Change in credit policy

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Introduction
In order to have excellent borrowing and lending system, organizations maintain credit
policies and according to Harmon (2014) these polices explain how an organization prefers to
carry out business transactions. Arranging credit policies is the most important foundation in
business and these policies reduce confusions and misinterpretations between organizations
and suppliers and creditors. The main advantage of credit policy is that it improves the
operational efficiency of organizations and also its cash flow. Damodaran (2010) states that
effective credit policies also improve revenue and profit figures of organizations. In the long
run, it is observed that organizations change their credit policies to make progressive changes
in sales figures. However change in credit policies without proper evaluation could adversely
impact on organizations.
In the first part of the following report, the researcher will analyse how change in credit
policy could impact upon an organization and the measures that it needs to take while
changing credit policies.
In the second section of this study, role of supply chain finance and relation between interest
rates and opportunity cost will be evaluated. The researcher will analyse how supply chain
finance differs from traditional working capital management and what are the advantages
offered by supply chain finance to organizations. The author will also analyse the impact
made by negative rate of return on opportunity cost of an organization in this report.
Change in Credit Policy
According to Singh and Dutta (2013) any change made by an organization in its credit policy
will have a direct impact on its sales figures. While changing the existing credit policy,
organizations need to analyse the change in profitability arising out of such decision. Lacarte
(2012) explains that the change in profitability can be analysed using cost-benefit analysis.
While conducting cost-benefit analysis the organization needs to consider every significant
factor like additional product demand arising out of changed credit policy, profit generated
out of additional sales, alteration made in average debtors collection and the requisite return
on investment.
In order to carry out cost-benefit analysis Kasiran, Mohamad and Chin (2016) explain that an
incremental model needs to be followed. In other words only those figures that get affected

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by the changed policy need to be considered while doing cost-benefit analysis. The costs

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considered for cost-benefit analysis must not be measured at sale price since organizational
investment does not consider profit margin integrated in selling price of products. Also those
fixed expenses that do not get changed due to changed credit policy must be avoided from
cost-benefit analysis. According to Harmon (2014) many among the cost-benefit analysis
conducted on changed credit policy would assume that no changes are made to fixed
expenses and thus investments that increase due to changed policy will be evaluated at
variable cost. On the other hand Kasiran, Mohamad and Chin (2016) find that is change in
credit policy affects fixed cost then such costs should also form part of cost-benefit analysis.
While considering the given situation of Borboleta, the following calculation can be made:
Increase in sales = 4,800,000 x 25% = 1,200,000
Contribution from increased sales = 1,200,000 x 0.15 = 180,000
a) If all customers adopt for 2 months credit period, the following additional
investment will be incurred:
Debtors during unchanged credit policy = 400,000
Debtors after changed credit policy = 800,000
Therefore increase in debtors = 400,000
New debtors with respect to additional sales (1,200,000 x 2/12) = 200,000
Therefore net increase in debtors = 600,000
Variable cost of investment in debtors (600,000 * 85%) = 510,000
Add: Increase in stock = 200,000
Less: Increase in creditors = 40,000
Therefore Net Investment arising out of changed credit policy = 670,000
Required ROI (Return on Investment) = 670,000 x 20% = 134,000
Hence Net Gain (Contribution of 180,000 – Required ROI 134,000) = 46,000
Answer:

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Since additional contribution due to change in policy (180,000) is greater than the required
Return on Investment (134,000) the recommended alteration in credit policy is acceptable. It
is also observed that change in credit policy contributes actual return on investment (180,000
÷ 670,000) of 26.9% which is greater than the current ROI of the organization (20%) the
proposed change is acceptable.
b) If only new customers select change in credit policy
New debtors with respect to additional sales (1,200,000 x 2/12) = 200,000
Variable cost of investment in debtors (200,000 * 85%) = 170,000
Add: Increase in stock = 200,000
Less: Increase in creditors = 40,000
Therefore Net Investment arising out of changed credit policy = 330,000
Now,
Contribution from increased sales = 180,000
Required ROI (Return on Investment) = 330,000 x 20% = 66,000
Hence Net Gain = 114,000
Answer:
Since additional contribution due to change in policy i.e. 180,000 is greater than the required
Return on Investment of 114,000 the recommended alteration in credit policy is acceptable. It
is also observed that change in credit policy contributes actual return on investment (180,000
÷ 330,000) of 54.55% which is greater than the current ROI of the organization i.e. 20%, the
proposed change is acceptable.
c) Impact of supply chain finance on traditional working capital management and
relation between negative interest rate and opportunity cost
Supply Chain Finance
According to Baltes (2015) supply chain finance is one among the latest payment solutions
offered to organization and suppliers. Supply chain finance is otherwise called as reverse

