It refers to the length of time given to the buyer to pay for their purchases. Throughout this period no interest is charged on the excellent amount. The credit period usually varies from 30 to 90 days and in some businesses still a period of 180 days is permitted. If a firm permits 45 days of credit along with no discount for early payment credit terms are stated like 'net 45'. In case the firm permits discount for early payment the credit terms are stated as 1.5/15, net 45' showing that if the payment is made in 15 days a discount of 1.5 % is permitted else the whole amount is to be paid in 45 days.
Raising the credit period results in raised sales but at similar time entails raised investment in debtors and higher incidence of bad debts. Reducing the credit period would have the opposite outcome. The consequence of rising the credit period on net profit can be estimated along with the assist of equation 2.
? NP = [? S (1-V) - ? Sbn] (1- t) - k ? I
In this case ? I computed as:
? I = (ACPn - ACP0) [S0/360] + V(ACPn)( ?S/360)
Here
? I = raise in investments
ACPn = new average collection period
ACP0 = old average collection period
In equation 2a the first term shows incremental investments in receivables related with existing sales and the next term presents the investment in receivables arising out incremental sales.