Credit Instruments Most credit is offered on open account.

This means that the only

formal credit instrument is the invoice, which is sent with the shipment of goods,
and which the customer signs as evidence that the goods have been received.
Afterwards, the firm and its customers record the exchange on their accounting
books. At times, the firm may require that the customer sign a promissory note or
IOU. This is used when the order is large and when the firm anticipates a problem in
collections. Promissory notes can eliminate controversies later about the existence
of a credit agreement. One problem with promissory notes is that they are signed
after delivery of the goods. One way to obtain a credit commitment from a customer
before the goods are delivered is through the use of a commercial draft. The selling
firm typically writes a commercial draft calling for the customer to pay a specific
amount by a specified date. The draft is then sent to the customers bank with the
shipping invoices. The bank has the buyer sign the draft before turning over the
invoices. The goods can then be shipped to the buyer. If immediate payment is
required, it is called a sight draft. Here, funds must be turned over to the bank
before the goods are shipped. Frequently, even a signed draft is not enough for the
seller. In this case she might demand that the banker pay for the goods and collect
the money from the customer. When the banker agrees to do so in writing, the
document is called a bankers acceptance. That is, the banker Ross_ch28.indd 769
6/11/09 11:36:09 AM Finanza aziendale Stephen Ross, David Hillier, Randolph
Westerfield, Jeffrey Jaffe, Bradford Jordan 2012 McGraw-Hill ___ 770 Chapter 28
Credit Management ___ accepts responsibility for payment. Because banks generally
are well-known and well-respected institutions, the bankers acceptance becomes a
liquid instrument. In other words, the seller can then sell (discount) the bankers
acceptance in the secondary market. A firm can also use a conditional sales
contract as a credit instrument. This is an arrangement where the firm retains legal
ownership of the goods until the customer has completed payment. Conditional
sales contracts are usually paid off in instalments and have interest costs built into
them. 28.2 The Decision to Grant Credit: Risk and Information Locust Industries has
been in existence for two years. It is one of several successful firms that develop
computer programs. The present financial managers have set out two alternative
credit strategies: the firm can offer credit, or the firm can refuse credit. Suppose
Locust has determined that if it offers no credit to its customers, it can sell its
existing computer software for $50 per program. It estimates that the costs to
produce a typical computer program are $20 per program. The alternative is to offer
credit. In this case customers of Locust will pay one period later. With some
probability, Locust has determined that if it offers credit, it can charge higher prices
and expect higher sales. Strategy 1: Refuse Credit If Locust refuses to grant credit,
cash flows will not be delayed, and period 0 net cash flows, NCF, will be P0Q0
C0Q0 = NCF The subscripts denote the time when the cash flows are incurred,
where P0 is the price per unit received at time 0, C0 is the cost per unit paid at time
0, and Q0 is the quantity sold at time 0. The net cash flows at period 1 are zero, and
the net present value to Locust of refusing credit will simply be the period 0 net
cash flow: NPV = NCF For example, if credit is not granted and Q0 = 100, the NPV
can be calculated as ($50 100) ($20 100) = $3,000 Strategy 2: Offer Credit
Alternatively, let us assume that Locust grants credit to all customers for one
period. The factors that influence the decision are listed here: