Providing and Obtaining Credit
ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS
The term “credit policy” embraces four variables:
(1) credit period,
(2) discount offered, including the discount percentage and when
payment must be made to get the discount, (3) credit standards, and (4)
Customers like easy credit, so the
credit policy, the higher sales will be.
policy will lower sales somewhat.
To ease credit policy, a firm might
do such things as increase the credit period from 30 days to 60 days,
ease its credit standards so as to offer credit to weaker customers
(who are likely to pay late or not at all), and use less tough
collection methods to avoid offending customers.
All of the easing actions would tend to increase annual sales, hence
The easing actions they would also increase the receivables
collection period—increasing the time customers have to pay would
obviously delay collections, and selling to weaker customers and being
less tough on collections would mean also lead to slower payments.
Furthermore, since the amount of accounts receivable is the product of
annual sales times the collection period, and since they both increase,
easing credit would increase the investment in accounts receivable:
Accounts receivable = (Sales/day)*(Receivables Collection Period)
If the company changed its discounts policy, this would have two
somewhat offsetting effects.
First, an increase in the discount would
normally cause more customers to pay in time to take the discount,
which would lower receivables.
Similarly, since receivables are
normally reported net of discounts, if discounts are raised, this tends
to lower receivables.
However, the higher discount would really mean a
price reduction, which would increase sales and thus receivables.
first two effects would, generally, be stronger, hence increasing the
discount would normally reduce receivables.
It is impossible to state, as a generalization, what the effect of
an easing or tightening of credit policy on profits would be.
increased sales from an easing is normally a positive, but negatives
would include an increase in bad debts rise and an increase in the cost
of carrying receivables.
Conversely, tightening credit would hurt
sales somewhat, but it would reduce the collection period and lower bad
The net effect of a credit policy change will depend on how
these factors interact with the gross profits on sales. A detailed
analysis is necessary to make a reasonable estimate about the effect of
credit policy on profits, and even then the estimate could turn out to
See the BOC model for an analysis of a proposed credit
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