Developing a Credit Policy

5 Factors to Consider When Deciding Whether to Extend Credit

Customer paying barista with credit card in cafe
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One of the basic decisions to make when starting a business is whether you are going to extend credit to suppliers and consumers, which can impact cash flow and profit .

Factors to consider when developing a credit policy include:

The Effect on Sales Revenue

Credit is convenient and will probably win customers but sales revenue will be delayed for either the discount period or the credit period, or perhaps longer if the customer is late in making the payment. The upside is that you may be able to raise your prices.

The Effect on Cost of Goods Sold

When you extend credit your business must have enough cash flow to compensate for the delayed payment, and you also lose any interest income you might have earned on that money.

Don't Discount the Probability of Bad Debts

With sales on credit there exists the possibility of bad debts—that is, debts you, as a business owner, will never collect. You have to decide if this is worth potentially more customers and higher sales.

Entice With a Cash Discount

Corporate cash discounts are often stated in a formula like 2/10 net 30, meaning a 2 percent discount if the bill is paid in 10 days. If the customer doesn't take the discount, then the bill is due within 30 days.

Working With Debt

If you decide to offer credit you likely will have to take on debt to finance your accounts receivables and maintain a good working capital base. Factoring in the cost of short-term borrowing should also be part of your decision to offer credit.