The risks associated with overextending credit are significant:
- Cash Flow Problems: If customers delay payments, the business may struggle to meet its own financial obligations. - Bad Debt: There is always a risk that some customers will default on their payments, leading to bad debt that can impact the business's financial health. - Reduced Profit Margins: Offering credit often involves additional costs, such as interest expenses and administrative costs, which can reduce profit margins. - Business Insolvency: In severe cases, overextension of credit can lead to insolvency, especially if the business is unable to meet its short-term liabilities.