A sales increase is not the decision result
Relaxing customer credit should be approved from an incremental profit-and-funding working, not the sales forecast alone. Extra contribution may be absorbed by losses on the larger credit-sales book, a longer collection period or additional administration. The ICAI Board of Studies working-capital material, credit-policy evaluation and receivables analysis, pages 43–55 provides the underlying evaluation framework. This article uses original scenarios and is reviewed as of 24 October 2026.
This is an internal management decision model. It does not determine financial-statement impairment, regulatory lending permission, tax deductibility or whether a particular invoice is legally overdue. Obtain customer credit evidence and the actual payment terms independently. Supplier early-payment discounts and receivable factoring are different decisions, even where they interact with the same cash forecast.
Build a consistent old-versus-new model
| Component | Calculation | Control |
|---|---|---|
| Contribution | Incremental sales less incremental variable costs | Use the actual relevant margin |
| Losses | New expected bad debts less existing expected bad debts | Apply each rate to its correct sales population |
| Funding | Change in receivable investment times required funding rate | Keep collection days and cost base consistent |
| Other costs | Incremental administration and capacity steps | Include costs actually caused by the policy |
Specify which sales change, whether variable cost ratios stay constant and which fixed costs truly remain unchanged. A customer-credit proposal may also change prices, discounts, stock, supplier credit or capacity. Those effects belong in a complete client model; the cases below hold them unchanged unless expressly varied. Do not assume a margin percentage already includes bad debts and then subtract the same loss again.
Separate a sales balance from the investment funded
These cases use a cost-based receivable-investment approximation: annual relevant operating cost multiplied by expected collection days divided by 360. Relevant cost here includes variable cost and the specified cash fixed-cost base. It is a stated management-model convention, not an accounting measurement rule for trade receivables. Other models can use different cash-flow assumptions; reconcile the choice rather than switching bases between alternatives.
Where the same fixed annual cost supports more sales, do not keep an obsolete fixed-cost percentage on all increased sales. Retain the fixed rupee amount, add any genuine step cost and recompute the proposed cost base. The funding cost is the difference between the new and old investment multiplied by the assumed annual marginal rate. A separate monthly cash forecast is still needed to see peak funding and payment dates.
The loss rate belongs to the full population it describes
If the proposed bad-debt rate applies to all proposed credit sales, calculate new losses on that full book and compare them with old losses on the old book. Applying the higher rate only to the sales increase can materially overstate benefit. If the rate instead applies only to a new customer cohort, model the cohorts separately with evidence.
Use collection behaviour rather than the printed credit term alone. A 45-day policy with actual average collection of 60 days creates more investment than the term suggests. Run a downside case for days and losses jointly, and consider concentration, disputes and credit limits. Expected-value profitability is not permission to expose the business to a single unacceptable default risk.
Use a measurable approval hurdle
Net benefit equals incremental contribution minus additional losses, extra operating costs and incremental funding cost. The break-even new loss rate can be solved from that same equation, with the model’s other assumptions held fixed. It is a sensitivity boundary, not an estimate of what customers will actually default. Compare forecast and actual performance by cohort after implementation.
All cases are annual, exclude tax and GST effects, assume even sales and a 360-day year, and use 12% annual funding cost. Original sales are ₹36 lakh, variable costs 70%, cash fixed costs ₹3.6 lakh, collection 30 days and expected losses 1% of sales. Proposed sales are ₹40 lakh and collection 45 days unless varied. The loss and funding assumptions are simplified independent inputs; an actual dated cash model should reconcile default timing and collection patterns.
Worked illustrations
These illustrations use fictional facts and expressly stated assumptions. Amounts are Indian rupees unless a different currency or unit is specified. They are independent examples, not findings about any actual client.
Illustrative example 1: Complete base proposal
Original operating cost is ₹28,80,000 and receivable investment ₹2,40,000. Proposed operating cost is ₹31,60,000 and investment ₹3,95,000. Extra investment ₹1,55,000 costs ₹18,600 annually. Extra contribution is ₹1,20,000. With proposed losses 2% of ₹40 lakh = ₹80,000 versus old ₹36,000, extra losses are ₹44,000. Net annual benefit is ₹57,400.
Illustrative example 2: Longer terms with no sales increase
Keep sales ₹36 lakh, costs ₹28,80,000 and loss rate unchanged, but collection rises from 30 to 45 days. Investment increases from ₹2,40,000 to ₹3,60,000: extra ₹1,20,000 and funding cost ₹14,400. With no incremental contribution or other benefit, net effect is a ₹14,400 annual cost.
