Question

What should be the effect of following changes on level of firm’s receivables:
a) Interest rate increases
b) Recession
c) Production and selling cost increases
d) The firm changes its credit terms from “2/10, net 30” to “3/10, net 30”

Answer 1

A) When the interest rate increases, the amount debited to Profit & Loss for interest expenses also increases which results in Higher cost of goods sold which results in higher sales in case company doesn't want to have any impact on profit margin. So, it increases the amount of firm's receivable.

In other words, the cost of production increases due to interest rates which brings in more investments in Debtors (Accounts Receivables)

B) Recession likely to reduce the sales of the company which results in Low investment in accounts receivables. The investor will be willing to defer the amount for some time due to recession which can increases the amount of debtors.

C) Production and selling cost likely to increase the accounts receivable as it will increase the cost of goods sold and more money would be needed to put in receivable to bring the consistent amount of gains.

D) 2/10 net 30 refers to 2% discount for trade credit if paid within 10 days otherwise it would have been paid in 30 days. similarly for 3/10 net 30 refers to 3% discount for trade credit if paid within 10 days otherwise it would have been paid in 30. So, The latter one has better doscount and the accounts receivable will decrease as more debtors would be wiiling to avail 3% discount.