What is the role of credit terms and credit standards in the credit policy of a firm?

A.4 Credit standards are criteria to decide to whom credit sales can be made and how much.
If the firm has soft standards and sells to almost all customers, its sales may increase but its costs in
the form of bad-debts losses and credit administration will also increase. The firm will have to
consider the impact in terms of increase in profits and increase in costs of a change in credit
standards or any other policy variable.
Credit standards influence the quality of firm’s customers, i.e., the time taken by customers
to repay credit obligation, and the default rate. The time taken by customers to repay debt can be
determined by average collection period (ACP). Default risk can be measured in terms of bad-debt
losses ratio – the proportion of uncollected receivable. Default risk is the likelihood that a customer
will fail to repay the credit obligation. The estimate of probability of default can be determined by
evaluating the character, i.e., willingness of customer to pay; customer’s ability to pay and
prevailing economic and other conditions. Based, on above, firm may categorize customers into
three kinds, viz., good accounts, bad accounts and moderate accounts.