Answer to Question #305296 in Finance for Jen

Question

You have recently been hired to be the COO (Chief Operating Office) of a start-up company and your primary goal is to help grow the business. The company reported sales of $2 million last fiscal year. The company currently does not offer trade credits because the majority of its customers use credit cards. In a bid to expand the business, you are asked to determine whether extending trade credits is a good idea.  

(a) List and explain 4 factors that will be important for you to make this decision? Meaning, as the COO, what factors do you need to take into consideration if you are planning to start offering trade credit.

(b) Given what you know, are you for or against the company offering trade credits.

Answer 1

The factors which are to be considered while extending trade credit facilities to the customers can be summed up as:

1) Must discount the bad debts happening: The company should consider the happening of bad debts because when trade credits are offered, it will invite the bad debts along.

2) Effect on cash flow: The company have to compensate for the delay in Sales payment to keep running the production and operations.

3) Should consider the Cash discount provision: When trade credits are provided to the customers, then it will always required to attempt the cash discount for the quicker payments from customers.

4) Have to borrow: It is important to borrow to fill-up the gap of the short fall in the cash flow due to trade credits provided to customers.

5) Cost of borrowing: The cost of borrowing should be considered while considering the expenses at the time of fixing prices and setting costs. Advantages of trade credits provision:

a) Higher sales and revenues due to cash payment being in future.

b) Creditability of the company extends to customers who are facing cash crunch with them. Disadvantages of trade credits provision: i) Lower income due to bad debts, cost of debt and cash discount. ii) Maintenance of the debtors accounts on daily bases, so additional work. iii) More paper work towards keeping records and updating customer data.