ch27_web - Chapter 27 Providing and Obtaining Credit...

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Chapter 27 Providing and Obtaining Credit Chapter 22 covered the basics of working capital management, including a brief dis- cussion of trade credit from the standpoint of firms that grant credit and report it as accounts receivable and also from the standpoint of firms that use it and report it as accounts payable. In this chapter we expand the discussion of this important topic, and we also discuss the cost of the other major source of short-term financ- ing, bank loans. Credit Policy As we stated in Chapter 22, the success or failure of a business depends primarily on the demand for its products—as a rule, the higher its sales, the larger its profits and the higher its stock price. Sales, in turn, depend on a number of factors, some exogenous but others under the firm’s control. The major controllable determinants of demand are sales price, product quality, advertising, and the firm’s credit policy. Credit policy, in turn, consists of these four variables: 1. Credit period, which is the length of time buyers are given to pay for their purchases. 2. Discounts given for early payment, including the discount percentage and how rapidly payment must be made to qualify for the discount. 3. Credit standards, which refer to the required financial strength of acceptable credit customers. 4. Collection policy, which is measured by the firm’s toughness or laxity in attempting to collect on slow-paying accounts. The credit manager is responsible for administering the firm’s credit policy. How- ever, because of the pervasive importance of credit, the credit policy itself is normally established by the executive committee, which usually consists of the president plus the vice-presidents of finance, marketing, and production. What are the four credit policy variables? Setting the Credit Period and Standards A firm’s regular credit terms, which include the credit period and discount, might call for sales on a 2/10, net 30 basis to all “acceptable” customers. Here customers are required to pay within 30 days, but they are given a 2 percent discount if they pay by the 10th day. Its credit standards would be applied to determine which cus- tomers qualify for the regular credit terms, and the amount of credit available to each customer. The textbook’s Web site contains an Excel file that will guide you through the chapter’s calcu- lations. The file for this chapter is FM11 Ch 27 Tool Kit.xls, and we encourage you to open the file and follow along as you read the chapter. FM e-resource Self-Test Question
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27-2 Chapter 27 Providing and Obtaining Credit Credit Standards Credit standards refer to the financial strength and creditworthiness a customer must exhibit in order to qualify for credit. If a customer does not qualify for the reg- ular credit terms, it can still purchase from the firm, but under more restrictive terms. For example, a firm’s “regular” credit terms might call for payment after 30 days, and these terms might be offered to all qualified customers. The firm’s credit
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