Galenic Inc. is a wholesaler for a range of pharmaceutical products. Before deducting any losses from bad debts, Galenic operates on a profit margin of 5%. For a long time the firm has employed a numerical credit-scoring system based on a small number of key ratios. This has resulted in a bad debt ratio of 1.00%. Galenic has recently commissioned a detailed statistical study of the payment record of its customers over the past 8 years and, after considerable experimentation, has identified five variables that could form the basis of a new credit-scoring system. On the evidence of the past 8 years, Galenic calculates that for every 10,000 accounts it would have experienced the following default rates: Number of Accounts Credit Score under Proposed System Defaulting Paying Total Better than 80 70 9,090 9,160 Worse than 80 30 810 840 Total 100 9,900 10,000 By refusing credit to firms with a poor credit score (worse than 80), Galenic calculates that it would reduce its bad debt ratio to 70 / 9,160, or just under 0.70%. While this may not seem like a big deal, Galenic’s credit manager reasons that this is equivalent to a decrease of one-third in the bad debt ratio and would result in a significant improvement in the profit margin. a. What is Galenic’s current profit margin, allowing for bad debts? (Round your answer to 2 decimal places.) b. Assuming that the firm’s estimates of default rates are right, what would the profit per $100 of original sales be under the new credit-scoring system? (Do not round intermediate calculations. Round your answer to 2 decimal places.) d. Suppose that one of the variables in the proposed new scoring system is whether the customer has an existing account with Galenic (new customers are more likely to default). Would you be more or less likely to accept the proposal? (Hint: Think about repeat sales.)
Bad Debts
At the end of the accounting period, a financial statement is prepared by every company, then at that time while preparing the financial statement, the company determines among its total receivable amount how much portion of receivables is collected by the company during that accounting period.
Accounts Receivable
The word “account receivable” means the payment is yet to be made for the work that is already done. Generally, each and every business sells its goods and services either in cash or in credit. So, when the goods are sold on credit account receivable arise which means the company is going to get the payment from its customer to whom the goods are sold on credit. Usually, the credit period may be for a very short period of time and in some rare cases it takes a year.
Galenic Inc. is a wholesaler for a range of pharmaceutical products. Before deducting any losses from
Galenic has recently commissioned a detailed statistical study of the payment record of its customers over the past 8 years and, after considerable experimentation, has identified five variables that could form the basis of a new credit-scoring system. On the evidence of the past 8 years, Galenic calculates that for every 10,000 accounts it would have experienced the following default rates:
| Number of Accounts | |||||||||
| Credit Score under Proposed System | Defaulting | Paying | Total | ||||||
| Better than 80 | 70 | 9,090 | 9,160 | ||||||
| Worse than 80 | 30 | 810 | 840 | ||||||
| Total | 100 | 9,900 | 10,000 | ||||||
By refusing credit to firms with a poor credit score (worse than 80), Galenic calculates that it would reduce its bad debt ratio to 70 / 9,160, or just under 0.70%. While this may not seem like a big deal, Galenic’s credit manager reasons that this is equivalent to a decrease of one-third in the bad debt ratio and would result in a significant improvement in the profit margin.
a. What is Galenic’s current profit margin, allowing for bad debts? (Round your answer to 2 decimal places.)
b. Assuming that the firm’s estimates of default rates are right, what would the profit per $100 of original sales be under the new credit-scoring system? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
d. Suppose that one of the variables in the proposed new scoring system is whether the customer has an existing account with Galenic (new customers are more likely to default). Would you be more or less likely to accept the proposal? (Hint: Think about repeat sales.)
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