Trade Credit creates debtors (book debts) or accounts receivable

Ø Trade Credit creates debtors (book debts) or accounts receivable. It is used as a marketing tool to maintain or expand the firm’s sales. A firm’s investment in accounts receivable depends on volume of credit sales and collection period. Ø Credit Policy The financial manager can influence volume of credit sales and collection period through credit policy. Credit policy includes credit standards, credit terms, and collection efforts. The incremental return that a firm may gain by changing its credit policy should be compared with the cost of funds invested in receivables. The firm’s credit policy will be considered optimum at the point where incremental rate of return equals the cost of funds. The cost of funds is related to risk; it increases with risk. Thus, the goal of credit policy is to maximise the shareholders wealth; it is neither maximisation of sales nor minimisation of bad-debt losses. Ø Credit Standards are criteria to decide to whom credit sales can be made and how much. If the firm has soft standards and sells to almost all customers, its sales may increase but its costs in the form of bad-debt losses and credit administration will also increase. Therefore, the firm will have to consider the