Portfolio Management Approach in Trade Credit Decision Making

TL;DR

This paper proposes a portfolio management-based method for trade credit decision making that considers risk and uncertainty to optimize enterprise value, moving beyond traditional profit-focused models.

Contribution

It introduces a novel application of portfolio management theory to determine optimal accounts receivable levels, accounting for risk and firm value impact.

Findings

Portfolio management approach can optimize accounts receivable levels.

Managing trade credit risk can increase firm value.

Liberal credit policies with risk management can be beneficial.

Abstract

The basic financial purpose of an enterprise is maximization of its value. Trade credit management should also contribute to realization of this fundamental aim. Many of the current asset management models that are found in financial management literature assume book profit maximization as the basic financial purpose. These book profitbased models could be lacking in what relates to another aim (i.e., maximization of enterprise value). The enterprise value maximization strategy is executed with a focus on risk and uncertainty. This article presents the consequences that can result from operating risk that is related to purchasers using payment postponement for goods and/or services. The present article offers a method that uses portfolio management theory to determine the level of accounts receivable in a firm. An increase in the level of accounts receivables in a firm increases both net working capital and the costs of holding and managing accounts receivables. Both of these decrease the value of the firm, but a liberal policy in accounts receivable coupled with the portfolio management approach could increase the value. Efforts to assign ways to manage these risks were also undertaken; among them, special attention was paid to adapting assumptions from portfolio theory as well as gauging the potential effect on the firm value.