What is your credit policy?

Profits are directly proportional to the amount of sales, provided all your business transactions are cash-based. Is it possible for a manufacturer, wholesaler or retailer to continue their business without offering credit in this competitive business environment? The answer is a clear “no” because expanding credit improves your sales and thus your profits. Problems arise only when a company is unable to recover the debt within the stipulated period from the customers.

What is customer management or debtor management?

It covers two aspects. One, the kind of money invested in debt rotation. Second, the risk factor that includes the loss of money or the opportunity costs that the company goes beyond. If these funds were not tied up in receivables, the company would have invested the same elsewhere and earned them. A transaction entirely through cash is certainly a possible option, but whether it is profitable in the long term should be considered. When customers are not offered credit, they choose concerns that extend credit facilities, and thus you can lose your former customers and also be exposed to the risk of declining sales proportions.

With credit turnover, the supplier offers credit for a specific period, which is an investment from the supplier’s angle and the largest single source of short-term financing from the customer’s angle. The supplier must be able to recover the interest on the credit investment he has made. How?

  • Debt recovery within the specified credit period
  • Customer interest in the period of delay
  • Quantity of sales
  • Excess capital to offset these adverse effects on the rotation of funds
  • Proper formulation and implementation of credit policies by the CFO
  • Discipline in collection policy and its execution.

Cash discounts, quantity discounts and trade discounts are offered by many companies to customers to encourage the sale of credit, which favors bulk purchases. It is not expected that a firm will survive long by pursuing the cash sales policy, while similar firms can overtake it by adopting a liberal credit policy.

The main aspects of receivables management decisions are as follows:

  • credit Period
  • Customer credibility
  • cash Discounts
  • trade Discounts

Credit policy, on the one hand, stimulates sales and thus also its gross earnings, but on the other hand can be accompanied by extra costs such as:

1) office expenses involved in investigating additional accounts and servicing additional receivables;

2) increased deficit debt due to credit extension to less creditworthy customers;

3) higher capital costs.

Incremental revenue from increased sales must be matched with the extra costs incurred due to credit terms to avoid funds being tied up in receivables. Over time, it would deprive you of your profits. The most important consideration of your credit policy will be the choice of creditworthy customers or debtors. If your funds become sticky, recovery is not an everyday task at all and you have to continue legally to claim your rights. Properly maintained accounts and vouchers will stand as a testimony to your advantage in court.