Extending Credit to More Customers

Extending Credit to More Customers

Buying or selling in credit means being given goods or services, but payment will be made in the future. This depends on the credit period provided by the seller. Even though this type of selling is risky to the employer, it benefits both the seller and the buyer because the seller gets income, and the buyer acquires what he or she needs without spending any money. Extending credit to more customers has many effects on the company. This paper will discuss the impact of extending credit to more customers on the company’s financial reports.

Extending credit to more customers will increase the sales of a company (Li, 2016). This is because extending credit to customers means that they purchase goods and services and pay for them later. This will give them more purchasing power, which makes them buy more products and services because there is no restriction of money at the time they are making purchases. The fact that the customers have a long time to pay for the goods and services gives them more freedom to purchase hence increasing the sales of the company. Extending credit to more customers will harm the company’s account receivable. This is because some customers may fail to pay the debts within the time agreed. These unpaid debts may have to be written as bad debts as the customers who bought on credit may never be able due to pay because they may go bankrupt.

Having more customers who buy on credit on a company will reduce the cash flow of the company. Selling on credit means that the goods and services purchased will be paid for in the future; thus, there is less cash flow at the moment but more in the future. Selling on credit also may involve a lot of risks since some of the customers might not be in a position to pay the debt at the right time. The delay will reduce the cash flow of the company. The reduction of the cash flow will affect the company as there will be less cash to pay for different production activities. This will negatively affect the production of the company.

Selling on credit to more customers also will lead to bad debts. This is because even with proper monitoring of customer’s credit rating, there must be some who will fail to repay the debts. This will necessitate the hiring of collection agencies to collect the debts. This will give an extra expense to the company as they have to be paid. If the collection fails, then the company will have to write it off as a bad debt. This will lower the profit of the company, make it less competitive, and might make some of the customers leave for other companies.

Extending credit to more customers will affect the company’s balance in different ways. The amount that is owed to the company by its customers is account receivable. Because this is the company’s money for selling goods or offering customers services, it is classified as an asset. This will impact positively on the balance sheet because it shows that the company has more assets. Account receivable, however, might not be paid by the customers until they are written off as bad debts. This will force the company to put account receivable into the liability section. This is because it will show that the company has made sales but has not been paid. This will impact negatively on the balance sheet since it will show that the company’s net worth is the same without the account receivable.

Selling on credit to more customers have a positive effect on a company’s Income statement. Income statement breaks down the sales made by a company, the expenses incurred, and the net profit over a given period. Since the amount owed to the company by its employees is regarded as the company’s wealth, it means that the company made more sales. Giving credit to the customers will boost the sales of the company, which means that the company will have more profit. This is because it increases the amount from sales minus the fixed cost will increase the company’s profit.

The company’s statement of the cash flow will be lowered by selling on credit to more customers. The statement of cash flow shows all the cash the company has received from all of its activities. The statement also shows all the cash out flows of the company. For instance, the expenses on wages of the workers or rent. Extending credit to more customers would mean that there is less cash flow into the company since the goods and services sold to the customers will be paid in the future. The less income due to debts will impact negatively on the company’s statement. This case, however, will be the opposite When the customers pay their debts to the company. The statement of cash flows will show that there is more profitable because of the increase in income due to the payment of debts.

Liquidity ratio is the amount of liquidity or cash a company has to deal with its debts. The company’s liquidity ratio is significantly reduced by selling to more customers on credit. This is because there is less cash flow. After all, the customers pay for goods after a while.  Crediting more customers will improve the efficiency ratio of the company. This is because the efficiency ratio is measured between 3 to 5 years, which means the customers would have paid their debts (Raymond, 2015). The profitability ratio also is improved by crediting more customers. Crediting more customers will increase the sales of a company hence increasing the profit of the company. The leverage ratio shows how well the company uses long term debts to improve the business. This will be enhanced by selling to more customers on credit because it will give high profits. Other activities, such as training staff in the company, will be limited. This is because of the lack of enough money in the company due to the debts of the customers.

References

Li, J. Y., & Tang, D. Y. (2016). The leverage externalities of credit default swaps. Journal of Financial Economics, 120(3), 491-513.

Raymond, A. E., & Adigwe, P. K. (2015). The Credit Management on Liquidity and Profitability Positions of a Manufacturing Company in Nigeria. European Journal of Research and Reflection in Management Sciences Vol, 3(3).