Optimal Trade Credit Limits

Abstract

Trade credit limits trigger action in the management of accounts receivable. In practice, these limits are usually set by unaided managerial judgment. This paper develops two methodologies based on wealth maximization: information credit limits and risk credit limits. Information limits signal the need for additional credit investigation. Risk credit limits are maximums applied to order size or accounts receivable balances and represent the point at which the marginal present value of granting further credit becomes negative because of increases in risk or unit costs.

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