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Unit 10: Receivable Management

2. Sound Liquidity Position: The firm that follows stringent credit policy will have sound Notes
liquidity position, due to the receipt of all payments from customers on due date, the firm
can easily pay the currently maturing obligations.

Disadvantages of Stringent Credit Policy

1. Less Sales: Stringent credit policy restricts sales, because it is not extending credit to
average credit worthiness customers.
2. Less Profits: Less sales automatically reduces profits, because firm may not be able to
produce goods economically, and it may not be able to use resource efficiently that leads
increase in production cost per unit.

10.2.2 Credit Policy Variables

As we have seen in the credit policy that majority of firms follow a credit policy is one, which
maximizes firm’s operating profit. For establishing optimum credit policy, the financial manager
must consider the important decision variables, which have bearing on the level of receivables.
In other words, the credit policy variables have bearing on level of sales, bad debts loss, discounts
taken by customers, and the collection expenses. The major credit policy variable includes the
following:
1. Credit Standards,

2. Credit Terms, and
3. Collection Policy and Procedures.
1. Credit Standards: Firm has to select some customers for extension of credit. For this firm
has to evaluate the customer. In evaluation of customers what standards should be applied?
Credit stands refer to the minimum criteria for the extension of credit to a customer.
Credit ratings, credit references, average payment periods. And certain financial ratios
provide a quantitative basis for establishing and enforcing credit standards. The firm’s
decision, to accept or reject a customer, and to extend credit depends on credit standards.
Firms may have more number of standards in this respect, but at one point it may decide
not extend credit to any customer, even though his/her credit rating is strong. On the
other point, firm may decide to provide goods on credit to all customers irrespective of
their credit creditworthiness. Practical ones lie between these two points.
2. Credit Terms: The second decision criteria in receivables management are the credit terms.
Credit terms mean the stipulations under which goods or services are sold on credit. Once
the credit terms have been established and the credit worthiness of the customers has been
assessed, the financial managers have to decide the terms and conditions on which credit
is extended to customer and the discount, if any, given for early payment. Credit terms
have three components such as:

(a) Credit Period: The period of time, for which credit is allowed to a customer to economic
value of purchases. It is generally expressed in terms of a net data. If a firm’s credit
terms are not 60, it is understandable that payment will be made within 60 days
from the date to credit sales. Generally the credit period is decided with the
consideration of industry norms and depending on the firm’s ability to manage
receivables. A decision regarding lengthening of credit period increases sales by
increases sales by inducing existing customers to purchase more and attracting new
customers. But it also increases investment in receivables and lowers the quality of

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