A firm may follow a stringent or a lenient credit policy. The firm subsequent of a lenient credit policy tends to sell on credit to customers on extremely liberal terms and credit is granted for a longer time. Firms following a stringent credit policy on another hand sell on credit on a highly choosy basis simply to those customers who such have proven credit worthiness and who that are financially strong.
However a lenient credit policy will result in increased sales and increased contribution margin. Therefore, these will result also in increased costs like:
1.Increased bad debt losses2.Opportunity cost of tied up capital in obtainable3.Increased cost of carrying out credit study4.Increased collection cost5.Increased discount costs to encourage early payments