The Cash Flows from Granting Credit

In a previous chapter, we described the accounts receivable period as the time it takes to collect on a sale. There are several events that occur during this period. These events are the cash flows associated with granting credit, and they can be illustrated with a cash flow diagram:

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Credit sale is made

Time

The Cash Flows of Granting Credit Customer Firm deposits mails check in check bank

- Accounts receivable -

Bank credits firm's account

As our time line indicates, the typical sequence of events when a firm grants credit is as follows: (1) the credit sale is made, (2) the customer sends a check to the firm, (3) the firm deposits the check, and (4) the firm's account is credited for the amount of the check.

Based on our discussion in the previous chapter, it is apparent that one of the factors influencing the receivables period is float. Thus, one way to reduce the receivables period is to speed up the check mailing, processing, and clearing. Because we cover this subject elsewhere, we will ignore float in the subsequent discussion and focus on what is likely to be the major determinant of the receivables period, credit policy.

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