Influencing Credit Policy

In addition to the factors discussed in previous sections two other points should be made regarding credit policy.

Profit Potential

We have emphasized the costs of granting credit. However, if it is possible to sell on credit and also to impose a carrying charge on the receivables that are outstanding, then credit sales can actually be more profitable than cash sales. This is especially true for consumer durables (autos, appliances, and so on), but it is also true for certain types of industrial equipment. Thus, GM’s General Motors Acceptance Corporation (GMAC) unit, which finances automobiles, is highly profitable, as is Sears’s credit subsidiary. Some encyclopedia companies even lose money of cash sales but more than make up these losses from the carrying charges on their credit sales. Obviously, such companies would rather sell on credit than for cash!

The carrying charges on outstanding credit are generally about 18 percent on a nominal basis: 1.5 percent per month, so 1.5% × 12 = 18%. This is equivalent to an effective annual rate of (1.015)¹² – 1.0 = 19.6%. Having receivables outstanding that earn more than 18 percent is highly profitable unless there are too many bad debt losses.

Legal Considerations

It is illegal under the Robinson Patman Act, for a firm to charge prices that discriminate between customers unless these differential prices are cost-justified. The same holds true for credit it is illegal to offer more favorable credit terms to one customer or class of customers than to another, unless the differences are cost-justified.