Credit to a Tea Stall with a 60-Day Overdue Balance
A small wholesale-retail business in Jorhat supplies packaged tea and snacks to four roadside tea stalls. Monthly sales are ₹1,20,000, of which ₹30,000 is sold on credit. One stall has owed ₹12,000 for 60 days and is asking to extend payment to 90 days; it also wants a 2% cash discount if it pays within 10 days. The business earns a gross margin of 18% on these goods. Its bank overdraft costs about 12% a year, and the owner has no formal credit policy, no customer ledger and no written terms. The owner is worried about bad debt but does not want to lose the stall, which has bought regularly for two years. He asks whether to continue the credit, what limit to set, and how to record and control the balance.
1. Should the owner continue credit to this stall? Assess the risk and set a credit limit with reasoning.
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The stall has bought regularly for two years, so an immediate cut-off would be a poor commercial decision. But ₹12,000 overdue for 60 days is a serious signal.
The gross profit on ₹12,000 at 18% is ₹2,160. If the balance becomes a bad debt, the owner must make extra sales of ₹12,000 ÷ 0.18 = ₹66,667 at the same margin just to recover the loss. That is more than half of a normal month's total sales (₹1,20,000), so the risk is not small.
Credit limit: a common judgement rule is to limit credit to about 15–20 days of the customer's average purchases, or 50% of monthly purchases, whichever is lower. If the stall buys about ₹12,000 a month, 50% gives ₹6,000. The existing ₹12,000 is already double that limit. The owner should therefore:
- stop new credit until the balance falls to ₹6,000 or below;
- require a post-dated cheque, a UPI standing instruction or the owner's personal guarantee;
- set a written due date on every invoice;
- review the limit after three months of on-time payment.
This keeps the customer while capping the exposure. If the stall refuses any security and insists on 90 days, cash-on-delivery with a small discount is safer than open credit.
2. Evaluate the 2% discount for payment within 10 days versus 90 days. Show the annualized cost and decide, using the overdraft rate.
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On a ₹12,000 bill, a 2% discount reduces the payment by ₹240, so the owner receives ₹11,760. Paying 80 days earlier (day 10 instead of day 90) is equivalent to borrowing ₹11,760 for 80 days at a cost of ₹240.
Annualized cost of giving the discount:
= (2 ÷ 98) × (365 ÷ 80)
= 0.02041 × 4.5625
= about 9.3% a year
The overdraft costs 12% a year. On this comparison, offering the discount is cheaper than financing the receivable on the overdraft, provided the customer actually pays within 10 days.
But the customer is currently 60 days late and is asking for 90 days. If the stall takes the 2% discount and still pays late, the owner loses both the discount and the cash-flow benefit. The discount should therefore be conditional:
- clear the existing ₹12,000 first;
- pay the discounted amount within 10 days by UPI or cheque;
- lose the discount permanently if payment is late.
A smaller 1% discount for 10 days would cost about 4.6% annualized, which is even cheaper, or the owner could charge interest after 30 days. The 2% offer is acceptable only with the conditions above.
3. What records and controls should be introduced? Show how the ₹12,000 balance should be treated in the accounts.
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The ₹12,000 is not a cash sale. It should be recorded as accounts receivable (debtor balance), with the sale and the GST invoice, if applicable, recorded at the time of supply. The entry is: debit the customer's account, credit sales. When payment comes, debit cash or bank and credit the customer's account. If the debt is later judged irrecoverable, it is written off against a provision or bad-debt expense with the owner's written approval, not simply removed from the ledger.
Records to introduce:
- one ledger page or spreadsheet row per stall, showing invoice date, invoice number, due date, amount, payment received, balance and days overdue;
- a signed credit application with the stall owner's name, phone number, address and agreed terms;
- duplicate invoices or a carbon copy book, and a receipt for every payment;
- a monthly statement sent to each stall;
- an ageing list showing 0–30, 31–60 and 61–90 days;
- a daily cash book and regular bank deposits, keeping business cash separate from personal cash.
Controls: stop supply when the limit is reached; follow up seven days before the due date; require approval before any limit increase; review overdue balances weekly; and keep a small provision for bad debts. These steps turn an informal credit relationship into a controlled one without losing the customer.