Accounting Business Reporting for Decision Making

536 Accounting: Business Reporting for Decision Making

Benefits and costs of granting credit

Why do entities sell goods or provide services to their customers on the promise that they will be

paid, when they are well aware that there is a chance that some customers will not pay? Consider a

department store which chose to have a cash-only policy. It would be losing a great number of poten-

tial customers just because the store did not offer flexible means of payment. As with most financial

decisions, there are benefits and costs, and managers face a trade-off between the costs and benefits

of providing credit. With careful management, it is hoped that benefits can be maximised and costs

minimised.

The benefits of granting credit include:

• increasing sales, because of:
  
  
  • attracting new customers from other cash-only suppliers
  
  
  • encouraging customers to bring planned purchases forward
  
  
  • attracting impulsive purchases
  
  
  • attracting customers who would not otherwise have purchased
  
  
  
  


• reducing the cost of making sales, such as in the case where counter staff merely fill out delivery

dockets, and specialist pricing people calculate actual charges.

The costs of granting credit include:

• the opportunity cost of the funds being tied up, as there is no direct return to the funds


• the cost of the (hopefully small) proportion of slow payers and bad debts; even with the best of credit

rating and collection systems, there will normally be a small percentage of accounts receivable who

will be slow to pay or will not pay at all

• the cost of administering the system, including office staff, stationery, postage, telephone and, possibly,

specialist collection services.

Determinants of the level of accounts receivable

The value of accounts receivable carried by any entity depends on a number of policies and processes

that the entity determines and manages. Figure 13.1 gives a diagrammatical overview of the determi-

nants. This section discusses each of the determinants in turn.

Credit policies

Total

sales ($)

Value of

credit sales ($)

Debtors

($)

Collection

policies and

procedures

FIGURE 13.1 Determinants of the level of accounts receivable