Almost every business that sells to other businesses sells on credit. The customer takes the goods today and pays in 30 or 60 days, and for that period the seller is lending money to the customer for nothing. The sale is not complete until the cash arrives, and some of it never will.
Receivables are therefore both the engine of sales and the main source of cash flow trouble. A company needs a deliberate policy: to whom to give credit, on what terms, how to watch it and how to collect it.
This topic covers why credit is given and what it costs, how to evaluate a change in credit policy with a calculation, the four stages of a credit policy (assessing creditworthiness, setting the terms, monitoring, collecting) and the techniques at each stage, including the age analysis of receivables. The next topic covers debt factoring and invoice discounting.
Credit management is tested in the working capital scenarios: in November Diet, 2025, Question 2(d) (5 marks) asked for the difficulties in cutting receivables to 40 days, and in May Diet, 2026, Question 1(b) (15 marks) the memorandum covered receivables, bad debts and the proposal to double the credit period. Read inventory management: economic order quantity, reorder levels, just-in-time and ABC analysis first.
In 30 seconds
Companies give credit to increase sales, gain a competitive advantage, build loyalty and widen their market. The costs are finance costs (average receivables × cost of capital, where receivables = days ÷ 365 × credit sales), administration costs, bad debts and opportunity costs. A change in policy is worth making if the increase in contribution exceeds the increase in costs. The objective is to balance profitability (more sales on credit) against liquidity (prompt collection).
A credit policy has four stages: assess creditworthiness (trade and bank references, published information, credit agencies), set credit terms (period, limit, penalties), monitor (age analysis, ratios, statistics) and collect (prompt invoicing, statements, reminders, stop lists, agencies, legal action).
Why companies give credit, and what it costs
Goods are normally sold on agreed credit terms, a number of days from the invoice date. It is assumed that good customers will take the whole period; some may default. Credit may be given because it can increase sales volume and so contribution and profit, give a competitive advantage, build customer loyalty and relationships, and support growth by reaching new customers.
- Finance costs: the cost of financing the receivables. The longer the credit period, the greater the investment. Cost = average receivables × cost of capital; average receivables = receivable days ÷ 365 × credit sales. It is assumed that the receivables are financed by overdraft, so the cost of capital is the interest rate.
- Administration costs: negotiating terms and monitoring customers’ positions, counting only the extra cost caused by the credit.
- Bad debt costs: sales revenue that customers do not pay and that is written off.
- Opportunity costs: the opportunities lost because capital is tied up in receivables.
Evaluating a change in credit policy
A policy is viable if the extra contribution is greater than the extra costs. Example: sales are ₦90m with a contribution of 30% and bad debts of 1.5% of sales, with customers paying after 30 days. The cost of capital is 12% and a 365-day year is used. A proposal would extend the credit period to 60 days, raise sales by 15% and raise bad debts to 2.2% of sales, with extra administration of ₦0.2m.
| ₦m | |
|---|---|
| New sales ₦90m × 1.15 | 103.50 |
| Current receivables 30 ÷ 365 × 90 | 7.40 |
| New receivables 60 ÷ 365 × 103.5 | 17.01 |
| Increase in receivables | 9.62 |
| Benefit: increase in contribution 30% × ₦13.5m | 4.05 |
| Cost of financing 12% × ₦9.62m | (1.15) |
| Increase in bad debts (2.277 − 1.35) | (0.93) |
| Extra administration | (0.20) |
| Net gain | 1.77 |
The policy is viable on these figures, with a net gain of ₦1.77m. The result depends on the forecast of the sales increase: if sales rose by only 5%, the contribution would be ₦1.35m and the policy would lose money, so the sensitivity of the decision to the estimates should be reported.
Managing receivables: the credit policy
The objective is a balance between profitability (more sales through more credit) and liquidity (collecting promptly to cut the cost of credit). The credit policy is influenced by the demand for the products, competitors’ credit policies, the cost of credit control, the cost of finance and the risk of bad debts. It has four stages.
1. Assessing creditworthiness
New customers should be assessed before credit is given, and existing customers periodically. Information comes from trade references (suppliers already giving credit, although the customer will name only those it has a good relationship with), bank references (with the customer’s permission and within the law), published information (annual reports, press and social media, court judgements for non-payment) and credit reference agencies, for a fee.
2. Credit terms
The terms for each customer include the credit period (for example 30 or 60 days), the credit limit (the maximum credit, small for a new customer and increased as the relationship strengthens) and the penalties on overdue payments.
