Question

Question:

You are the credit manager for Konza Supply Company .One of your sales staff has made a Ksh.5,000,000 credit sales to Zizes Elecronics , a manufacturer of small computers.Your responsibility is to decide whether to approve the sale.You have the following data from the computer industry and Zizes:

For the years 2008-2012	Industry	Zizes Electronics
Average annual Growth	13.4%	17.6%
Average Annual Operating Profit	10.8%	9.7%
Average annual net profit growth	14.4%	9.9%
Average annual asset growth	10.3	14.2
Average debt-to -equity ratio	0.32	0.26
Average Current ratio	4.04	3.71
Average inventory turn over	2.53	2.06
Average Accounts receivable turnover ratio	3.95	4.18

For Zizes, you have the following data for the year ended December 31,2012

Sales Revenue	Ksh.390,800,000
Net Income	Ksh.35,900,000
Total Sales	Ksh.362,600,000
Current Ratio	1.82
Debt-Equity Ratio	0.37
Inventory turnover ratio	1.79
Accounts Receivable turnover ratio	3.62

The sales person believes that ZIzes would order about Ksh.20,000,000 per year of materials that would provide a gross margin of Ksh.3,500,000 to Konza if reasonable credit terms could be arranged.

Required:

State whether or not you would grant authorization for Zizes to purchase on credit and support your decision

Answer 1

The authorisation for sale shall be granted for the following reasons:

• Annual growth rate of Zizes is better than the industry growth rate(17.1& compared to 13.4%)
• Average annual operating profit in only a little less than industry (9.7% as compared to 10.8%)
• Asset growth rate (14.2% compared to 10.3%) is better and assets can recover the debt in event of bankrupcy.
• Debt in capital structure is lesser than industry average (0.26 compared to 0.32) which again shall not cause major problem for an increase in debt
• Current ratio, although less than industry average(3.71<4.04) is still high to cover for current debt payments
• Accounts receivables turnover is better than the industry
• Also, the purchase of Ksh 20,000,000 is approximately (20,000,000/390,800,000=5.12%) of total sales revenue and can be recovered easily from sales revenue

Although there are some issues like inventory turnover being not so good or net profit growth not being good but the industry growth rate is good and shall not cause any major problems to company to honour its credit sales.