9.19 Altering Credit Policy

The liberalization of the firm’s credit terms should only be done for financial reasons, i.e., if it increases (gross) profits more than ensuing costs. The effect of liberalization is that, first, sales should increase (with gross profits ensuing), but so too will bad debts and opportunity costs.

For every action there is an opposite (and not necessarily exactly offsetting) reaction. In all such decisions, management must consider the competition.

What if the firm tightens its credit policies? Here we go!

Good Effect  Bad Effect 
Raise credit Standards
  • Reduction in Accounts Receivable
  • More cash sales (?)
  • Lose some credit customers.
Decrease Net Due Period
  • Speedier collections and cash flow
Decrease Discount
  • Some customers choose not to take discount
  • Lose some credit customers.
  • Uncertain net effect on receivables.
Decrease Discount Period
  • Collect sooner

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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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