Chapter 13 • Management of working capital
Loss of customer goodwill
If its competitors grant credit it will be difficult for a business to deny credit, unless it
offers instead some special inducement (such as discounted prices), which itself may
be as expensive as granting credit. Where the supplier is in a monopolistic, or near-
monopolistic, position, it may be able to sell as much as it wishes without offering
credit. In a competitive market, however, credit may be used as a basis of competition,
so that it may be necessary to offer unusually extended credit to attract large and
recurring orders.Inconvenience and loss of security of collecting cash
Administratively, supplying goods or services on credit can be very convenient. Cash
is not usually paid until the customer is satisfied that the goods are as ordered, which
avoids the necessity for refunds in respect of defective goods. Cash is collected cent-
rally, usually by direct bank credit. It is unnecessary for delivery drivers to collect
cash: thus the delay and potential administrative and security problems likely to arise
from such decentralised cash collection may be avoided. The existence of trade credit
tends to allow specialisation and segregation of duties; delivery drivers deliver the
goods and credit controllers collect the cash.Some practical points in management of trade receivables
Establish a credit policy
The business should consider whether it judges it appropriate to offer trade credit
at all, and if so, how much, to whom and under what circumstances. It might, for
example, decide generally that trade credit is not a good idea, but nonetheless identify
specific circumstances where it is prepared to offer it. For example, a retailer may be
prepared to offer credit only for orders above £100.
One way or another, each business should establish a policy, not merely accept that
credit is inevitable.Assess customers’ creditworthiness
Although in principle the business may have decided that it is in its best interests to
offer credit, it should not offer unlimited credit to any potential customer who seeks
it. Those seeking credit are, in effect, asking for an unsecured loan, and supplying
businesses should assess matters in those terms.
The business should establish a policy for investigating creditworthiness, and
should not be prepared to grant credit before satisfying itself that the risk of doing so
in respect of each customer is an acceptable one. It is not just a question of either grant-
ing credit or not. Credit limits should be established, and these will almost certainly
vary from customer to customer depending on the supplying business’s confidence in
each one’s individual creditworthiness. Once established, each customer’s credit limit
should be rigorously applied until such time as there is some fundamental review by
a senior employee.
The supplying business should try to establish some ‘ear to the ground’ routines so
that signs that any particular established credit customer is experiencing liquidity
problems can be picked up quickly and action taken. Such routines might include regu-
larly monitoring the customers’ financial statements (in the annual report). Another