Effect of Credit Policy and Price Level Changes On Working Capital

Every business requires a smooth working capital management policy in order to remain in good health and compete with its competitors. The policies a business adopts affect its working capital management norms.

For example, the credit policy of the firm and price level changes affect the firm’s financial norms greatly. Here’s how.

Effect of Credit Policy On Working Capital

Firms often need to sell their goods in credit to remain attractive to the customers. However, a firm should not be slack in maintaining the credit policy in order to avoid unnecessary delays and missed opportunities. Credit sale creates debtors and managing debtors well enough should be the priority of businesses.

• The credit terms offered to a business’s customers usually depend on the norms of the industry the business operates. However, a company can use discretion within the limits permitted by the industry norms. Depending on the nature of the professional relationships, different credit terms may be offered to different customers.

• A liberal credit policy that does not rate the credit history of the customers may affect harmfully. A company must be quick in collecting the debtors as a long collection period is detrimental to the company. As money is tied up in long-term debtors, the companies must not create debtors that take a too long time to pay the money. A company must also be vigilant in the collection so that no anomaly takes place in collecting the amounts. The credit policy must be strict enough not to offer too much leeway to debtors.

The Credit Policy of the Suppliers

The suppliers’ credit policies also affect the working capital management of a company.

• If the supplier offers credit liberally, the companies will have to rely less on its own working capital.

• Liberal credit also helps the companies avoid taking loans from the bank. However, when the suppliers are strict in the collection, companies must resort to fund collection from the banks.

• Having a reasonable rate of interest on the fund collected from the banks can help the company avoid having troubles in operating efficiency.

Therefore, suppliers’ credit policy also impacts the companies enormously.

Effect of Price Level Changes On Working Capital

Price level changes also affect the working capital management policies of a company.

• Usually, a company that faces a sudden increase in current assets needs to maintain higher working capital. So, increasing levels of prices make the job of the finance manager difficult. They need to adapt to new working capital requirements when price-level changes occur in the industry.

• The companies that can increase the price of its product in sync with the growing price of resources, do not need to care much about the price-level increment. They can easily increase the price of the goods to derive the profit without having to rely much on the working capital.

• Moreover, companies feel the effect of price level changes differently as price change impacts different products in different manners. However, if the company cannot adapt to newer conditions readily, price level changes can be detrimental to the company.

Conclusion

Both the credit policy of a company and the price level changes impact the working capital of a company. A company with a better management policy would adapt readily to newer conditions in terms of credit policy and price-level changes as soon as possible. Without having the flexibility to change their stance, companies may face great troubles in managing working capital when credit policy and price-level changes occur.

Therefore, it is good for companies they stay prepared for better credit policy and price level change mechanisms so that no discrepancies occur if such situations of adaptations arise.