Zomo Ltd. currently has a turnover of 120 lakhs, 75% of which is on credit. The variable cost ratio is 80%, and the credit terms offered are 2/10,…

1. In-House Management of Receivables (With Dynamic Discounting) Particulars: Cash Discount Cost: Revised discount rate: 2.5%60% of customers avail discount.Cost of Discount:90,00,000 × 60% × 2.5% = 1,35,000 Bad Debts (Reduced to 0.8% due to dynamic discounting): 90,00,000 × 0.8% = 72,000 Administration Cost: 1,20,000 Cost of Financing Receivables: Working Note 1 (Average Collection Period): (10 days × 60%) + (60 days × 40%) = 30 days Working Note 2 (Average Receivables): 90,00,000 × (30/360) = 7,50,000 Working Note 3 (Cost of Financing): Cost of Bank Funds:7,50,000 × 1/2 × 15% = 56,250Cost of Owned Funds:7,50,000 × 1/2 × 14% = 52,500 Total Cost of Financing Receivables: 1,08,750 Total Cost with In-House Receivables Management and Dynamic Discounting: Particulars Amount (₹) Cash Discount (₹ 90,00,000 × 60% × 2.5%) 1,35,000 Bad Debts (₹ 90,00,000 × 0.8%) 72,000 Admin Cost 1,20,000 Cost of Financing Receivables 1,08,750 Total Cost (In-House with Dynamic Discounting): 4,35,750 2. Factoring Firm's Offer: Particulars: Factoring Commission: 90,00,000 × 4% = 3,60,000 Interest Charges on Receivables: Factor Reserve: 12%, so financing on 88% of receivables. Interest for 25 days: (₹ 90,00,000 - 3,60,000) × 88% × 15% × (25/360) = 79,200 Cost of Owned Funds (Receivables not factored): 13,96,800 × 14% × (25/360) = 13,580 Owned Funds: (₹ 90,00,000 - 3,60,000) × 12% + 3,60,000 = 13,96,800 Total Cost with Factoring Firm: Particulars Amount (₹) Factoring Commission (₹ 90,00,000 × 4%) 3,60,000 Interest Charges on Receivables 79,200 Cost of Owned Funds 13,580 Total Cost with Factoring: 4,52,780 3. Impact of Extending Credit Period: If Zomo Ltd. extends the credit period to 75 days: Sales increase: 10% of 120,00,000 = 12,00,000 New total turnover = 120,00,000 +12,00,000 = 1,32,00,000 Credit Sales (75%) = 99,00,000 Increased Bad Debts (1.5%): 99,00,000 × 1.5% = 1,48,500 Late Payment Penalty: Customers delaying beyond 60 days (40%):99,00,000 × 40% × 5% = 1,98,000 A. Cash Discount Cost: Discount rate: 2% (since there's no mention of dynamic discounting in this case)Percentage of customers availing discount: 60%Calculation:99,00,000 × 60% × 2% = 1,18,800 B. Bad Debts (Increased to 1.5%): Calculation:99,00,000 × 1.5% = 1,48,500 C. Administration Costs (Remains the same): The administration cost stays fixed at 1,20,000, as no change in admin structure is mentioned. D. Cost of Financing Receivables (Based on the new extended credit period): Working Note 1 (Average Collection Period): Credit period has been extended to 75 days for customers who don't take the discount (40% of customers). Revised Average Collection Period: (10 days × 60%) + (75 days × 40%) = 36 days Working Note 2 (Average Receivables): 99,00,000 × (36/360) = 9,90,000 Working Note 3 (Cost of Financing Receivables): Cost of Bank Funds (15%):9,90,000 × 1/2 × 15% = 74,250Cost of Owned Funds (14%):9,90,000 × 1/2 × 14% = 69,300Total Cost of Financing Receivables:74,250 +69,300 = 1,43,550 Revised Bad Debts after Penalty: Bad debts before penalty:1,48,500Penalty earned:1,98,000Net effect on bad debts:1,48,500 -1,98,000 = (-49,500) (Zomo Ltd. would effectively earn - 49,500 from penalties, reducing bad debt cost.) 4. Total Cost Calculation: Now, summing up all the components: Particulars Amount (₹) Cash Discount (₹ 99,00,000 × 60% × 2%) 1,18,800 Net Bad Debts after Penalty (− 49,500) -49,500 Administration Costs 1,20,000 Cost of Financing Receivables 1,43,550 Total Cost (In-House with Extended Credit Period) 3,32,850 5. Final Decision: Option Total Cost (₹) In-House with Dynamic Discounting 4,35,750 Factoring Firm's Offer 4,52,780 In-House with Extended Credit Period 3,32,850 Recommendation: Zomo Ltd. should extend the credit period and continue in-house management. This option will not only reduce costs (due to lower bad debts offset by penalties) but also increase sales by 10%. Factoring is the least beneficial due to its high commission charges, and dynamic discounting offers only marginal savings compared to the credit extension option.