CREDIT POLICY
A firm’s credit policy is the set of principles on the basis of which it determines who it will lend money to
or gives credit (the ability to pay for goods or services at a later date)
In simple terms, the credit policy of a financial institution or business is a set of guidelines that highlight
the following points –
• The terms and conditions for supplying the goods on credit
• Customer credit worthiness
• Collecting procedure
• Precautionary steps in case of customer default
In economics, credit policy is government policy at a particular time on how easy or difficult it should be
for people and businesses to borrow money and how much it will cost. This is done through change in
interest rates.
Credit policy varies from firm to firm and is based on particular business, cash flow circumstances,
industry standards, current economic conditions and the degree of risk involved. It also has impact on
performance, as a relaxed credit policy boosts sales but also increases defaults and bad debts whereas a
conservative credit policy may restrict sales but will also minimize defaults.
Example: The use of clauses such as “3/10 net 30” is a part of credit policy. The clause states that if the
customer pays the money within 10 days then he/she/it eligible to 3% discount on the total amount else
the entire amount is to be paid within 30 days.
TYPES OF CREDIT POLICY:
Credit policy is an important part of the overall strategy of a film to market its products. It refers to
those decision variables that influence the amount of trade credit i.e. investment in receivables. Credit
policy can be lenient or stringent.
There are two types of credit policies. Let us know about them in brief.
(a) Lenient/Loose/expansive Credit Policy:
Under this policy, firms sell on credit to customers very liberally even to those customers whose
creditworthiness is not known is not known or doubtful. Because of liberal policy, sales
increases and as a result, profit also increases but bad debts also increase and hence the firm
faces the liquidity.
(b) Stringent/Tight/Restrictive Credit Policy:
Here, the firm is very selective in extending credit. Credit sales are made only to those customers who
have proven worthiness. Because of tight credit standards, chances of bad debts and other credit costs
are minimized but at the same time sales and profits, margins are restricted.
Therefore, the objectives of credit management should be the achievement of balance that maximizes
the overall return of the firm. The firm normally follow a credit policy which is in between lenient and
stringent credit policies
, ASPECTS OF CREDIT POLICY:
The important dimensions of a firm’s credit policy are credit terms, credit standards and collection
policies.
1. Credit terms:
Credit terms are the stipulations under which the firm sells on credit to its customers. These are with
regard to the repayment of the credit sales
• Credit Period:
It is time duration for which credit is extended to the customers. It is generally stated in terms or a net
date. For example, ‘net 30’ refers to the payment to be made within 30 days from the date of the credit
sale.
• Cash discount:
In order to induce customers/debtors to pay their bills early, the cash discount is allowed. It indicates
the rate of discount and the period for which discount is offered. The customer is expected to make the
payment by the net date if he does not avail himself of this discount offer.
2. Credit Standards:
Credit should be allowed to only those customers who contribute good credit risk. Credit standards are
the basic criteria for extension of credit to customers. They are influenced by three C’s of credit viz
1. Character: The willingness of the customer to pay.
2. Capacity: The ability of the customer to pay.
3. Condition: The prevailing economic condition.
Liberal credit standards push up sales by attracting more customers. But, this increases the incidence of
bad debts loss, investment in receivables and cost of collection. Stiff credit standards tend to depress
sales but at the same time, also reduce the incidence of bad debt loss, investment in receivables and
collection costs.
3 . Collection policy:
It should aim at accelerating collection from slow payers and be reducing bad debts losses. The
collection program should consist of the following:
• Monitoring the state of receivables.
• Dispatch of letters to the customers whose due date is nearing.
• Telegraphic and telephonic advice to the customers around the due date.
• The threat of legal action to overdue accounts.
If the firm is strict in its collection policy with the permanent customers who are temporarily slow
payers, they get offended and shift to the competitors and thus, the firm loses its permanent business.
If the firm is lenient in collection policy, receivables increase and thus profitability reduces.
