Trade receivables management

Company B, a US based company, has an annual turnover of $4,000,000. The company employs four people in its sales ledger and credit control department at an annual salary of $25,000 each. All sales are on 40 days' credit with no discount for early payment. Bad debts represent 3% of turnover and Company B pays annual interest of 9% on its overdraft.

Company B is considering offering a discount of 1% to customers paying within 14 days, which it believes will reduce bad debts to 2.4%. The company also expects that offering a discount for early payment will reduce the average credit period taken by its customers to 26 days. The consequent reduction in the time spent chasing customers where payments are overdue will allow one member of the credit control team to take early retirement. Two-third of customers are expected to take advantage of the discount.

1. Suppose there are $550,000 trade receivables outstanding at the end of this year. Determine if a discount for early payment of 1% will lead to an increase in profitability for Company B.