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(^226) Financial Management
initial effect of granting long credit periods may be adverse because of the extra costs
involved but profits from increased volumes should more than offset the losses. If it
does not there is no use in extending longer credit periods. Even otherwise it is necessary
to look to the longer term where, among other possibilities, selling prices may be increased
because smaller competitors have been eliminated in the 'credit war'.
Shorter credit may be imposed if demand is inelastic, so that the quantity sold will not be
affected simply by changes in credit terms.
Influence of Credit Policy
Credit policy will directly influence sales, investment levels, bad-debt losses, and collection
costs.
Sales: Sales vary directly with the extent to which credit terms are liberalised. The
demand for a firm's product is greatly influenced by the ease with which the products
can be purchased on credit. Sales will be at their lowest level if they are strictly for
cash. Those who want to buy on credit will patronise other manufacturers who extend
credit. Sales will start increasing as credit terms are liberalised. Sales will be at their
maximum level when the firm does not screen buyers for credit worthiness. Rather,
credit is extended to all who want to buy the firm's products.
Investment Levels: Sales on credit result in accounts receivable. As discussed above,
sales are directly related to the liberality of credit terms. As credit terms are liberalised,
sales increase and to service this increased level of sales properly, the firm needs to
increase its investments in cash and inventories. Finally, if sales increase sufficiently,
the firm may have to increase its productive capacity. As credit terms are made more
liberal, the firm's investment in cash accounts receivable, inventories, and perhaps physical
equipment increases in a complimentary fashion.
Bad-Debt Losses: Without credit sales the firm will not incur any bad-debt losses.
With a very conservative credit policy, bed-debt losses will be nonexistent or minimal.
As credit terms are liberalised, the firm begins to give credit to marginally less-credit-
worthy clients. The liberalisation of credit terms result in increases in bad-debt losses.
Collection Costs: Collection costs are the clerical and administrative costs associated
with granting credit and managing accounts receivable. When credit is not granted,
collection costs are minimal. As credit terms liberalised, the firm's volume of accounts
receivable increases. The clerical and administrative costs of invoicing, collecting, and
book keeping also increase as credit terms are liberalised. A second type of collection
cost is the one related to efforts to collect on delinquent accounts. As credit terms are
liberalised, delinquent accounts increase and the costs of efforts to collect on these
accounts also increases.