Total Cost Curve & Organizing the Credit Function

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  • 0:02 Offering Credit
  • 1:04 The Total Credit Cost Curve
  • 2:05 Organizing Credit
  • 3:02 Lesson Summary
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Lesson Transcript
Instructor: Natalie Boyd

Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.

How much credit can a business offer to its customers? In this lesson, we'll look at the total credit cost curve, including what it is and how it can be graphed. In addition, we'll examine how to organize the credit function of a business.

Offering Credit

Theresa runs a company that provides services to other companies. It's a good business, and they make quite a bit of money, but Theresa wonders if they could make more by offering credit to their customers.

Businesses can bring in more customers if they offer credit, but there is a cost. The carrying cost of credit is what it costs to offer credit to customers, such as the cost of managing collections, bad debt from customers who don't pay, and the cost of not having cash on hand.

At the same time, though, there's an opportunity cost, or the potential loss of a benefit that happens when you make a choice, for the loss of business when a company does not offer credit. Businesses like Theresa's must balance the carrying cost and opportunity cost. That is, they have to figure out the optimal amount of credit to offer to reduce the opportunity cost while also keeping the carrying cost low.

To help Theresa figure out how to do that, let's look at the total credit cost curve and explore how businesses can organize the credit function.

The Total Credit Cost Curve

As we've seen, Theresa wants to offer credit to her customers, but she doesn't want a huge carrying cost. How does she know the ideal amount of credit she can offer to her customers?

The total credit cost curve is a mathematical curve that graphs the opportunity cost plus the carrying cost of extending credit. It is mapped against the amount of credit offered to see how cost varies according to how much credit a company offers to all its customers. That's why it's called the total credit cost curve: it's the cost of the total amount of credit a company can lend out.

When Theresa graphs the total credit cost curve alongside the individual lines for carrying and opportunity costs, she notices something interesting. The lowest point of the curve will be the place where the opportunity cost and the carrying cost meet on the graph. The place where the opportunity cost and carrying cost are equal represents the minimum total credit cost. This is the ideal amount of credit for a company to lend out, since it offers the optimal balance between benefits and risks.

Organizing Credit

Now that Theresa has graphed her company's total credit cost curve, she knows how much total credit she can lend out to her customers. But how can she do that? What type of organization does she need to put into place to offer credit?

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