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.

• Decision Criteria

  • ROC measures are, therefore, useful as a management tool, in that they link short-term policy with long-term decision making.
  • Another factor affecting working capital management is credit policy of the firm.
  • It includes buying of raw materials and selling of finished goods either in cash or on credit.

• Evaluating Interest Rates

  • The return expected on debt depends upon the credit rating of the company, which takes into account a number of factors to determine how risky loaning funds to a company will be.
  • ROC measures are therefore useful as a management tool, in that they link short-term policy with long-term decision making.
  • Debtors management involves identifying the appropriate credit policy -- i.e. credit terms which will attract customers -- such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and, hence, return on capital (or vice versa).
  • If inflation is at a high level or there are opportunities foregone because of lack of working capital, a firm will more than likely have a stricter credit policy.
  • For instance, inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan or to "convert debtors to cash.".

• Short-Term Approach

  • While a firm could even achieve a negative cash conversion by collecting from customers before paying suppliers, a policy of strict collections and lax payments is not typically sustainable.
  • The aim of the study and calculation of the cash conversion cycle is to change the policies relating to credit purchase and credit sales.
  • A firm can change its standards for payment on credit purchases and getting payment from debtors on the basis of cash conversion cycle.
  • If the firm is in an effective cash liquidity position, it can maintain its past credit policies.

• 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.

• Identifying Varying Conditions

  • Management uses policies and techniques for the management of working capital such as cash, inventory, debtors and short term financing.
  • Management will use a combination of policies and techniques for the management of working capital.
  • The policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short-term financing, such that cash flows and returns are acceptable.
  • Identify the appropriate credit policy (i.e., credit terms which will attract customers such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence return on capital or vice versa).
  • The inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring. "

• 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.

• Answers to Chapter 14 Questions

  • The Fed could grant adjustment credit, seasonal credit, or extended credit.
  • When the Fed conducts monetary policy, the policy affects the federal funds rate first.
  • By the time monetary policy influences an economy, the economy is already growing, and the monetary policy causes the economy to grow quickly, creating inflation.
  • Over time, monetary policy influences the intermediate targets.
  • The Fed's monetary policy coincides with the business cycle.

• Open-Market Operations

  • Moreover, the Fed can use Open-Market Operations, Discount Policy, and Reserve Requirements to implement a monetary policy.
  • Noticing one thing, open-market operations affect the interest rates because the T-bill is a short-term credit instrument.
  • Therefore, short-term interest rates on all short-term credit instruments will rise and fall together.
  • Contractionary monetary policy works similarly to expansionary monetary policy.
  • Furthermore, the short-term interest rates for other credit instruments rise.