Question

How does credit policy affect the CCC?

How does collection policy influence sales, the collection period and the bad-debt loss percentage?

How do profit potential and legal considerations affect a firm’s credit policy?

Answer 1

The credit policy affects the cash conversion cycle,

CCC = DOH + DSO – DPO,

A company has a small CCC , so that it can efficiently manage the working capital and and minimise the need for short term financing. If the credit policy is strict , the CCC is small as receivables will be collected quickly and will also have fewer bad debts which is favourable for the firm an it indicates a healthy firm but costs will rise in the form discounts offered to customers as a part of the relaxed credit policy. A liberal credit policy leads to a longer CCC which is harmful for the company but will also result in higher sales. On comparing costs with the benefits, a company should choose an appropriate credit policy.  The company will neednadditional financing to finance the working capital needs . A large CCC can lead to insolvency for the firm.

With a liberal credit policy, a firm will attract more sales that is inventory will be sold out faster, but due to the liberal credit policy the receivables will slow down. This can lead to more bad- debts and larger investments in receivables.

With a strict credit policy, the firm will lose out on sales to it's competitors. So, inventory sales will be slowed down. The receivables collection rate will improve , there will be less invested  in receivables and bad debt losses will slow down.

Impact of profit potential on the credit policy : the firms that offer credit sales, carry charges on the credit sales. Some companies can lose.more, as the carrying charges on credit sales than they gain on cash sales, infact they lose on the cash sales. The credit sales can be more profitable than the cash sales.

The legal considerations impact on the credit policy : It is not legal to offer favourable terns of credit to one class of customers and not to others unless it is justified in terms of costs for the company to do  this.