Question

Regina Golden, the vice president of sales for Tropical Pools and Spas, wants the company's credit department to be less restrictive in granting credit. “How can we sell anything when you guys won't approve anybody?” she asks. Discuss the pros and cons of easy credit. What are the accounting implications?

Answer 1

Liquidity is one of the most important factors for successful conduct of business. It is the measure of a business’s ability to not depend on external financing to meet its normal operations. One of the main components that effect the liquidity of the company is its credit policy, and the competence of the receivables team to collect this debt. So, a company's credit department plays a vital role in liquidity of the company. Now we will look into pros and cons of providing credit.

Advantages of providing easy credit

• Customer base will increase, as customers would prefer companies that provide credit over which does not.
• Sales value per customer will increase, as large customers will always want a credit period, which can be gained by a lenient credit policy.
• Middle-man (like agencies that sell bundle offers), especially in cases of spas and pools, will prefer a credit policy. Major sales for many spas and pools come from such deals via middle-men agencies.
• The company can kill the competition in market by providing a very lenient credit policy.

Disadvantages of providing easy credit

• The major disadvantage is the, probability of receivables to turn bad debt.
• The liquidity of company will be affected as major sales are ties up as receivables.
• The company might require to procure external funds to finance operations, there by incurring extra interest costs
• Will have to employ, labour to keep track and collect receivables.

Accounting implications include the extra man power required to track and collect receivables, Had the sales been cash, there would be a single-entry during sales. But on easy credits, the company will have to focus on preparing ageing analysis for debtors, provisions for bad debts, actual expensing of bad debts etc. Thus, accounting work increases on easy credit policies.