A firm’s credit policy is the set of principles on the basis of which it determines who it will lend money to
or gives credit (the ability to pay for goods or services at a later date)
In simple terms, the credit policy of a financial institution or business is a set of guidelines that highlight
the following points –
• The terms and conditions for supplying the goods on credit
• Customer credit worthiness
• Collecting procedure
• Precautionary steps in case of customer default
In economics, credit policy is government policy at a particular time on how easy or difficult it should be
for people and businesses to borrow money and how much it will cost. This is done through change in
interest rates.
Credit policy varies from firm to firm and is based on particular business, cash flow circumstances,
industry standards, current economic conditions and the degree of risk involved. It also has impact on
performance, as a relaxed credit policy boosts sales but also increases defaults and bad debts whereas a
conservative credit policy may restrict sales but will also minimize defaults.
Example: The use of clauses such as “3/10 net 30” is a part of credit policy. The clause states that if the
customer pays the money within 10 days then he/she/it eligible to 3% discount on the total amount else
the entire amount is to be paid within 30 days.
TYPES OF CREDIT POLICY:
Credit policy is an important part of the overall strategy of a film to market its products. It refers to
those decision variables that influence the amount of trade credit i.e. investment in receivables. Credit
policy can be lenient or stringent.
There are two types of credit policies. Let us know about them in brief.
(a) Lenient/Loose/expansive Credit Policy:
Under this policy, firms sell on credit to customers very liberally even to those customers whose
creditworthiness is not known is not known or doubtful. Because of liberal policy, sales
increases and as a result, profit also increases but bad debts also increase and hence the firm
faces the liquidity.
(b) Stringent/Tight/Restrictive Credit Policy:
Here, the firm is very selective in extending credit. Credit sales are made only to those customers who
have proven worthiness. Because of tight credit standards, chances of bad debts and other credit costs
are minimized but at the same time sales and profits, margins are restricted.
Therefore, the objectives of credit management should be the achievement of balance that maximizes
the overall return of the firm. The firm normally follow a credit policy which is in between lenient and
stringent credit policies
, ASPECTS OF CREDIT POLICY:
The important dimensions of a firm’s credit policy are credit terms, credit standards and collection
policies.
1. Credit terms:
Credit terms are the stipulations under which the firm sells on credit to its customers. These are with
regard to the repayment of the credit sales
• Credit Period:
It is time duration for which credit is extended to the customers. It is generally stated in terms or a net
date. For example, ‘net 30’ refers to the payment to be made within 30 days from the date of the credit
sale.
• Cash discount:
In order to induce customers/debtors to pay their bills early, the cash discount is allowed. It indicates
the rate of discount and the period for which discount is offered. The customer is expected to make the
payment by the net date if he does not avail himself of this discount offer.
2. Credit Standards:
Credit should be allowed to only those customers who contribute good credit risk. Credit standards are
the basic criteria for extension of credit to customers. They are influenced by three C’s of credit viz
1. Character: The willingness of the customer to pay.
2. Capacity: The ability of the customer to pay.
3. Condition: The prevailing economic condition.
Liberal credit standards push up sales by attracting more customers. But, this increases the incidence of
bad debts loss, investment in receivables and cost of collection. Stiff credit standards tend to depress
sales but at the same time, also reduce the incidence of bad debt loss, investment in receivables and
collection costs.
3 . Collection policy:
It should aim at accelerating collection from slow payers and be reducing bad debts losses. The
collection program should consist of the following:
• Monitoring the state of receivables.
• Dispatch of letters to the customers whose due date is nearing.
• Telegraphic and telephonic advice to the customers around the due date.
• The threat of legal action to overdue accounts.
If the firm is strict in its collection policy with the permanent customers who are temporarily slow
payers, they get offended and shift to the competitors and thus, the firm loses its permanent business.
If the firm is lenient in collection policy, receivables increase and thus profitability reduces.