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factoring and this method is mainly applied by entities to improve their cash flows. Graham
and Smart (2012) define supply chain finance as resolution policies where organization are
allowed to extend its payment terms with suppliers while small, medium and large scale
suppliers of organizations are allowed with early payments. As per Baltes (2015) supply
chain finance benefits both debtors and creditors. While debtors can improve their working
capital through reverse factoring, higher operating cash flow benefit creditors to reduce
supply chain risks.
In the study of Jamalinesari and Soheili (2012) it could be observed that supply chain finance
allows organization in financing of products and services along their movement in the supply
chain. Financial method of discounting and latest technologies support the system of supply
chain finance (Baltes, 2015). Graham and Smart (2012) observe that the main reason behind
increasing popularity of supply chain finance is globalisation and rising levels of offshore
manufacturing. As supply chain finance assist firms to augment their financial efficiency, this
system has replaced traditional method of working capital management in many business
situations.
As detailed by Zhang et al. (2014) while traditional financing credit targets a single entity,
supply chain finance targets the entire supply chain through which the products/ services
move. Similarly the author finds that the credit rating points in traditional mode is the
financial statements of the organization while supply chain finance considers only the asset
transactions carried out. Harmon (2014) explains that supply chain finance provides finance
terms for shorter period thus making substantial reduction in working capital of an
organization while traditional working capital management offers short term, medium term
and long term periods for financing. Due to this reason many organizations adopt supply
chain finance. Another major difference of supply chain finance with traditional working
capital management has been pointed out by Jamalinesari and Soheili (2012). The author
explains that supply chain finance promotes collaboration between debtors and creditors and
thus reduces unnecessary competition among them.
It has been observed by Lacarte (2012) that supply chain finance is mostly used by
automotive and retail organization and it largely improves the operational efficiency of the
concerned organization. It also improves the transparency of transaction and makes financial
transfers more value-added and safe. However Singh and Dutta (2013) fid that financial risks
are high with supply chain finance and also it incurs higher financing costs. Therefore supply

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chain finance is still an area which requires improvement and only when this method
overcomes current issues could replace traditional working capital management completely.
Negative interest rate and opportunity cost
It has been stated by Aktas, Croci and Petmezas (2015) that a healthy and well established
business house generates income to pay for the ongoing costs. Since the business
environment is highly dynamic, there would be situations where the organization would
require additional costs for growth and expansion or to add new assets like machineries,
equipments etc. Irrespective of the income generated by the firm, the additional expenses
borne will be considered as its cost of capital and as explained by Kasiran, Mohamad and
Chin (2016) these costs are highly affected by any change in interest policies made by the
firm.
According to Baltes (2015) opportunity cost of capital of an entity can be defined as the
increase in return on investment foregone by an organization due to its investment in ongoing
projects. Harmon (2014) explains that opportunity cost of capital is the return foregone by an
organization and hence an increase in organization’s interest rates will also increase its return
had it invested amount in other investments rather than that in organizational projects.
However negative interest rates have adverse affects on opportunity cost. In simple terms,
negative interest rates refer to those rates which fall below zero. According to Singh and
Dutta (2013) negative interest rates begin from banking sector.
As cited by Zang et al. (2014) banks need to use its cash to provide loans to public and
organization. However in many cases banks do not use their entire cash for lending activities
and keep extra cash with apex bank. In such situations, they are charged for not utilising the
extra cash to provide loans at low rates and this result in negative interest rate in various
sectors of economy. According to Singh and Dutta (2013) majority among the organizations
procure fund from various banks for their expansion plans and negative rate of return will
mean that business growth will diminish and will affect future cash flows further affecting
opportunity cost.
Conclusion
In the first section of this study, the researcher conducted an analysis of change in credit
policy in Borboleta. It was understood that change in credit policy could be accepted when an

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increment could be observed in actual rate of investment that the current rate of investment.

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Or in other words, the researcher deduced that if the change in credit policy generated
contribution higher than the return on investment, such changes could be accepted by the
organization. After comparing supply chain finance over traditional working capital
management, the researcher observed that supply chain finance improves operational
efficiency of organization. It was also found by the author that negative interest rates
adversely affected opportunity cost of firms by diminishing business growth and its cash
flows.
Reference:
Aktas, N., Croci, E. and Petmezas, D., 2015. Is working capital management value-
enhancing? Evidence from firm performance and investments. Journal of Corporate Finance,
30, pp. 98-113
Baltes, G., 2015. New perspectives on supply and distribution chain financing. Grin Verlag.
Damodaran, A., 2010. Applied corporate finance. New Jersey: John Wiley and Sons.
Graham, J. and Smart, J.B., 2012. Introduction to corporate finance: what companies do.
Mason: Cengage.
Harmon, P., 2014. Business process change. 3rd
ed. London: Elsevier
Jamalinesari, S. and Soheili, H., 2015. The relationship between the efficiency of working
capital management companies and corporate rule in Tehran stock exchange. Procedia -
Social and Behavioral Sciences, 205, 9, 499-504
Kasiran, F.W., Mohamad, N.A. and Chin, O., 2016. Working capital management efficiency:
a study on the small medium enterprise in Malaysia. Procedia Economics and Finance, 35,
pp.297-303
Lacarte, J.M., 2012. Applied corporate finance: what is a company worth?. Manuel Lacarte
Singh, K. and Dutta, V., 2013. Commercial bank management. New Delhi: Mc Graw Hill
Zhang, Z., Shen, Z.M., Zhang, J. and Zhang, R., 2014. LISS 2014: Proceedings of 4th
international conference on logistics, informatics and service science. London: Springer.

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