Balsam Corporation is concerned about their current bad debt ratio of 9%.The CFO believes imposing a more stringent credit policy may reduce sales by 8% and reduce the bad debt ratio to 6%.If the cost of goods sold is 85% of the selling price, determine if the new policy should be undertaken.

Question

Quizplus · Accepted Answer

First, we need to calculate the current profit margin:

Profit Margin = (Revenue - Cost of Goods Sold) / Revenue
9% = (1 - 0.85) / 1

Next, we need to calculate the potential profit margin under the new credit policy:

Profit Margin = (Revenue x 0.92 - Cost of Goods Sold x 0.92) / Revenue x 0.92
6% = (1 - 0.85 x 0.92) / 0.92

We can now calculate the percentage increase or decrease in profit margin:

Profit Increase = (New Profit Margin - Current Profit Margin) / Current Profit Margin
Profit Increase = (0.06 - 0.09) / 0.09 = -0.3333 = -33.33%

Since the potential profit margin is lower under the new credit policy, we should not undertake the new policy. Therefore, the correct answer is option (D) "Do not undertake; decrease of 34% in profits".

Balsam Corporation Is Concerned About Their Current Bad Debt Ratio