Accounting Best Practices, Fifth Edition

7–28. Modify the Credit Policy Based on Changing Economic Conditions

When economic conditions within an industry worsen, a company whose credit policy has not changed from a more expansive period will likely find itself granting more credit than it should, resulting in more bad debts. Similarly, a restrictive credit policy during a boom period will result in lost sales that go to competitors. This latter approach is particularly galling over the long term, since customers may permanently convert to a competitor and not come back, resulting in lost market share.

The solution is to schedule a periodic review of the credit policy with senior management to see when it should be changed to match economic conditions. A scheduled quarterly review is generally sufficient for this purpose. To prepare for the meeting, one should assemble a list of leading indicators for the industry, tracked on a trend line, that show where the business cycle is most likely to be heading. This information is most relevant for the company’s industry, rather than the economy as a whole, since the conditions within some industries can vary substantially from the general economy. If a company has international operations, then the credit policy can be tailored to suit the business cycles of specific countries.

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