3. a firm maintains receivables, some of the firm’s
resources remain blocked in them because there is a
time lag between the credit sale to customer and
receipt of cash from them as payment.
When
the extent that the firm’s resources are blocked in
its receivables, it has to arrange additional finance to
meet it own obligations toward its creditors and
employees, like payments for purchases, salaries and
other production and administrative expenses.
To
4. Additional
finances is met from its own
resources or from outside, it involves a cost to
the firm in terms of interest ( if financed from
outside or opportunity costs (if internal
resources which could have been put to some
other use are taken).
5. Administrative costs:
When a company maintains receivables, it has
to incur additional administrative expenses in
the form of salaries to clerks who maintain
records of debtors, expenses on investigating
the creditworthiness of debtors etc.
6. Collection costs:
These are costs, which the firm has to
incur for collection of the amount at the
appropriate time from he customers.
7.
Defaulting cost:
When
customers make default in payment
not only is the collection effort to be
increased but the firm may also have to
incur
losses
from
bad
debts.
8. OPTIMUM CREDIT POLICY
If
a firm sells on credit , it has to decide the
optimum credit policy. It has to be neither too
liberal nor too rigid. The sales must go on rising
and yet the bad debts and collection costs are kept
to the minimum.
9.
10. Liberal Policy
Strict Policy
• When a customer is allowed a longer
credit period for payment of credit sales or
when money is accepted even after credit
period, it is a liberal or lenient credit policy.
• When a customer is allowed a limited
credit period for payment of credit sales or
strict actions are taken , if money is not
repaid within a credit period, it is a strict or
tight or stringent credit policy.
• Liberal credit policy leads to increased
sales and rise in profitability.
• Due to tight credit policy, sales do not
increase and as a result profitability does
not increase.
• Due to liberal policy, the total amount of
receivable increases, which reduces
liquidity and more working capital is
needed.
• Due to stringent credit policy, the amount
of receivables remains within limits and
less working capital is needed in business.
• The prestige of the firms improves among • The marginal customers move away from
the customers and new customers are
the firms having a strict policy and it will
attracted towards such liberal firm. A new
adversely affect the prestige of the firm.
firms needs such a policy.
