CHAPTER 13 Financing the business 537Total sales
The value of total sales has an impact on the value of credit sales, so long as the entity exercises a policy
of offering sales on credit. Thus, it follows that the greater the total sales, the greater the credit sales and
the greater the value of accounts receivable.
Moreover, as we saw in the previous section, credit policies also have an impact on total sales.
Credit policies
Credit policies determine the value of credit sales. Credit policies may be broken up conveniently into four
aspects, all of which must be managed. These aspects are all decision variables, in that managers are free to
make whatever decisions or policies they think best to achieve the entity’s objectives. The aspects are:
- deciding to offer credit or not
- selecting suitable creditworthy customers
- setting credit limits
- deciding payment terms.
Competition in markets normally forces suppliers to offer similar services and trading terms. The stronger
the competitive pressures, the more likely it is that no entity can stand out from the pack and offer signifi-
cantly less advantageous selling terms. If an entity’s competitors offer credit, it too will be forced to offer
credit sales. Additionally, in terms of pure economics, it is highly likely that the marginal sales revenue from
credit-induced sales at normal profitable prices, initially at least, will exceed the marginal cost of these sales.
In other words, an entity not offering credit sales at all is very likely reducing its potential profitability.
Entities seeking to determine the creditworthiness of potential customers face different tasks,
depending on the size and status of the applicant customer. Very large entities may be rated by the global
ratings agencies such as Moody’s Investors Service and Standard & Poor’s (S&P), and these ratings
are publicly available. Other agents, such as Veda Advantage (Australia’s leading data intelligence and
insights company) and Dun & Bradstreet, collect data on the operations, financial standing and credit
history of many entities, and are able to sell this information to entities which require it.
Many entities ask potential credit customers to fill in a credit-scoring questionnaire. Such a ques-
tionnaire asks for information on the age and stability of the entity, details of any past credit diffi-
culties, bank account details and so on. More sophisticated entities may use more complex credit-scoring
models. These models rely on quantifying the answers to questions that ask about issues considered
to be determinants of creditworthiness, and combining the quantitative data into a model. The data are
compared with past experience in that particular industry. Often, if a company is applying for credit
terms, a director’s personal guarantee will be requested.
Entities granting credit normally set an upper credit limit, either explicitly or implicitly. The credit
limit is set with regard to the level of knowledge of the customer and the expected size of the sales
during any period. Thus, a new customer, about whom little is known, may have a relatively small credit
limit imposed. On the other hand, a potato grower contemplating a new contract with Woolworths to
supply potatoes all year round is not at all likely to impose a small credit limit.
The final of the four decisions that a manager must make is the terms of credit to be offered. Credit
terms involve the possibility of a discount for early payment; (if so) what discount for what period and
what will be the total allowed credit period are the decisions to be made. Discount terms are often stated
as, for example, ‘1/10, net 30’, meaning 1 per cent discount if paid in 10 days, and net if paid within
30 days. The standard net period is 30 days in most industries, although many entities that do not want to
finance large amounts of accounts receivable often state their term as ‘net 7 days’. The aim of granting a
settlement discount is to provide a monetary incentive for accounts receivable to pay quickly.
Collection policies and procedures
What can a supplier do to ensure it collects the highest possible proportion of its accounts receivable? The
answer is to have written policies and procedures in place, monitor the ageing of accounts and apply the pro-
cedures rigorously. These days, when almost all entities have computerised accounting packages (following
the introduction of the goods and services tax (GST), which forced many smaller entities to install electronic