N5 Entrepreneurship 6.2 Cost of credit
As mentioned earlier, the decision to grant credit does have financial implications for a business. These costs must be determined before deciding on a credit policy. The potential costs include:
1. Record keeping
Allowing credit implies that you must keep a record of all the customers. Costs associated with this are: • system (computer) to handle this • labour costs • stationery and postage
2. Tied-up capital
Credit means that part of your working capital is tied up and is not available. Costs associated with this are: • lost interest • creation of additional business
3. Bad debts
The history of granting credit suggests that bad debts are inevitable. The size of bad debts, however, is controllable. The credit policy of the business will have a direct impact on this. The success of your screening efforts is an important part of it. The business must therefore prepare itself for the cost of bad debts. Legal fees associated with bad debts can also be substantial. These costs must be justifiable in terms of increased sales, if not, then the credit policy must be reviewed.
4. Lost interest
As mentioned earlier, when allowing customers to buy on credit, the outstanding money cannot earn interest for your business. Even worse, if you finance your business with credit, then it costs you more by paying interest.
5. Follow-up costs
Costs in following up customers that are not paying must also be considered. This includes costs such as: • telephone • opportunity costs (could have done something more profitable during that time) •
tracing costs (customer disappeared) • legal costs
Activity 4 1. Approach a business or an attorney and collect a credit application form. You may also find a variety of credit application forms on the Internet. Change this form to suit your business.
2. Design a credit policy for your business given all the different costs involved. Include this into your business plan.
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