Receivables Management FACTORS AFFECTING A FIRM’S CREDIT POLICY EXTERNAL The availability of credit or short term finance is a majordeterminant of a firm’s credit policy. In most cases when a firm advances more credit to its customers it faces a need of increased working capital needs (Talekar, 2005). . An increase in credit advanced to customers, means that there will inevitably be a need to raise more short term funds to finance the increased working capital needs. These funds can be obtained through short term borrowings, bank overdrafts, credit purchases or reducing the amount of inventory/stock held. It is possible that the company’s suppliers and short term lenders do not wish to advance more credit. This would mean that a firm may either have to abandon its plan for a liberal credit policy or it may end up having cash flow crisis if it continues with the plan.
Competitors’ actions and reactions of customers to a change in the credit policy are important. It is possible that customers may shift their business in favor of a competitor who offers the best credit terms. Credit controllers in firms should take a competitors and customers analysis to determine possible effects to a change in credit policy. The management should ensure that it adopts a policy that poses minimal risk of lost customer goodwill as well as providing a sustainable competitive advantage (Bartels, 1967).
Probability of bad debts and the managements risk appetite are also a major influence of a credit policy. If the management of a company determines that there is a high risk of their credit sales becoming bad, they would probably set up a tight credit policy. Companies whose management is risk averse do not favor loose credit policies.
Impact of the credit policy on turnover, profitability and liquidity should also be considered. The management should seek to maintain a balance between increasing sales and profits and maintaining liquidity at appropriate levels (Talekar, 2005). This trade-off dictates the credit policy of a firm.
REDUCING THE RISK OF BAD DEBTS ARISING FROM HIGH RISK CLIENTS.
The company may opt to reduce the credit limits of clients who are perceived to pose a high risk. The management should carry out customer due diligence and analyses so as to assess the credit worthiness of their clients. This should be done periodically, and the management should ensure that credit limits are lowered for high risk clients. This should be done carefully so that the customer’s loyalty is not eroded. The amount of $ credit sales should be capped to a certain limit depending on the credit worthiness assessment.
The management may seek to use third parties to manage their accounts receivables or specifically to collect cash from clients. The management may choose to use debt factoring or contract debt collectors. This method may ensure that the risk of default is minimized or totally eliminated. However, aggressive debt collectors may destroy the company’s reputation leading to lost customer loyalty and lost future revenue and profits (Ross, 1997).
The company may also consider giving generous discounts to encourage the debtors to clear their balances early. This may not be as effective the other methods discussed above but it is widely applied in practice. The company may also consider to reducing their credit periods. This would allow the managers to detect clients who are lagging behind with their payments early.
The management should adopt one of these policies so as to reduce the risk of bad debts. This is important because credit policies affect the performance of an organization to a great extent.
Bartels, R. (1967). .Credit management. New York: Ronald Press Co
Talekar, S. D. (2005). .Management of working capital. New Delhi: Discovery Pub. House.
Ross, D. A., &. Deloitte &. Touche. (1997). .Debt management. London: CTA Financial.