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Impact of Credit Policy on Working Capital Management
Role of Credit Policy
It is known to all that having a good amount of working capital is necessary for the smooth functioning of businesses. For example, the credit policy of a company plays a pivotal factor in managing the working capital of a company.
Companies often need to sell their products on credit to keep and gain market share. It is not possible for all products to get sold instantly which can generate immediate revenues. Therefore, the retailers may ask for a credit to sell the products and then pay for them to the manufacturers.
A business company therefore must adhere to a good credit policy to offer the minimum days of credit to the sellers. But at the same time, the credit terms must also follow the industry norms. Therefore, a credit policy should be created in such a manner that the businesses do not find it rough to pay the bills but also, at the same time, it is not too long for the company.
Impact of Credit Policy on Working Capital Management
Various policies of businesses play key roles in the working capital management of companies. Credit policy is one of them. Let us see its impacts on working capital management as mentioned below −
Bad Debt
Sale on credit creates debtors. Companies that follow a liberal credit policy without following the credit rating of companies risk creating bad debts that would eat the profits of the company.
Selling products in bad debt for the long term can restrain the business's existence for a foreseeable future. Therefore, businesses must resort to practices that are healthy for their survival.
Bad debt is a common feature of manufacturing companies that do not follow a strict credit policy. It is the nature of retailers and other business units in the sales process to ask for credit as much as possible. Therefore, the manufacturer must make a decision depending on the needs of the sellers and their credit history. Being too liberal is not going to fetch any fruit in the long run.
Credit from the Suppliers
While the credit policy for the sellers is important for the manufacturers, the credit policy of its suppliers of raw materials and resources also plays a key role in its business operations. If the suppliers offer a long credit period, the companies would have to rely less on working capital.
The inventories are funded by suppliers’ credit so it reduces the cash conversion cycle of a company. It is notable to mention here that getting enough time to pay suppliers credit can help the business offer credit to the sellers ultimately. So, a liberal credit policy of the suppliers can help a company to offer extended credit to its customers.
Dependence On Bank Finance
A liberal credit policy also helps companies use their own resources more reliably. This in turn helps them to rely less on bank finances. Without a liberal credit policy for suppliers, the companies would need to meet their finances that are obtained from banks.
Bank finances that have low or reasonable rates of interest can help the businesses run smoothly. If the interest is low, the manufacturing companies can offer the products to sellers at a low cost which can lower the price of products at the end of the cycle.
Conclusion
The impacts of credit policy on business companies are palpable in nature. It can be easily understood that with a great credit policy, the companies may get an upper hand in staying and growing in business operations.
When the credit policy is wrong, the businesses would find it tough to stay intact on the path of business operations. Therefore, all business organizations must understand the impact of the credit policy on their businesses and form them judiciously.
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