## Credit Policy in Receivables Management
When a firm sells on credit, it creates receivables (debtors). The credit policy is the set of decisions a firm makes about to whom, on what terms, and how aggressively to collect. The policy directly drives the size of the firm's investment in receivables.
### The Core Trade-off
Every credit decision balances two opposing forces:
| Lenient (Liberal) Policy | Stringent (Tight) Policy | |
|---|---|---|
| Credit terms | Liberal | Selective / restrictive |
| Sales volume | ↑ Increases | ↓ May fall (esp. if rivals offer better terms) |
| Receivables level | ↑ Higher | ↓ Lower |
| Bad-debt risk | ↑ Higher | ↓ Lower |
| Financing/collection cost | ↑ Higher | ↓ Lower |
The goal is not to minimise receivables, nor to maximise sales — it is to find the optimal trade-off where the extra profit from higher sales exceeds the extra cost of carrying receivables and bad debts.
### Factors That Shape Credit Policy
- Effect on sales volume — lenient terms tend to lift sales; strict terms can suppress them.
- Credit terms — the credit period, interest, and repayment schedule offered.
- Cash discounts — discounts for early payment speed up inflows and shrink outstanding receivables.
- Customer selection policies — criteria for who gets credit, balancing risk against sales growth.
- Customer payment habits — historical paying behaviour predicts delays/defaults.
- Collection policies — strict collection ensures timely payment; lenient collection invites bad debts.
- Operational efficiency — billing, record-keeping and adjustments; efficient processes cut errors and cost.
- Other costs — interest, collection expense and bad debts all add to the investment in receivables.
### What the Finance Manager Controls
The finance manager is the custodian of receivables policy. Their levers are:
| Responsibility | What it achieves |
|---|---|
| Supervising credit administration | Efficient approvals and collections |
| Deciding credit policies | Balancing risk vs. sales growth |
| Setting credit-selection criteria | Defining who qualifies for credit |
| Speeding up cash collections | Converting receivables to cash faster |
| Balancing costs & profits | Optimal trade-off between receivables investment and profitability |
### Parking Idle Cash: MMMFs
While managing the cash freed up from receivables, firms often hold temporary surplus in Money Market Mutual Funds (MMMFs) — a popular short-term investment for parking excess cash. (Note: deposits with sister concerns/associate companies are another, riskier, parking option.)