Nyumbani Security Ltd. is a wholesaler of household security fittings. Over the last 12 months the company has encountered increasing problems with late payment by debtors. The last 12 months of credit sales of Sh.67.5 million show an increase of 10% over the previous years sales, but the companys overdraft on which it is charged 20% per annum has also increased by Sh.1.8 million over the previous year.

The company wishes to reduce its working capital requirements by reducing the debtor collection period.

Nyumbani Security Ltd.s accountant has extracted average debtors profile which is shown below:

Percentage of total debtors payments	Average collection period (days)
5 28 10 30 16 11	30 45 60 75 90 120

Bad debts currently stand at Sh.2 million per annum. Nyumbani Security Ltd. is considering the introduction of early settlement discounts. The current invoicing terms require payment to be made within 30 days of date of issue of the invoice. The accountant has suggested that a 1% discount be offered to all customers who comply with these payment terms and he estimates that 50% of total payments (by value) would be on these terms (an average settlement period of 30 days for these payments can be assumed). The discount scheme would be expected to be taken up by customers who already pay in 75 days or less.

As an alternative way of reducing the debtors figure, Nyumbani Security Ltd. would use a debt collection service which has quoted a price of 1% of sales receipts. It is estimated that using the service will have the effect of reducing debtor days by 20 and eliminating 50% of bad debts.

Required:

(a) Calculate the change in working capital requirements and bad debts which would result

from:

The introduction of the early settlement discounts. (6 marks)

The use of the debt collection service. (6 marks)

Recommend which policy should be adopted by Nyumbani Security Ltd.

(2 marks)

(b) Explain the term Invoice discounting and the merits and demerits of its use as a way of improving cash flow. (6 marks)

(Total: 20 marks)