3. Monitoring
The company reviews receivables regularly and acts promptly, using an age analysis, ratios compared with earlier periods or targets, and statistics on the causes of default and the incidence of bad debts among different classes of customer and trade. An age analysis (aged receivables list) shows how much is owed and for how long.
For example, receivables of ₦18.0m are ₦12.6m up to 30 days (70%), ₦3.6m for 31 to 60 days, ₦1.2m for 61 to 90 days and ₦0.6m over 90 days. With a 30-day credit period, ₦5.4m, or 30%, is overdue, and the older items should be chased first because the longer a debt stays, the higher the chance of default.
4. Collecting
Efficient collection needs prompt invoicing, regular statements showing totals owed and amounts due, and checks that customers do not exceed the agreed terms. For overdue debts the steps are reminder letters or emails, telephone calls, withholding supplies (a stop list), debt collection agencies and legal action, in that order of escalation.
The ideas in more depth
Why credit decisions turn on contribution, not profit
Extra sales earn only their contribution, because fixed costs do not change. So the gain is the contribution on the extra sales, while every cost of the longer credit period is charged against it. Bad debts matter twice: the sale is lost and the cost of the goods is lost too, which is why a bad debt rate of 2% needs far more than 2% of extra sales to repay.
Why the extra receivables include the existing sales
When the credit period is extended, all customers pay later, not just the new ones, so the increase in receivables arises on the whole sales figure. The calculation must therefore use new sales and the new period, and subtract the old balance.
Sources and references
- Receivables and bad debts are accounted for under International Financial Reporting Standard (IFRS) 9 Financial Instruments, which requires an allowance for expected credit losses on trade receivables. The credit management techniques here are management methods.
These points are stated as at 5 November 2026.
Worked examples
Example 1: receivables financing. Credit sales are ₦103.5m; customers take 60 days; the cost of capital is 12%. Required: receivables and the cost of financing them.
- Receivables.
60 ÷ 365 × ₦103.5m = ₦17.01m. - Cost.
12% × ₦17.01m = ₦2.04m.
Example 2: the extra contribution. Sales rise from ₦90m to ₦103.5m at a contribution of 30%. Required: the increase.
- Increase.
30% × ₦13.5m = ₦4.05m.
Example 3: overdue balances. Receivables ₦18.0m, of which ₦12.6m are within 30 days; the credit period is 30 days. Required: the overdue share.
- Overdue.
₦18.0m − ₦12.6m = ₦5.4m, which is 30%.
How to answer in the exam
- Evaluate a policy with a table of extra contribution against extra finance cost, bad debts and administration.
- Calculate receivables from days and sales on the whole of the new sales figure.
- Give the practical difficulties of a tighter policy: lost customers, system costs, relationships.
- Describe the four stages with an example at each.
Common mistakes in the exam
- Costing only the increase in sales and ignoring the later payment by existing customers.
- Using sales instead of contribution for the benefit.
- Leaving out the increase in bad debts.
- Mixing 360 and 365 days in one answer.
- Listing collection methods without escalation.
- Ignoring the effect on customer relationships.
Quick revision
- Credit costs: finance, administration, bad debts, opportunity.
- Extra receivables = new days ÷ 365 × new sales − old receivables.
- Four stages: assess, set terms, monitor, collect.
- Viable if extra contribution exceeds extra costs.
Practice questions
These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.
Recall check: multiple choice
Question 1. A reason for giving credit is to:
- Reduce sales
- Reduce risk to zero
- Increase sales and gain a competitive advantage
- Increase bad debts
Show the answer
C. Also to build loyalty and widen the market.
Question 2. The finance cost of receivables is:
- Sales × cost of capital
- Average receivables × cost of capital
- Contribution × days
- Bad debts ÷ sales
Show the answer
B. Assuming the receivables are financed by overdraft.
Question 3. Average receivables are:
- Receivable days ÷ 365 × credit sales
- Sales ÷ 365
- Cost of sales ÷ days
- Purchases ÷ 12
Show the answer
A. It converts the days of credit into naira.
Question 4. Credit terms include:
- The credit period only
- The share price
- The dividend
- The credit period, the credit limit and penalties on late payment
Show the answer
D. Each customer’s terms are set within company guidelines.
Question 5. An age analysis shows:
- The profit of each customer
- How much is owed and for how long
- The share price
- Inventory by age
Show the answer
B. It helps to decide which customers to chase.
Question 6. A source of information on a new customer is:
