Page 167 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes Lenient Credit Policy

It is that policy where the seller sells goods on very liberal credit terms and standards. In other
words, goods are sold to the customers whose creditworthiness is not up to the standards or
whose financial position is doubtful.

Advantages of Lenient Credit Policy

1. Increase in Sales: Lenient credit policy expands sales because of the liberal credit terms
and favorable incentives granted to customers.
2. Higher Profits: Increase in sales leads to increase in profits, because higher level of
production and sales reduces permit cost.

Disadvantages of Lenient Credit Policy

1. Bad Debt Loss: A firm that follows lenient credit policy may suffer from bad debts losses
that arise due to the non-payment credit sales.

2. Liquidity Problem: Lenient credit policy not only increases bad debt losses but also creates
liquidity problem because when the firm is not able to receive the payment at a due date,
it may became difficult to pay currently maturing obligations.

Caselet Subprime Lending in USA

fter the global recession, we all know that a sub-prime loan in US meant the loans
that the banks created to offer people that otherwise would not be able to qualify
Afor a regular fixed mortgage loan. Since there were a lot of people that fell under
that category, the banks saw a great scope of making good money from such people when
they repaid. In 2000, the Federal Reserve lowered the interest rates to avoid the country
from going into a recession. This caused the economy to expand and housing prices to go
up. The lowering of interest rates hit 1%. The banks now armed with these new sub-prime
loans needed home buyers and that too in good numbers. Consequently, the banks and
mortgage lenders started issuing sub-prime loans to everyone and many requirements to
obtain these loans were no longer need to qualify (like income statements, tax returns,
etc). As a result, the borrower who already was below the creditworthy standard had to go
deeper in debt and default while repayment.
This lenient credit policy of these banks and mortgage lenders put US and later on nearly
the whole world in a financial crisis.

Stringent Credit Policy

Stringent credit policy seller sells goods on credit on a highly selective basis only i.e., the
customers who have proven credit worthiness and financially sound.

Advantages of Stringent Credit Policy

1. Less Bad Losses: A firm that adopts stringent credit policy will have minimum bad debts
losses, because it had granted credit only the customers who are creditworthy.

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