Credit Terms

Are those terms on the basis of which credit sales are made to customers. These are also called terms of repayment of receivable. These are 3 main constituents of credit terms. They are:

(a)Credit Period:-

It is the period for which goods are sold on credit to customers i.e. the period after which payment is to be made by customers. For example, if customers are required to pay before the end of 30 days from date of sale, it will be written as ‘Net 30’. Credit period normally depends on the standard of the industry. By raising credit period, not only the sales and profits of firm rise but its costs also rise. Similarly, by reducing the credit period sales & profits decline on one hand & cost of fund & bad debt go down on the other. Therefore, on optimum credit policy should be determined by establishing balance in costs and profits of different credit periods.

(b)Cash Discount:-

A Firm gives cash discount to encourage its customers to pay quickly. In terms of cash discount, we include rate of cash discount and period for cash discount. The customers who do not to avail of cash discount, they have to make payment before expiry of general credit period. Due to availability of cash discount average collection period is reduced. As a result, the amount locked up in receivables declines. Cash discount is a loss to the firm. Therefore, decision to allow cash discount or to change its rate should be undertaken on the basis analysis of its costs and benefits.

(c )Cash Discount Period:-

is the period during which cash discount is available. The period of cash discount affects average collection period.

Thus, the terms of credit collectively include credit period, cash discount and period of cash discount. For example, if terms of credit are expressed as ‘2/10, Net 30’ , it means that if the payment is made with in 10 days, 2% cash discount will be paid. If this cash discount is not availed of, the payment has to be made with in 30 days of date of sale.

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