Your superior, the general manager of Plastics Manufacturers Limited, has recently been talking to the chief buyer of Plastic Toys Limited, which manufactures a wide range of toys for young children. At present, Plastic Toys is considering changing its supplier of plastic granules and has offered to buy its entire requirement of 2,000 kg a month from you at the going market rate, provided that you will grant it three months’ credit on its purchases. The following information is available:

1 Plastic granules sell for £10 a kg, variable costs are £7 a kg, and fixed costs £2 a kg.

2 Your own business is financially strong, and has sales revenue of £15 million a year. For the foreseeable future it will have surplus capacity, and it is actively looking for new outlets.

3 Extracts from Plastic Toys’ financial statements:

 

Â	Year 1	Year 2	Year 3
Â	£000	£000	£000
Sales revenue	800	980	640
Profit before interest and tax	100	110	(150 )
Capital employed	600	650	575
Â	Year 1	Year 2	Year 3
Current assets	£000	£000	£000
Inventories	200	220	320
Trade receivables	140	160	160
Â	340	380	480
Current liabilities	Â	Â	Â
Trade payables	180	190	220
Overdraft	100	150	310
Â	280	340	530
Working capital	60	40	(50)

Required:

(a) Write some short notes suggesting sources of information that you would use to assess the creditworthiness of potential customers who are unknown to you. You should critically evaluate each source of information.

(b) Describe the accounting controls that you would use to monitor the level of your business’s trade receivables.

(c) Advise your general manager on the acceptability of the proposal. You should give your reasons and do any calculations you consider necessary. (Hint: To answer this question you must weigh the costs of administration and cash discounts against the savings in bad debts and interest charges.)