Solved – Matlock Gauge Company makes wind and current gauges for pleasure boats. The gauges are sold throughout the Southeast to boat dealers

Question

Matlock Gauge Company makes wind and current gauges for pleasure boats. The gauges are sold throughout the Southeast to boat dealers, and the average order size is $50. The company sells to all registered dealers without a credit analysis. Terms are “net 45 days,” and the average collection period is 60 days, which is regarded as satisfactory. Sue Ford, vice president of finance, is now uneasy about the increasing number of bad-debt losses on new orders. With credit ratings from local and regional credit agencies, she feels she would be able to classify new orders into one of three risk categories. Past experience shows the following:

Order Category

Low RiskMedium RiskHigh Risk
Bad Debt Loss3%7%24%
Category order to total orders30%50%20%

The cost of producing and shipping the gauges and of carrying the receivables is 78% of sales. The cost of obtaining credit information and of evaluating it is $4 per order. Surprisingly, there does not appear to be any association between the risk category and the collection period, the average for each of the three risk categories is around 60 days. Based on this information, should the company obtain credit information on new orders instead of selling to all new accounts without credit analysis? Why?

Answer

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