Receivables Management Case Study
Down East Pharmaceuticals
Kathleen Rogan received her Ph.D. in Pharmacology ten years ago from the University of Maine. While there, she became interested in the business side of drug distribution and stayed on for an extra year to earn a Master in Business Administration (MBA) degree. After graduation, she went to work for Criser Corporation, a major drug manufacturer, where she managed the development of a new nonprescription anti-allergy drug. Although the drug passed all Food and Drug Administration (FDA) trials and was certified for general use, Criser simultaneously developed another drug that was cheaper to produce and equally effective in treating most, but not all, allergy symptoms. Consequently, Criser decided not to produce the drug Kathleen helped develop; however, it was willing to license production and distribution rights for the same drug to another company. Kathleen viewed this as a golden opportunity, so she quit her job with Criser to found her own company, Down East Pharmaceuticals. The sole purpose of the new company was to obtain licensing, production, and distribution rights for the new drug, which Kathleen dubbed Sneeze Relief.
Kathleen is currently working on the business plan that she will present at a venture capital conference to be held in Boston. The purpose of the conference is to match entrepreneurs with venture capitalists who are interested in providing capital to fledgling firms. Kathleen has spent a lot of time thinking about how her proposed company’s receivables should be managed; she is concerned about this issue because she knows of several small drug manufacturers that have got into serious financial difficulty because of poor receivables management. Initially, Down East Pharmaceuticals will sell exclusively to drug wholesalers in the Northeast that specialize in nonprescription drugs. Depending on the demand, the company will expand its sales to other regions. Sales are expected to be seasonal: allergy drug sales are slow during the cooler winter months, but pick up dramatically in the spring, when plant pollen levels peak. Subsequently, business drops in the summer, but picks up in the fall when ragweed season begins. Kathleen’s sales forecasts for the first year are in Table 1. Assuming her company receives capital and begins operations, the sales forecasts for the second year are also in the table.
Table 1: Down East Pharmaceuticals: Partial Sales Forecasts
Month
Sales (in dollars) for Year 1
Sales (in dollars) for Year 2
January
100,000
200,000
February
250,000
350,000
March
400,000
500,000
April
600,000
700,000
May
450,000
550,000
June
300,000
350,000
Kathleen does not plan to give discounts for early payment; discounts are not widely used in the industry. Approximately 30 percent (by dollar value) of the wholesalers (her customers) are expected to pay in the month of sale, 50 percent are expected to pay in the month following sales, and the remaining 20 percent are expected to pay two months after sales. Kathleen does not foresee bad debt losses; the wholesalers she plans to sell to have been in business for a long time. Furthermore, she plans to carefully screen her customers, to eliminate such losses. On average, Kathleen believes that 20 percent of receivables will contribute to profits, so 80 percent of receivables represent cash costs. Additionally, the First National Bank of New England has indicated that its receivables financing would cost 10 percent annually. In spite of her optimism regarding bad debt losses, Kathleen is concerned about the company’s potential level of receivables, and she wants to have a monitoring system in place that allows her to quickly spot any adverse trends in case they do develop. Kathleens total sales forecast for the first full year of operations is 800,000 packages. Each package, which contains 12 tablets, is priced at $5.
Kathleen also knows that uncollected balances schedules are superior to aging schedules in assessing receivables performance when sales are seasonal or cyclical. Table 3 has an illustrative, uncollected balances schedule. At the end of each quarter, the dollar amount of receivables remaining from each months sales is divided by that month’s sales to obtain three receivables-to-sales ratios. Using this data to illustrate, at the end of the first quarter, 20 percent of January sales are still outstanding, 60 percent of February sales are still out, and 90 percent of March sales are uncollected. Exactly the same situation is revealed at the end of each of the next three quarters meaning payment patterns have remained constant.
The uncollected balances schedule permits managers to remove the effects of seasonal and cyclical sales variation and to construct an accurate measure of receivables payment patterns. Therefore, it provides financial managers with better aggregate information than crude measures such as the average collection period or aging schedule.
Table 3: Down East Pharmaceuticals: Illustrative Uncollected Balance Schedule (thousands of dollars)
Quarter and Month
Sales (dollars)
Remaining in Receivables (dollars)
Receivables-Sales Ratio (in percent)
Quarter 1
January
60
12
20
February
60
36
60
March
60
54
90
Total
102
170
Quarter 2
April
60
12
20
May
90
54
June
120
108
90
Total
174
170
Quarter 3
July
120
24
20
August
90
54
60
September
60
54
90
Total
132
170
Quarter 4
October
60
12
20
November
60
36
60
December
60
54
90
To
Receivables Management Case Study© 2007 South University
Down East Pharmaceuticals
Select the appropriate input values and enter them in cells colored red. Once you do this, the base case solution will appear.
INPUT DATA:KEY OUTPUT:
Sales Forecasts:Average Collection Period (Days):
End of March#DIV/0!
MonthSalesEnd of June#DIV/0!
January$0
February0Receivables Balance:
March0End of March$0
April0End of June$0
May0
June0Aging Schedules:
End of MarchEnd of June
Assumed Collection Pattern:0 – 30:#DIV/0!#DIV/0!
30 – 60:#DIV/0!#DIV/0!
Month of sale0.0%Over 60:#DIV/0!#DIV/0!
One month after sale0.0%
Two months after sale0.0%Payment Pattern:
End of MarchEnd of June
Total#DIV/0!#DIV/0!
MODEL-GENERATED DATA:
Calculation of AverageEnd of Month
Collection Period (ACP):MarchJune
Receivables balance$0$0
Average daily sales$0.00$0.00
ACP#DIV/0!#DIV/0!
Aging Schedules:
Age of
AccountEnd of MarchEnd of June
in DaysA/R%A/R%
0-30$0#DIV/0!$0#DIV/0!
30-600#DIV/0!0#DIV/0!
60-900#DIV/0!0#DIV/0!
Total$0#DIV/0!$0#DIV/0!
Uncollected Balances Schedules:
End of March:
Accts RecRemaining
MonthSalesfor monthRec/Sales
January$0$0#DIV/0!
February00#DIV/0!
March00#DIV/0!
Total$0#DIV/0!
End of June:
Accts RecRemaining
MonthSalesfor monthRec/Sales
April$0$0#DIV/0!
May00#DIV/0!
June00#DIV/0!
Total$0#DIV/0!
tal
102
170
