Investments in Receivables or the Average Collection Period
The investment in accounts receivable involves a capital cost as funds have to he arranged by the finn to finance them till customers make payments. Moreover, the higher the average accounts receivable, the higher is the capital or carrying cost, A change in the credit standards-relaxation or tightening to a change in the level of accounts receivable either through a change in (a) sales, or (b) collections. A relaxation in credit standards, as already implies an increase in sales which, in rum, would lead 10 higher average accounts receivable. Further, relaxed standards would mean that credit is extended liberally so that it is available to even less customers who will take a longer period to par over dues .. The extension of trade credit to slow-paying. customers would result in a higher level of accounts receivable. In contrast, a tightening of credit standards would signify (i) a decrease in sales and lower average accounts receivable, and (ii) an extension of credit limit e d to more creditworthy customers who can promptly pay their bills and, thus, a lower average level of accounts receivable. Thus, a change in sales and change in- collection period together with a relaxation in standards would produce a higher carrying costs, while changes in sales and collection period result in lower costs when credit’ standards are tightened, These basic reactions also occur when changes in credit terms or collection procedures are made. we have discussed these in the subsequent sections of this chapter.