Written by True Tamplin, BSc, CEPF®
Updated on July 10, 2021
When goods are sold and cash is not received immediately but postponed to a future date then this is termed as credit sales.
A major portion of wholesale and retail sales in the United States is on credit. As a result, some firms have a substantial portion of their current assets in the form of accounts receivable. For example, at the end of 2019, Sears, Roebuck and Company’s accounts receivable totaled over $15 billion, and IBM’s totaled over $6 billion. The ability of these firms, as well as others, to collect these amounts affects their cash liquidity and financing needs. In a cash-tight economy this is an essential aspect of overall cash management.
The ability of a firm to collect its credit sales depends on (1) the initial decision about to whom to extend credit, (2) the particular credit policies of the firm such as the use of sales discounts or interest charges on unpaid accounts, and (3) general economic conditions. A firm obviously has more control over the first two factors than over the third.
In large firms, the credit department is charged with the responsibility of granting credit as well as subsequently collecting unpaid accounts. In smaller firms, this responsibility often lies with the owner-manager. In deciding whether originally to grant credit or to extend credit limits, the firm must Obtain information about customers, such as their financial condition and past credit history. This information can be obtained through credit applications and the services of credit rating bureaus.
If January 1, 2019, Mr. C sold goods worth $1,000 and cash is not received but postponed to Feb.1, 2019. This will be termed as credit sales.