Fundamentals of Financial Management, Third Edition

SUMMARY

Credit sales lead to the creation of accounts receivable. Receivables lead to greater sale and profitability, help absorb any fluctuations in demand, provide greater liquidity, act as a tool for price discrimination and encourage intermediaries. But they have costs too, in form of administrative cost, financial cost, collection cost and bad debt losses.

A firm’s credit policy should be such that helps maximise corporate wealth. It can be determined through a cost-benefit analysis or through preparing a proforma income statement. However, deviations can be made to suit the firm’s overall strategy. Any change in the credit standard or the period of the credit or in the discount policy must ensure that benefits exceed the costs.

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