Credit Policy Effects

In evaluating credit policy, there are five basic factors to consider:

1. Revenue effects. If the firm grants credit, then there will be a delay in revenue collections as some customers take advantage of the credit offered and pay later. However, the firm may be able to charge a higher price if it grants credit and it may be able to increase the quantity sold. Total revenues may thus increase.

2. Cost effects. Although the firm may experience delayed revenues if it grants credit, it will still incur the costs of sales immediately. Whether the firm sells for cash or credit, it will still have to acquire or produce the merchandise (and pay for it).

Ross et al.: Fundamentals VII. Short-Term Financial 21. Credit and Inventory of Corporate Finance, Sixth Planning and Management Management Edition, Alternate Edition

714 PART SEVEN Short-Term Financial Planning and Management

3. The cost of debt. When the firm grants credit, it must arrange to finance the resulting receivables. As a result, the firm's cost of short-term borrowing is a factor in the decision to grant credit.2

4. The probability of nonpayment. If the firm grants credit, some percentage of the credit buyers will not pay. This can't happen, of course, if the firm sells for cash.

5. The cash discount. When the firm offers a cash discount as part of its credit terms, some customers will choose to pay early to take advantage of the discount.

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