ABSTRACT
On February 8, 2020, Krish Fernandez, Chief Executive Officer (CEO) of Spark Electrical Enterprise, called her secretary and instructed: “Call Pragati, Pallavi and Prapti for an urgent meeting at 3.00 pm today, in my conference room. Inform them; we will discuss the credit policy changes (Exhibit 7.1) for the rapidly growing, high-margin, Fast Moving Electric Good (FMEG) business.” Pragati, Pallavi, and Prapti were Chief Marketing Officer (CMO), Chief Financial Officer (CFO), and National Sales Manager (NSM), respectively, at Spark. Each one of them was associated with Spark for over a decade. Pallavi's Email to Krish
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February 8, 2020 Dear Krish, Greetings. Further to our meeting on February 1, 2020, I prepared the following proposals based on inputs received from Prapti and my analysis. We have three-stage credit management process. Credit granting decision, credit terms and collection process. Currently, we divide our dealers and customers into four major categories: Excellent, good, average and sub-standard. We extend full credit to our Excellent and good category customer, whereas we grant limited credit to average customers and sell goods only on open account to sub-standard customers. Our standard credit terms are “2.5/10 net 60.” However, only 10 percent of the customers avail discount and those customers who do not avail the benefit of discount take about 75 days to pay their dues. Given business compulsions and competitive pressures, we do not take any action in such cases. Our collection efforts are robust, and the bad debt losses are around 2% of total sales. However, some dealers and customers think that we are too aggressive compared to our competitors. A few dealers have mentioned that while they might be willing to do business with us, they view our prudent collection efforts as arm twisting. We have come up with four proposals to incentivise our dealers and customers. We can look at implementing any one or a combination after a thorough discussion on underlying assumptions and consequences. Please note that these proposals are for FMEG business only. Proposal 1: Offer full credit to dealers and customers with an average rating, and that will boost sales by 10%. However, this incremental sale might come with higher bad debt losses of close to 5%. I hope our sales team can ensure that such high bad debt losses remain confined to incremental sales only. Proposal 2: Change credit terms from current “2.5/10 net 60” to “2.5/10 net 75". It will increase sales by 6% and reduce the proportion of customers availing discount to only 5% and those who do not avail discount will pay only after 85 days. I am not sure, but such a decision might increase bad debt losses by 0.2% on entire sales rather than just incremental sales. Proposal 3: Change in credit terms from “2.5/10 net 60" to "3/10 net 75". It will encourage those who want to pay early and at the same time, offers flexibility to those who require a more extended credit period. Such a decision will increase sales by 12% and the proportion of customers availing discount from present 10% to 35%. Those who do not avail of discount might pay only after 85 days. The higher proportion of customers availing of discount might reduce the percentage of bad-debt losses by at least 20 basis points, given that some customers having cheap access to bank credit might not want to forgo the benefit of higher trade discount offered. Proposal 4: Relaxation in collection efforts will increase sales by 5%. However, such a decision will lead to the average collection period going up to 75 days (proportion of customers availing discount will not change.) It will also increase bad debt losses by 30 basis points on entire FMEG sales. Our post-tax weighted average cost of capital is 13%, and we pay an effective 25% tax on our income. We can borrow funds from the bank at 8%. I have done some preliminary cost-benefit analysis for these proposals and will present it during the meeting. Yours Sincerely Pallavi |
