(a) Additional profit contribution from sales
(b) Cost of marginal investment in account receivables
(c) Cost of marginal investment in bad debts
CSS Solved Business Administration Past Paper 2018 | Daud Tools, a manufacturer of lathe tools, is currently selling a product for $10 per unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $6. The firm’s total fixed costs are $120,000. The firm is currently contemplating a relaxation of credit standards that is expected to result in the following; a 5% increase in unit sales to 63,000 units; an increase in average collection period from 30 days (the current level) to 45 days; an increase in bad debt expenses from 1% of sales (current level) to 2%. The firm determines that its cost of tying up funds in receivables is 15% before taxes. Question: Determine whether it would be profitable for Daud Tools to relax its credit standards. To arrive at your decision, show the calculation of…
The following question is attempted by Miss Nimra Masood, the top scorer in CSS Business Administration papers. Moreover, the answer is written on the same pattern, taught by Sir to his students, scoring the highest marks in compulsory subjects for years. This solved past paper question is uploaded to help aspirants understand how to crack a topic or question, how to write relevantly, what coherence is, and how to include and connect ideas, opinions, and suggestions to score the maximum.
Topic Breakdown
Finance is one of the pillars of business administration; therefore, the CSS examiner gives two questions from this portion every year. A clear understanding of finance not only assists in this paper but also in Accounting and Auditing.
Subject: Finance
Chapter: Variance Analysis
Data Available:
Actual Sales = 60000 units @ $10 per unit
Variable Cost = 60000 units @ $6 Per unit
Fixed Costs = $ 120000
Change after relaxation in credit standard:
Change in units sold = 63000 units
Increase in Avg. Collection period from 30 to 45 days
Increase in bad debts= from 1% to 2% of sales
Cost of tying up funds in receivable = 15% before tax
Additional Profit Contribution from Sales:
- Formula:
Sales = units sold * price per unit
Old Sales = 60000 * 10 = $600000
New Sales= 63000 * 10 = $630000
Change of sales = new profit – old profit = 630000 – 600000= $30000
| Actual Profit | Profit with Credit Relaxation | |
| Sales | 60000 * 10 = 600000 | 63000 * 10 = 630000 |
| Fixed Cost | (120000) | (120000) |
| Variable Cost | 60000 * 6 = (360000) | 63000 * 6 = (378000) |
| Operating Profit | 120000 | 132000 |
Additional profit contribution from sales = 132000 – 12000 = $12000
Cost of marginal investment in Accounts Receivable:
Cost before Credit Relaxation= 120000 * 0.15 = 18000
Cost after Credit Relaxation = 132000 * 0.15 = 19800
Cost of marginal investment in Accounts Receivable = 1800
Cost of Marginal investment in bad debts:
Accounts receivable = all sales are credit
Cost of bad debts before credit relaxation = a/c receivables * 1%
= 600000 * 0.01 = 6000
Cost of bad debts after credit relaxation = 630000 * 0.02 = 12600
Cost of marginal investment in bad debts = 12600 – 6000 = 6600
Net additional profit earned after credit relaxation = profit contribution from sales – cost of investment in A/C receivable – Cost of Bad debts
= 12000 – 1800 – 6600 = $3600
Decision
From the above financial analysis it is determined that the revenues after credit relaxation surpass the costs of credit relaxation; hence, it is feasible for Daud tools to relax its credit standards
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