A firm may face a situation when it has several credit policies before it & has to select one such policy which is the most profitable to the firm. Every credit policy will result in a particular sales level. Normally ,longer the credit period, higher will be the sales, and therefore, larger would be the profit  of the firm.

There is no doubt that increase in sale will increase the contribution(Sales-variable Cost). But simultaneously , the firm will face the risk of increase in other costs also . The cost may be:

Increase  in credit period will naturally result in higher & higher amount of outstanding debtors, which results in more funds of the firm blocked in debtors. There is always a cost of funds to the funds. So higher the average debtors results in higher cost to the firm.

Longer credit period will attract more and more customers. Some of the customers may turn out  to be defaulters, and the firm will have bear the cost of bad debts .As the sale increases (because of longer credit period ) , the chances of bad debts also increases.

So, on one hand , the firm has benefits(in the form of higher profits)from the increase in credit period, while on the other hand, the firm has top bear some additional costs. The firm should select that proposal which is expected to give highest net profit (benefits-costs) . At the time of evaluation of different proposals of credit policies, what is required is to compare(trade-off) the cost & benefits associated with each credit policy.

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