Question

What are some of the factors that determine the length of the credit period? Why is the length of the buyer's operating

   What are some of the factors that determine the length of the credit period? Why is the length of the buyer's operating

Fundamentals of Corporate Finance

Fundamentals of Corporate Finance

Stephen A. Ross;… 11th Edition

Chapter 20, Problem 5

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Step 1

Creditworthiness of the buyer: The credit period may be determined based on the buyer's creditworthiness. If the buyer has a good credit history and is considered low risk, the seller may be willing to offer a longer credit period. Show more…

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What are some of the factors that determine the length of the credit period? Why is the length of the buyer's operating

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Key Concepts

Industry Standards

Common practices within an industry often dictate typical credit periods. Suppliers consider industry norms and competitive credit policies to remain attractive in the market while managing the inherent risks and financial constraints associated with offering extended credit.

Cost of Funds

Suppliers must consider the opportunity cost associated with extending credit. The longer the credit period, the longer funds remain tied up, which can affect liquidity and the overall cost of capital. This factor influences decisions on setting credit terms to balance competitive offerings and financial prudence.

Operating Cycle

The operating cycle refers to the time span between purchasing inventory and collecting cash from the sale of goods. A buyer with a longer operating cycle may need a longer credit period to effectively convert inventory into cash, making the operating cycle a critical factor in determining credit terms.

Credit Risk Assessment

This concept involves evaluating the buyer's creditworthiness, including their financial stability and history of meeting payment obligations. Suppliers use this assessment to decide how much risk they are willing to take and to set a credit period that reasonably mitigates the potential for default.

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