There are two possible approaches to defining optimum credit policy. The first is a basic theoretical model that can be built by comparing incremental gross margin and incremental accounts receivable expense:

Accounts receivable expense = carrying cost + bad debt expense + credit department administration expense.

Credit policy is at a theoretical optimum if, for every possible increment in sales, incremental accounts receivable expense will at least equal incremental gross margin. In other words, to achieve optimum credit policy, keep adding sales until the gross margins are less than accounts receivable expense.

A more useful approach, however, can be found in recalling the interplay between, Finance, Accounts Receivable, and Credit, on the one side, and Sales and Marketing Management on the other. In short, as we all know, the optimum credit policy is one consistent with both financial and sales objectives. If both the Finance and Sales side find the results of the credit policy acceptable, then you've reached a good equilibrium.

With that in mind, we've constructed two checklists on the factors that can define an acceptable credit policy. As with all checklists, these serve as a good starting point and your situation will undoubtedly be unique.