DoD Ltd has an annual turnover of Tsh.30 million before taking into account bad debts of Tsh.0.2 million. All sales made by the business are on credit, and, at present, credit terms are negotiable by the customer. On average, the settlement period for trade receivables is 60 days. Trade receivables are financed by an overdraft bearing a 15% rate of interest per year. The business is currently reviewing its credit policies to see whether more efficient and profitable methods could be employed. Only one proposal has so far been put forward concerning the management of trade credit. The credit control department has proposed that customers should be given a 2% cash discount if they pay within 30 days. For those who do not pay within this period, a maximum of 45 days’ credit should be given. The credit department believes that 65% of customers will take advantage of the discount by paying at the end of the discount period, and the remainder will pay at the end of 45 days. The credit department believes that bad debts can be effectively eliminated by adopting the above policies and by employing stricter credit investigation procedures,which will cost an additional Tsh. 25,000 a year. The credit department is confident that these new policies will not result in any reduction in sales revenue. The department also believes that the new policy will improve the cash level of the company which has been poor in the recent past. DoDLtd has enough retained profits which the management feels could be a free source of finance for the business.Assume 360 days in a year. Required: (a) Evaluate the proposal to abandon the existing credit policies and adopt the proposals of the credit control department.(b) Explain whether retained profits are a free source of finance to thebusiness. (c) Discuss the reasons a business may decide to hold at least some of its assets in the form of cash.
