2.

1. The four variables that make up the credit policy of a firm consist of the credit standards, credit period,
cash discount and collection policy. The credit standards provide regulations and limits when it comes to
extending credit to customers, while the credit period is the length of time allocated to the customers to
pay for their purchases. Cash discounts are allowed to customers when they pay for their purchases with
an indicated discount period. Lastly, the collection policy refers to the firm’s method when it comes to the
collection and monitoring of its receivables.

If the credit policy would be tightened it may alter its credit standards to be tight, credit period to be
lower, decrease the discount period while maintaining the percent of cash discount, and applying greater
efforts in collecting its receivable. A tight credit policy can possible decrease the sales, the level of
receivables held and the amount of bad debt expense.

2. The five C’s of credit includes the character, capital, conditions, capacity and collateral. Character refers
to the credit history and reputation of the debtor and this may be a factor in the credit standard of the
firm. A high credit rating of the debtor can ease the strictness of the credit policy. On the other hand,
capital refers to the amount of money contributed by the borrower to an investment and this may affect
the level of credit standard and collection policy of the lender. Accordingly, lenders are more willing to
extend credit for borrowers with great seriousness when it comes to handling money. Capacity obviously
refers to the capability of the borrower to repay his/her debt and this is a very significant factor in the
credit standard, period and collection policy. Conditions are the agreed settlement of the debt, which can
be in the form of interest. This may affect the collection policy, credit period, cash discounts and credit
standards of the credit policy. Finally, collateral can ease the credit standard of the credit policy because
it can grant security to the lender in case the borrower defaults on the debt.