9.22 Five Steps to Credit Management

  1. Establish terms of sale
    • Payment period
    • Discounts
  1. Do business on “open account” or via contract
    • Open account – obtain signed receipt only (no collateral provided nor contract)
    • Contract – promissory note, trade acceptance, or letter of credit
  1. Assess credit worthiness (for open account sales terms).
    • What is your customer experience?
    • What are others’ experiences?
    • Credit agency information
    • Bank information
    • Financial statements
    • Statistical “credit scoring”
  1. Establish credit limit.
    • A vendor may extend credit to customers to whom it may not otherwise do so in order to expand into a new territory or product market. This may cause an undesired increase in slow or bad collections.
    • In any event, it is incumbent upon the firm to minimize bad debts and maximize profits
    • This says that the firm should do business with new credit accounts iff (i.e., “if and only if”) the probability of payment times the profit exceeds the probability of default times COGS
    • Sometimes this means using judgment about future prospects
  1. Collect!


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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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