The implementation of credit standards in the company is necessary for the exit of its products or services. The correct implementation of these standards can become a barrier to obtaining income in the short term
Accounts receivable represent the credit that the company grants to its customers. Credit terms may vary between different industrial fields, but companies within the same industrial field generally offer similar credit terms.
Credit sales, which result in accounts receivable, typically include credit terms that stipulate payment over a specified number of days. Although all accounts receivable are not collected within the credit period, most of them are converted into cash in less than one year; consequently, accounts receivable are considered as current assets of the company.
Continuous attraction. To retain their customers and to attract new buyers, companies have an alternative in offering credit.
Credit policies
A company's credit policy sets the tone for determining whether and how much credit should be granted to a customer. The company must not only deal with the credit standards that it establishes, but also with the correct use of these standards when making credit decisions.
That is why adequate sources of information and credit analysis methods must be developed. Each of these aspects of credit policy is important to the successful administration of the company's accounts receivable.
The inadequate execution of a good credit policy or the successful execution of a poor credit policy do not produce optimal results.
Credit standards
The company's credit standards define the minimum criteria for granting credit to a customer. Issues such as credit evaluations, referrals, average pay periods, and certain financial ratios offer a quantitative basis for establishing and enforcing credit standards.
When carrying out the analysis of the standards, a series of fundamental variables must be taken into account, such as office expenses, investment in accounts receivable, the estimation of bad debts and the company's sales volume.
Office expenses
If credit standards are made more flexible, more credit is awarded. Flexible credit standards increase office costs, on the contrary, if credit standards are more rigorous, less credit is granted and therefore costs decrease.
Accounts receivable investment
There is a cost related to managing accounts receivable. The higher the average accounts receivable of the company, the more expensive it is to manage and vice versa. If the company makes its credit standards more flexible, the average level of accounts receivable should be raised.
Lines of credit are established to eliminate the need to verify a major customer's credit each time a business transaction is made with him
Allowance for doubtful accounts
The risk of acquiring a difficult to collect account increases as the credit standards are more flexible and decreases if they are restrictive.
Turnover
Changes in credit standards can be expected to modify the volume of sales of the company, the more flexibility of these tends to increase them, but factors must also be taken into account, such as the effect of applying costs and income.
Effects on decision making
To decide whether a business should make its credit standards more flexible, marginal profit on sales must be compared to the cost of marginal investment in accounts receivable. If marginal profits are greater than marginal costs, credit standards should be made more flexible; otherwise they must remain the same.
It should also be taken into account the aspect of accounts receivable that are not recovered in the stipulated time and those that for one reason or another can no longer be collected, the analysis of these variables can significantly change the decision made in front of this aspect.
Credit analysis
Once the company has established its credit standards, it must establish the procedures to evaluate the applicants for it. Sometimes it is necessary to determine not only the merits that the client has, but also calculate the amount for which he can respond, in order to establish a line of credit, stipulating the maximum amount of credit that the client can access at a time anyone.
Two basic steps are used to carry out the investigation process, the first one must obtain detailed and reliable information on the client's credit and the second one must carry out an exhaustive analysis of said information to make the pertinent decisions.
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In the following video, Professor Julián Gómez presents the strategic guidelines for portfolio management, a good complement to the issue of business credit policies.
