credit policy

Examples of credit policy in the following topics:

• Setting a Credit Policy

  • To establish a credit policy, a company must establish credit standards, credit terms, and a collection policy.
  • There are three steps a company must undergo when developing a credit policy:
  • Another important factor in determining credit standards involves a company evaluating the credit worthiness, or credit score, of an individual or business.
  • The last step is to establish a collection policy.
  • Collection policies vary widely among industries.

• Collecting Receivables

  • By comparing this number to the number in the credit policy, a business can determine whether its policy is effective or not.
  • The accounts receivable days is important because investors utilize this measure to evaluate a firm's credit management policy.
  • If the percentages in the lower half of the schedule begin to increase, the firm needs to evaluate the effectiveness of its credit policy.
  • Another way to evaluate a credit policy is to look at the receivable turnover ratio.
  • This is an insurance policy and a risk management product offered by private insurance companies and governmental export credit agencies to business entities wishing to protect their accounts receivables from loss due to credit risks like protracted default, insolvency, or bankruptcy.

• Choosing a Policy

  • A firm will use a combination of policies for managing working capital, focusing on cash flow, liquidity, profitability, and capital return.
  • Management should identify the appropriate credit policy so that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and return on capital.
  • Moreover, management should implement appropriate credit scoring policies and techniques so that the risk of default on any new business is acceptable given these criteria.
  • A final area management should be concerned with when deciding on a working capital policy is short-term financing.
  • Inventory is ideally financed by credit granted by the supplier.

• Managing the Business Cycle

  • When the economy is not at a steady state, the government and monetary authorities have policy mechanisms to move the economy back to consistent growth.
  • If the economy needs to be slowed, these policies are referred to as contractionary and if the economy needs to be stimulated the policy prescription is expansionary.
  • Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions.
  • Similarly, contractionary monetary policy is the opposite of expansionary monetary policy and occurs when the supply of loanable funds is limited, to reduce the access and availability to relatively inexpensive credit.
  • Identify how changes in monetary and fiscal policy can manage the business cycle, and why that is desirable

• Arguments For and Against Fighting Recession with Expansionary Monetary Policy

  • Expansionary monetary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates.
  • Expansionary monetary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into investing, leading to overall economic growth.
  • For example, if the central bank is implementing expansionary policy but is committed to keeping interest rates low, the central bank needs to convey this policy with credibility, otherwise economic agents may assume that expansionary policy will lead to inflation and begin augmenting behavior to initiate the outcome expected, higher inflation.
  • The increase in the money supply is the primary conduit for expansionary monetary policy.
  • Assess the value of discretionary expansionary monetary policy and the associated shortcomings.

• International Credit Rating Agencies

  • International credit-rating agencies do not focus on risk for particular companies but assess investment risk associated with countries.
  • Two well-known credit agencies are A.M Best and Coface.
  • Best is an international credit agency that classifies country risk into five tiers.
  • Best examines local accounting rules, government policies and regulations, a country's economic growth, and social stability.
  • Coface, France's export credit underwriter, is another international credit-rating agency.

• Monetary Policy and Fiscal Stabilization

  • As a result of the Great Depression in the 1930s, Congress gave the Fed authority to vary reserve requirements and to regulate stock market margins (the amount of cash people must put down when buying stock on credit).
  • During much of the 1970s, the Fed allowed rapid credit expansion in keeping with the government's desire to combat unemployment.
  • The growing importance of monetary policy and the diminishing role played by fiscal policy in economic stabilization efforts may reflect both political and economic realities.
  • Political realities, in short, may favor a bigger role for monetary policy during times of inflation.
  • One other reason suggests why fiscal policy may be more suited to fighting unemployment, while monetary policy may be more effective in fighting inflation.

• The Effect of Expansionary Monetary Policy

  • Monetary policy is referred to as either being expansionary or contractionary.
  • Expansionary policy seeks to accelerate economic growth, while contractionary policy seeks to restrict it.
  • Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding.
  • Expansionary policy attempts to promote aggregate demand growth.
  • Monetary policy focuses on the first two elements.

• Arguments For and Against Fighting Recession with Expansionary Fiscal Policy

  • Fiscal policy is a broad term, describing the policies enacted around government revenue and expenditure in order to influence the economy.
  • Expansionary fiscal policies involve reducing taxes or increasing government expenditure.
  • Increasing government spending, creating a budget deficit, and financing the shortfall through debt issuance are typical policy actions in an expansionary fiscal policy scenario.
  • This raises interest rates across the economy because government borrowing increases demand for credit in the financial markets.
  • Evaluate the pros and cons of fiscal policy intervention during recession

• Problems of Long-Run Government Debt

  • Deficit spending during times of recession widely seen as a beneficial policy that can mitigate the effects of an economic downturn.
  • During periods of expansionary fiscal policy, the government will often fund programs by issuing debt .
  • This could limit the government's ability to pursue expansionary fiscal policies to address future recessions.
  • A sovereign credit rating is the credit rating of a sovereign entity (i.e., a national government).
  • Publicly issued debt is one means governments use to fund expansionary fiscal policy.