Essay About Credit Policy And Credit Period

Texas Rose Company Case Study
Texas Rose Company LB Cubed ConsultantsApril 18, 2017Introduction        The purpose for our analysis is to minimize bad debt losses, maximize the efficiency and effectiveness of your receivable management system, ensure you have enough cash, and help you prepare your presentation at the venture capitalist seminar.Credit PolicyThe four components of any firm’s credit policy include discounts, credit period, credit standards, and collection process. Discounts are an attractive component of a credit policy because its purpose is to increase sales by providing incentives on purchasing products such as roses. So, for instance a firm would offer 0% financing within 6 months or 2/10 net 30 which is a 2% discount on accounts paid in full within 10 days.  Otherwise the balance must be paid within the 11 to 30 days. The discount component also allows for DSO to be reduce due to the incentives of paying the balance in full early.  Customers will be more likely to pay all of the balance early in exchange for a small discount such as 2%. Credit period is the amount of time that a policy will allow for a balance to be unpaid. The longer the credit period the higher the DSO. In the case of a discount that offers 0% financing the credit period may be longer.  Typically, credit policies allow for 30 days for the balance to be paid.  Shorter credit periods allow for a shorter DSO. If the credit period is too short customers may not enter into an agreement to purchase products on credit due to failure to make payments in a timely manner. Credit standards are an important factor to considered because it limits the type of customers that can use credit. Tighter credit standards will reduce the number of eligible customers that can take advantage of credit. The effect of limiting the type of customer that can use credit will also negatively impact sales. However, credit standards are a vital factor in controlling a firm’s bad debt expense. DSO is reduced when tighter credit standards are enacted. If credit standards are loose, then sales would increase but DSO can be increase as a result. The collection process for outstanding receivables will determine what bad debt expense is going to be.  If the collection methods aren’t effective and balances are being paid bad debt expense will increase.  The more effective a collection policy is the lower bad debt expense will be.  If collection policies are tough, customers may be upset with the firm and no longer continue patronizing the firm. Regardless of the emotions of the customer, the collection policy should be effective in recovering unpaid receivables. Competitors will respond to various changes in each component within reason to their current existing policies. For instance, if a competitor utilizes a very tight credit policy and sees opportunity to offer discounts that can potentially increase sales exponentially then they would definitely consider updating their credit policy. The opposite can be said if a firm is operating within a very loose credit policy and is experiencing very high bad debt expenses they would most certainly consider making the appropriate changes to components such as collection policy and credit standards.  The changes to each component of a credit policy is independent to each individual firm and is often due to seasonal changes for firms such as yours.