Illustrative example 3: Higher default risk reverses the proposal
Return to the base proposal but use a 3.5% loss rate on the entire ₹40 lakh proposed book. New losses are ₹1,40,000; extra over old ₹36,000 is ₹1,04,000. ₹1,20,000 contribution less ₹1,04,000 extra losses and ₹18,600 funding yields a ₹2,600 loss. Applying 3.5% only to the extra ₹4 lakh would be wrong under this stipulated rate scope.
Illustrative example 4: Additional collection staff
The base proposal needs an extra cash fixed cost of ₹40,000 per year. Proposed operating cost becomes ₹32,00,000 and 45-day investment ₹4,00,000. Extra investment ₹1,60,000 costs ₹19,200. Net benefit is ₹1,20,000 − ₹44,000 − ₹40,000 − ₹19,200 = ₹16,800. Include the step cost in both operating profit and the relevant investment base consistently.
Illustrative example 5: Actual collection stretches to sixty days
Use base sales and operating cost ₹31,60,000, but proposed actual collection is 60 days. Investment is ₹5,26,666.67; extra investment versus ₹2,40,000 is ₹2,86,666.67. Funding cost using unrounded amounts is ₹34,400. With extra contribution ₹1,20,000 and extra losses ₹44,000, net benefit falls to ₹41,600.
Illustrative example 6: Solve the new loss-rate ceiling
Under the base assumptions, contribution ₹1,20,000 plus old losses ₹36,000 less incremental funding ₹18,600 leaves ₹1,37,400 available for proposed losses at break-even. Divide by proposed sales ₹40 lakh: 3.435%. At that stipulated rate, new losses ₹1,37,400, extra losses ₹1,01,400 and funding ₹18,600 exactly absorb the contribution. Any changed assumptions require a new hurdle.
Ten-step verification table
| Step | Verification | Evidence to retain |
|---|---|---|
| 1 | Define the affected customer and sales population | Cohort list and policy proposal |
| 2 | Reconcile old sales and contribution | Books and relevant-cost schedule |
| 3 | Support forecast sales and variable costs | Commercial evidence and capacity assessment |
| 4 | State unchanged and additional fixed costs | Cash cost and step-cost working |
| 5 | Estimate losses on the correct populations | Cohort history and risk assumptions |
| 6 | Estimate actual collection days | Ageing and cash-receipt evidence |
| 7 | Calculate consistent old and new investment | Chosen cost base and day-count model |
| 8 | Apply marginal funding cost and other effects | Facility/opportunity-rate and working-capital bridge |
| 9 | Stress-test losses, days and concentration | Sensitivity and peak-cash forecast |
| 10 | Approve limits and track realised performance | Decision hurdle, owners and follow-up dashboard |
Sixteen practitioner FAQs
1. Does higher sales establish a good credit policy?
No. Compare contribution with the additional losses, costs and funding needed.
2. Should the new loss rate always apply only to extra sales?
No. Apply it to the population it actually describes; these cases use the whole proposed book.
3. Can the fixed-cost percentage stay unchanged automatically?
Not where the fixed rupee amount is unchanged. Recompute the cost base consistently.
4. Why use a cost-based investment here?
It is the expressly chosen management approximation for funding relevant costs during collection, not the book value of receivables.
5. Is the model’s investment the accounting receivable balance?
No. Accounting measurement and impairment require their own framework.
6. Why use 360 days?
It is a transparent modelling convention. Change the basis consistently if actual financing or management analysis requires another.
7. Does a 45-day contract prove 45-day collection?
No. Use expected actual receipt behaviour, supported by ageing and collection data.
8. What if sales do not increase?
Longer collection can still add funding cost without contribution, as the second case shows.
9. Should extra staff cost be omitted as administration?
No. Include incremental cash costs and reflect the chosen investment model consistently.
10. Can unchanged existing salaries be treated as new costs?
Not merely by reallocating them. Identify costs actually caused by the decision.
11. Is the funding rate a customer invoice interest rate?
No. It is the business’s assumed marginal funding or opportunity cost for the model.
12. Can a positive expected benefit override concentration risk?
No. Separate risk limits and liquidity constraints can still prevent approval.
13. Is the break-even loss rate a default forecast?
No. It is a model-specific sensitivity boundary holding other inputs fixed.
14. Do these cases include tax and GST effects?
No. Add their actual cash and profit effects separately where relevant.
15. Does annual benefit show peak cash demand?
No. A dated cash forecast is needed for seasonality and funding peaks.
16. What should be monitored after rollout?
Realised sales, margin, collection days, losses, extra costs, funding and performance against the approved hurdle.
Conclusion
Approve customer-credit changes from a consistent incremental model, supported loss populations and actual collection behaviour. Monitor the cash requirement as carefully as the sales result.