Page 164 - DMGT409Basic Financial Management

Unit 9: Basics of Receivables

9.4 Credit Policy Notes

Credit policy means a firm’s credit policy regarding its credit standards, credit period, cash
discounts, and collection procedures. The credit policy may be lenient or stringent (tight).

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.
Stringent Credit Policy

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

Notes Credit Policy Variables
The major credit policy variables include the following:

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 standards 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.
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, then the financial managers have to decide the terms and

conditions on which the credit will be granted. The credit terms specify the lengthy
of time over which credit is extended to a customer and the discount, if any, given for
early payment. Credit terms have three components such as: (i) credit period, and (ii)
cash discount, and (iii) cash discount period.

3. Collection Policy: This is the third aspect in receivables management. The collection
of a firm is the procedures passed to collect amount receivables, when they become

due. It is needed because all customers do not pay the bill receivables in time
collection procedures includes monitoring the state of receivables, dispatch of letters
to customers whose due date is approaching, electronic and telephonic advice to
customers around the due date, threat of legal action to overdue customers, and legal
action against overdue accounts.

9.5 Credit Evaluation of Individual Accounts

Receivables management requires a lot of decision making exercises, setting credit standards,
identifying credit terms (credit period and cash discount), collection policy, evaluation of
individual accounts. Evaluation of individual accounts is the prime activity, which affects fi rm’s

profitability. In this, firm should develop procedures for evaluating credit applicants and consider
the possibilities of bad debt or slow payment. Mere determination of appropriate credit policy
will not serve the purpose of minimizing investment in receivables and reducing bad debt losses,

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