Credit Period: What is it & its Importance

Credit arrangements are established by businesses with their consumers or suppliers to ensure seamless transactions. Commercial activities are sped up with credit purchases, and sales are augmented as dealers/distributors can purchase the products before they have the capital to pay for them.

However, for sales to be formed on credit, the credit terms must be agreed upon before a sale. If the discount is not accepted, the dealers/distributors or buyer must clear the full invoice amount within thirty credit days, and this 30-day term is known as the credit period. Continue reading to understand its meaning and its importance. 

Credit Period Definition

The credit period is the duration of time given to the dealers/distributors by the seller to pay for the items they have bought from the seller. 

There are three essential components of the credit period, and they are as follows:

• Credit Analysis: Credit analysis or assessment aims to comprehend a dealer’s trustworthiness. For credit analysis, different financial methodologies can be utilized. The likelihood of the dealer/distributor repaying their debts can be determined through trend assessment. 
• Collection Policy: The collection policy of an enterprise refers to the practices chosen by the business to recover accounts receivable. The policy also outlines the interest, late penalties, and additional fees if the payments are late. 
• Credit Terms or Sales Term: The credit length is specified in the credit terms. Some vendors prefer thirty credit days, while others want longer or shorter credit periods according to their sales terms. 

Why is the Credit Period Significant?

The credit period is essential because it helps organizations determine the creditworthiness of the distributors or buyers. The company can enhance its sales by expanding the buyer universe. As for buyers, paying the suppliers or sellers within the stipulated period ensures they remain in their good books. 

The credit period is the specific period given to the dealers to pay an invoice. It shows how much working capital an enterprise is willing to invest in accounts receivable to produce sales.

When it comes to the fulfillment of credit, there’s one platform that can help manage all your transactions: Yubi Flow. By registering on this platform, corporate can unlock the financial capabilities of your organization and carry out transactions seamlessly. Corporate can provide discounts to your buyers or meet with lenders to expand your business. 

Credit Period Formula

The formula to compute the credit period is Average Accounts Receivable / (Net Credit Sales / Credit Days) or Credit Days / Receivables Turnover Ratio. 

To better understand the credit period formula, it is critical to know how to find out each component of the formula. 

• Average Accounts Receivable: The average accounts receivable is determined by adding the ending and the beginning of the company’s account receivable. The net result is divided by two. 
• Net Credit Sales: Net credit sales refer to the sum of the organization’s earnings from net credit sales during the consideration period. 
• Credit Days: Credit days refer to the total number of days in a specific period, such as 365 days in a year. 
• Receivable Turnover Ratio: The receivable turnover ratio is determined by dividing the net credit sales of a company by its average accounts receivable. 

Example of Credit Period

There can be different credit periods, and here are some examples. 

• A credit period of ten days is applicable if the consumer prefers a 2% early payment discount if the enterprise providers terms of 2/10 net 30. 
• If the dealer/distributor pays the full invoice amount, a 30-day credit period is applicable. 
• Terms of 1/5 net 45 means that if a distributor decides to receive a 1% early payment discount, the credit period is going to be for five days. The terms of forty-five days mean that the payment term will be forty-five days. 

For further understanding, assume company X has sales of Rs. 300,000 and Rs. 24,700 unpaid invoices for the entire year. If the values are put in the formula (Rs. 300,000/Rs. 24,700), there will be a receivables turnover of 12.1457. The credit period will be approximately 30 days (365/12.1457). 

Advantages of Credit Period

• Minimal Cash Outlay: Minimal cash outlay is a type of loan with no interest, but you need to make sales regularly and clear the dues left with the supplier. Corporate can earn more revenue, and the company can quickly achieve its objectives. 
• Discount for Fast Payments: An enterprise must promptly clear the supplier’s payments. If the payments are cleared quickly, and within the stipulated period, the company will be in the good books of the suppliers and even receive huge discounts. 
• Improved Creditworthiness: The creditworthiness of an enterprise can be augmented by ensuring the suppliers’ dues are settled within the stipulated period. 
• Uninterrupted Supply of Products: It is a known fact that suppliers prioritize companies that quickly clear payments. In return, suppliers ensure that such organizations are provided with an uninterrupted supply of goods so that their business is unaffected and functions smoothly. 

Besides these, there are some other benefits that can be enjoyed:

• Companies can increase their sales and enhance their dealer/distributor base by extending the credit period for the buyers. Therefore, organizations can seamlessly achieve their sales target by offering flexibility to the buyers. On the other hand, buyers can purchase the required items even if they have been unable to raise funds for them. They can make the payment within the agreed credit period. 
• The buyers’ creditworthiness is determined with the help of the credit period. It allows businesses to filter their dealers/distributors for the future survival of the business. 

While the advantages of the credit period are tempting, one must be wary of its shortcomings. For instance, if the corporate allows too much time for buyers to clear the invoice amount, it could impact the working capital cycle of your company. Therefore, businesses must carefully decide on the credit period and ensure it doesn’t impact your working capital needs. 

Conclusion

The credit period of a business serves critical purposes, such as enabling the dealer/distributor to make payments later and enhancing the company’s overall sales. It also helps in the maintenance of the company’s working capital cycle. Corporate can register on the Yubi Flow platform to connect with businesses and dealers/distributors. It will help manage your credit period and receive or make timely payments. 

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FAQs

1) Is there a difference between credit and discount periods?

There’s a slight difference between credit and discount periods. The credit period is the length of time for which the trade credit is granted to the dealer or distributor. Until the credit period is over, no interest will be charged on the outstanding amount. On the other hand, the discount period is an incentive to encourage dealers/distributors to pay early. Under this, the business offers special discounts if the dealer or distributor makes the payment within a few days of the purchase. 

2) What is the meaning of 2/10 N 30? 

2/10 net 30 means that when the dealer or buyer pays the invoice in full within ten days, they are liable to get a discount of 2%. If not, the buyer has thirty days to pay the invoice amount. 

3) What is the meaning of credit policy? 

The payment and credit terms provided by the company to the dealers/distributors are referred to as the credit policy. The terms clearly state a specific course of action in case of late payments. 

4) Are there different types of credit available?

Installment, revolving and available credit are the three types available to you.