Question

What are the four key factors in a firm’s credit policy? How would a relaxed policy differ from a restrictive policy? Give examples of how the four factors might differ between the two policies. How would the relaxed versus the restrictive policy affect sales? Profits?

Answer 1

The four main factors that is important in a firm’s credit policy are credit period, discounts, credit standards and collections policy. A restrictive policy will aim to put necessary restrictions on the borrower, and the borrower has to make sure that those restrictions are followed else necessary actions can be taken by the lender towards borrower as per the terms of the loan. It can include ratios of debt to income, or timely payment of the amount etc.

                The main differentiation between relaxed and restrictive policy is that, under restrictive policy (in terms of 4 factors) credit period will be shorter, discounts will be none or negligible, the credit standards will be very high that means only selected individual will be given credit who has done timely repayment of their dues. A restrictive policy can have a direct impact on the overall sales as well as profitability of the firm because it will harm the amount of risk that a firm can take, and most of the time in business, the only way to make substantial money is by taking a bit more risk than then other players in the market.