Question 14

Reducing credit limits for slow paying clients can improve the contractor's liquidity.

By implementing a strategy to reduce credit limits for clients who are slow to pay, the contractor can enhance cash flow and improve accounts receivable turnover, thereby increasing overall liquidity.

A) Reduce wages by eliminating in-house sales

This option may not directly impact accounts receivable turnover or liquidity. While reducing wages could lower operating costs, it does not address the issue of slow payments from clients and could potentially harm sales if in-house sales support is diminished.

B) Increase inventory to lower order-related transaction costs

Increasing inventory could lead to higher carrying costs and may not solve the problem of low accounts receivable turnover. In fact, holding more inventory ties up cash that could otherwise be used to improve liquidity, making this option counterproductive.

C) Increase prices to allow for higher carrying costs

While increasing prices might boost revenue, it does not directly address the issue of collections from slow-paying clients. If clients struggle to pay their current amounts, raising prices could exacerbate the problem, leading to even slower payments and reduced liquidity.

D) Reduce credit limits for slow paying clients

This option directly targets the core issue of low accounts receivable turnover. By reducing credit limits for clients who do not pay on time, the contractor can mitigate risk and encourage faster payments, thereby improving cash flow and liquidity.

Conclusion

The most effective solution for the plumbing contractor to improve liquidity is to reduce credit limits for slow-paying clients, as this strategy directly addresses the issue of delayed payments. Other options either do not resolve the core problem or could worsen the contractor's financial situation by increasing costs or negatively impacting sales.