- Bank and trade references, published information and credit agencies
- The customer’s competitor only
- The tax office only
- Nothing is needed
Show the answer
A. Trade references are biased towards friendly suppliers.
Question 7. The longer a debt is overdue:
- The lower the chance of default
- The cheaper it is
- The higher the chance of default
- The more profitable it is
Show the answer
C. So follow up early.
Question 8. Bad debt cost is:
- Interest on the overdraft
- The cost of invoices
- The cost of the age analysis
- Sales revenue from customers that is written off
Show the answer
D. It is a loss of both profit and cash.
Question 9. A change in credit policy is viable if:
- Sales rise
- Receivables fall
- The increase in contribution exceeds the increase in costs
- Bad debts are zero
Show the answer
C. Compare the extra contribution with the extra costs.
Question 10. Steps for overdue debts include:
- Reminders, calls, a stop list, agencies and legal action
- Ignoring them
- Writing them off at once
- Raising the price
Show the answer
A. Escalating as the debt ages.
Section B style: written questions
Question 11 (10 marks). (a) State FOUR reasons for giving credit. (4 marks) (b) State the FOUR costs of giving credit. (4 marks) (c) State the FOUR stages of a credit policy. (2 marks)
Question 12 (15 marks). A company has sales of ₦120m, a contribution of 25% and bad debts of 1.0%, with customers paying after 45 days. It considers a 30-day period, which would reduce sales by 5%, cut bad debts to 0.6% of sales and save ₦0.3m of administration. The cost of capital is 14% and a 365-day year is used. (a) Calculate the old and new receivables. (4 marks) (b) Calculate the saving in finance cost.
(3 marks) (c) Calculate the loss of contribution and the saving in bad debts. (4 marks) (d) Calculate the net benefit and comment. (4 marks)
A further written question
Question 13 (20 marks). A company’s receivables are ₦25.0m: ₦15.0m up to 30 days, ₦6.0m for 31 to 60 days, ₦2.5m for 61 to 90 days and ₦1.5m over 90 days. The credit period is 30 days and the company borrows at 15%.
(a) Calculate the percentage of receivables that is overdue. (4 marks) (b) Calculate the annual cost of financing the overdue balances. (4 marks) (c) Describe the steps to collect the older debts. (6 marks) (d) State THREE difficulties of tightening the credit policy. (6 marks)
Model answers
Show the model answer to Question 11
(a) Increase sales volume and profit; gain a competitive advantage; build customer loyalty; support growth and new customers (1 each).
(b) Finance costs; administration costs; bad debts; opportunity costs (1 each).
(c) Assess creditworthiness; set credit terms; monitor; collect (0.5 each).
Show the model answer to Question 12
(a)
- Old receivables 45 ÷ 365 × ₦120m = ₦14.80m (2)
- new sales ₦114m, new receivables 30 ÷ 365 × ₦114m = ₦9.37m (2).
(b) Fall ₦5.43m × 14% = ₦0.76m (3).
(c)
- Contribution lost 25% × ₦6m = ₦1.50m (2).
- Bad debts fall from ₦1.20m to ₦0.68m, a saving of ₦0.52m (2).
(d)
- Net benefit 0.76 + 0.52 + 0.30 − 1.50 = ₦0.08m (2).
- It is marginal and depends on the forecast of lost sales, so the company should test it before changing the policy (2).
Show the model answer to Question 13
(a)
- Overdue ₦6.0m + ₦2.5m + ₦1.5m = ₦10.0m
- ₦10.0m ÷ ₦25.0m = 40% (4).
(b) ₦10.0m × 15% = ₦1.5m a year (4).
(c) Send reminders by letter or email (1.5); telephone the customer (1.5); put the customer on a stop list (1); use a debt collection agency (1); take legal action for the oldest debts (1).
(d) (2 marks each, any three) Customers may take their business elsewhere and sales fall; credit control needs more staff and systems; relationships with good customers may suffer; some customers genuinely need longer credit.
Pathfinder on Managing receivables: credit terms and credit control
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
Part (d) asks for the main difficulties in putting the directors’ policies into practice, which include tightening credit to 40 days: customer relations and lost sales, credit control systems and administration, supplier negotiation and the cost of change (5 marks).
Revise first: Managing receivables: the credit policy
The memorandum in part (b) (15 marks) covers receivables where the company is considering doubling the credit period: bad debts, the cost of longer credit, factoring and discounts for cash settlement.
Revise first: Why companies give credit, and what it costs
Source: ICAN Pathfinder, Financial Management. Diets covered: Every diet in the Pathfinder, November Diet, 2025 and May Diet, 2026, was reviewed here. The diets listed above test this topic directly..
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