10.8 Liberalizing Credit Policy (A Last Look)

A company may decide to liberalize its credit policy, e.g., by extending collection terms,  in order to expand into new product or geographic markets, or to increase sales in its current market. In doing so, it may have to put up with a higher percentage of late- and non-payers. The firm should do business with new credit accounts “iff” (i.e., “if and only if”) profits increase after accounting for increased bad collections. Let’s look at an example.

Current Posture (Per Unit)
Sales 5,000 u.
Price $120
Variable Cost $80
Fixed Cost $15
Total Cost $95
Terms 30 days

Due to the liberalization of Credit Policy, the company projects that its sales volume will increase by 40% and its bad debts by 5%. Assuming the firm is operating at less than full capacity, no additional fixed costs will be required.

This analysis ignores the opportunity cost of incremental resources tied up in accounts receivable.


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Corporate Finance Copyright © 2023 by Kenneth S. Bigel is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.

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