CREDIT MANGEMENT

Accumulation of a/c receivables

The total amount of accounts receivables

outstanding at any given time is determined by two factors: i. Volume of credit sales ii. Average length of time between sales and collection

CREDIT POLICY
Credit policy consist of these four

elements: A. Credit period: B. Discounts C. Credit standards D. The Collection policy

A. Credit period: Length of time buyers have, before they must pay for their purchases Credit terms 2/30, net 30 Credit period: 30, 60 or 90 days to pay. Generally there is relationship b/w the normal inventory holding period of the firms customers and its credit terms . Fresh fruits, vegetables = very short credit terms Jewelry, tools = 90 days credit period

B. Discounts: a reduction in the price of goods given to encourage early payments Cash discounts Decisions on the size of the discounts are analyzed by balancing the cost and benefits of different discounts terms. 2/10, net 30 This would benefit in two ways: 1) To attract new customers 2) Reduction in the days sales outstanding

C. Credit standards: Minimum strength of acceptable customers It is potential and credit worthiness a customer may exhibit in order to qualify for credit. 1. The credit standards would be applied to determine which customer qualified for the regular credit terms which one is not. 2. And how much credit each customer should receive

 Consideration should be taken whether

the customer will pay slowly or even end up as a bad debt loss
Setting credit standards requires a

measurement of credit quality which is defined in terms of the probability of a customers default.

Credit standards:
Methods for measuring credit quality
I. Credit scoring II. 5 Cs system

III. Sources of credit information: (1)credit

associations (2) Credit reporting agencies IV. Management by exception

I. Credit Scoring
Cos that sales to large no: of small

customers often use statistical procedures to determine the probability that a give customer will default of granted credit Info: could be: Length of time, type of job, ownership of home or on rent, income, other sources, other outstanding debt, past payment structure, bankruptcy etc

 Score 1===very low probability of default

Score 2==== some probability of default Score 3=====too high probability of

default

5 Cs
The factors used to evaluate credit risk:
Character Capacity

Capital
Collateral

Conditions

 Character: making honest effort to make

payments that debtor promises, Credit report include background and past performance is considered gathering info: from suppliers, customers even its competitors

 Capacity: to judge ability to pay

Observing firms past records

Business methods

Physical observation of plants and

machinery, store, ware houses

 Capital: general financial position

Financial statements Financial ratio and analysis especially

Liquidity ratios, Debt ratios, Risk ratio: Debt /asset ratio, current ratio, time interest earned ratios

 Collateral: any assets that customers

may offer to obtain credit

 Conditions: analyzing the economics

trends and to special developments in certain geographic regions/sectors of the economy that might affect a customers ability to meet its obligations

 Management by exception: internally

using statistical procedure to classify customers in to 5 or 6 categories according to degree of risk Credit managers then concentrates by giving enough time and attention on the customer that might cause problem

D. The collection policy

The collection policy: The firm toughness

or laxity in following up on slowing accounts The procedure that a firm follows to collect accounts receivables Using letter, Phone calls Risk: Firm can lost good will and it is expensive Benefits: Prevent undue lengthening period, minimize losses

 Change in collection policy may

influence the level of sales collection period the bad debt loss % % of customer take discounts cont..