The provision of credit facilities

The majority of businesses will sell to their customers on credit and state a defined time within which they must pay (a credit period). 

The main benefits and costs of doing so are as follows:

1.Benefits/costs

Benefits

• The business may be able to enter new markets.
• There is a possibility of increased sales.
• Customer loyalty may be encouraged.

Costs

• Can be costly in terms of lost interest since the business is accepting payment later.
• Cash flow of the business may deteriorate.
• There is a potential risk of irrecoverable debts.

Aged receivables analysis

Where credit facilities are offered, it is normal for a business to maintain an aged receivables analysis.

• Analysis is usually a list, ordered by name, showing how much each customer owes and how old their debts are.
• The credit control function of a business uses the analysis to keep track of outstanding debts and follow up any that are overdue.
• Timely collection of debts improves cash flow and reduces the risk of them becoming irrecoverable.

Credit limits

It is also normal for a business to set a credit limit for each customer. This is the maximum amount of credit that the business is willing to provide.

The use of credit limits may:

• reduce risk to business of irrecoverable debts by limiting the amount sold on credit
• help build up the trust of a new customer
• be part of the credit control strategy of a business.