bad debts average 1% of total sales, and the annual profit is as follows: K

Sales 1,800,000

Less: cost of sales (1,440,000)

Gross profit 360,000

Less: bad debts (18,000)

Net profit 342,000

The current debt collection period is one month, and the management consider that if credit terms were eased (option A below) then the effects would be as follows:

Present Policy Option A

Additional Sales 25%

Average collection Period 1 month 2 months

Bad debts (% of sales) 1% 3%

The company requires a 20% return on its investments. If the cost of sales are 75% variable and 25% fixed and on the assumption that:

• there would be no increase in fixed costs from the additional turnover
• there would be no increase in average stocks or creditors

Required:

What is the preferable policy, Option A or the present one? (20 Marks)

(b)What is meant by the cash conversion cycle? (5 Marks)