Limo Ltd is a small family owned company that has beensuffering from the credit...

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Accounting

Limo Ltd is a small family owned company that has beensuffering from the credit crunch and has very limited borrowingpower. The company gets it finance mainly from bank overdraft whichhas been tightened up and the interest rate has beenincreasing.
One of the main problems is that the company suffers from thelate payment of their debtors and even default. Limo offers creditto all of its customers and most of them pay after the due dates.The board of directors decided to look into their cash flowsituation and new proposal were put forward forconsideration.
1. Delaying payment to creditors: at the moment Limo pays itscreditors on 30 days from invoice. Often the invoice is receivedbefore the good arrived. The credit manager proposed delayingpayment to creditors till customers pay.
2. Offering discount for prompt payment to debtors. At themoment the debtor payment system is as follow:
· 0nly 20% of customers pay within one month
· 15% pay after two month
· As many as 50% pay after three month and
· 13% pay take four months to pay
The board of director consider this patter unacceptable andwants to bring payment forward. A marketing research conducted lastmonth showed that if a two-part-term is introduced for paymentwithin 1 month at 2.5% discount then the patter will improve asfollows:
· As many as 70% will take the discount and pay within onemonth
· Only 5% will pay within two month
· 10% will pay within three month and
· And the payment after four month increases by 1% to14%
3. The company may try to negotiate a five year loan backed upby one of the marketable assets.
The company’s cost of capital is 15% and the annual turnoveris £12m.
You are required to:
a) Discuss the different options and make somerecommendations.
b) Evaluate the discount for prompt payment to see whether ornot such a scheme is worth introducing (it is necessary to computethe expected costs and benefits of the discounts).
c) Discuss other additional benefits of introducing a promptpayment schemes

Answer & Explanation Solved by verified expert

3.7 Ratings (719 Votes)

a In the first proposal of the credit manager of Limo Ltd for delaying payment until the customer pays it to the company the company receives only a 20 of the debtors in one month which is the Payment cycle of present scenario but if payment gets delayed as per the receiving pattern from debtors then company can save its opportunity cost of paying instant See Answer

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In: AccountingLimo Ltd is a small family owned company that has beensuffering from the credit crunch...Limo Ltd is a small family owned company that has beensuffering from the credit crunch and has very limited borrowingpower. The company gets it finance mainly from bank overdraft whichhas been tightened up and the interest rate has beenincreasing.One of the main problems is that the company suffers from thelate payment of their debtors and even default. Limo offers creditto all of its customers and most of them pay after the due dates.The board of directors decided to look into their cash flowsituation and new proposal were put forward forconsideration.1. Delaying payment to creditors: at the moment Limo pays itscreditors on 30 days from invoice. Often the invoice is receivedbefore the good arrived. The credit manager proposed delayingpayment to creditors till customers pay.2. Offering discount for prompt payment to debtors. At themoment the debtor payment system is as follow:· 0nly 20% of customers pay within one month· 15% pay after two month· As many as 50% pay after three month and· 13% pay take four months to payThe board of director consider this patter unacceptable andwants to bring payment forward. A marketing research conducted lastmonth showed that if a two-part-term is introduced for paymentwithin 1 month at 2.5% discount then the patter will improve asfollows:· As many as 70% will take the discount and pay within onemonth· Only 5% will pay within two month· 10% will pay within three month and· And the payment after four month increases by 1% to14%3. The company may try to negotiate a five year loan backed upby one of the marketable assets.The company’s cost of capital is 15% and the annual turnoveris £12m.You are required to:a) Discuss the different options and make somerecommendations.b) Evaluate the discount for prompt payment to see whether ornot such a scheme is worth introducing (it is necessary to computethe expected costs and benefits of the discounts).c) Discuss other additional benefits of introducing a promptpayment schemes