When you’re in business, you may feel that you extend credit terms.

it terms. However, a (We explain them in detail in

that a competitor always lurks on the negative scenario is that, even under the best the next lesson)
background, plotting and scheming to take circumstances, there is no assurance that all will
 Know the type of business organization
away your customers, cut into your market pay on time.
of your customer.
share and take your profits. And you’re right.
Some helpful habits or practices are as
Competition is a fact of life, and with it comes You should know whether your
follows:
the pressure to extend credit to all customers customer is a sole
who come your way, whether they deserve it or proprietorship, partnership,
not. After all, if you don’t give credit to your corporation or other legal entity.
customers, they can probably find a competing Such knowledge helps you
business that will. When you compete with collect a delinquent balance.
others, try to be different Such information will help you
determine their capacity to pay
If you are new to the credit and
their obligation. Like for
collection process, you may be asking yourself
example, recall in your
several questions:
To improve your cash flow and control accounting subject that sole
 Should I always be willing to give credit your risk, you should: proprietorships have limited
to a customer? ability to raise capital or have
 Establish clear, workable credit policies,
 How do I balance the risk of extending limited financial resources
in writing
credit against the risk of losing the business of because of only one owner
customers I turn down? Credit policies are guidelines compared to a partnership or
that set the terms and corporation.
 What happens if a client does not pay
conditions for supplying goods
his obligation?  Beware of con artists
on credit, customer
 Can I file a lawsuit? How do I sue? qualification criteria, procedure Con artist is a person adept at
This first lesson will address these for making collections and steps lying or swindling by means of
questions and the succeeding lessons to be taken in case of customer confidence games. You should
will explore credit and collection issues delinquency. Your credit be able to detect a con artist and
in great detail. policies should be clear, beware also of other ways you
workable and in writing. may “accidentally” extend credit
Lesson Proper: because of the shenanigans of a
 Follow the five Cs of extending credit
customer who’s supposed to pay
The five Cs of credit are in full upon delivery.
Setting high goals for sales is a worthy character, capital, collateral,
 If you perceive the extension of credit
ambition, and achieving those goals is capacity and condition. These
admirable. What’s even better is your to be too risky, consider taking a lien or
are common factors used by a
customers paying their bills on time and in cash. personal guaranty, to help ensure that you’ll
creditor to help him decide
With that, many of your clients will prefer to do ultimately be paid.
whether to grant credit or not.
business on credit, and most will likely insist
 When you perceive that your  Liens that, in the event of default, allow payers. If you reach an agreement with a debtor
customer will not be able to pay you to take action against the customer’s involving repayment over time, you may need a
their obligation, you may assets. written payment plan, even if it’s just an email
consider asking for lien or from the debtor covering the basic elements of
(These will be discussed in detail in
collateral to ensure payment of the agreement, such as the amount to be paid
chapter 3)
obligation. However, in case and the payment schedule. Keep a copy of any
non-payment still by the Using documents in the billing process written agreement or confirmation in the
customer, you can sell the customer’s credit file.
collateral and apply the Don’t underestimate the Importance of
proper billing practices. Documents used in Despite your constant flow of
proceeds to the obligation.
billing include: reminders, such as invoices and monthly
A principal goal of a good credit and statements, some customers inevitably fall
collections manager is to avoid collection  Invoices that describe the goods or behind. As trouble brews, your patience and
problems before they occur. Although not every services you provide and request payment. determination may be tested to their limits.  
account receivable problem can be headed off  Debit memos, to correct or highlight an
amount due from a customer. Warning signs you shouldn‘t overlook
at the pass, many can.
include:
Using documents in the extension of credit  Credit memos, to document credits
given to a customer.  Changes in ownership of your
You can help keep the odds in your  Statements of account, summarizing customer’s business, which you may discover
favor by insisting on good documentation the transactions on the account. w Purchase by accident it you call and the business is using
throughout the credit and collection process. orders, to prove that an order was placed. a different name, or if you’re referred to an
Good documentation begins with a credit unfamiliar person.
application, which is required before your first  Change orders, to verify that customer
 Deterioration of paying habits, which
sale on credit to any customer. changes were authorized.
you may not notice unless you’ve implemented
 Delivery receipts, to prove that goods a policy to track monthly paying habits.
Even with a formal credit application in were delivered.
hand, you may require other key documents  Broken promises, from the cliché “the
before extending credit, including: Good billing practices ensure that your check is in the mail” to a missed payment on a
customer has detailed, accurate negotiated plan to pay off an overdue balance;
 Financial statements, which establish a documentation, minimizing the chance that when the debtor doesn’t keep a promise,
picture of the applicant's assets and liabilities as your client may inadvertently overlook serious trouble often lies ahead.
of a certain date. payment.  Communication issues and difficulty in
 Operating statements. which show the
Using documents in the collection of past due actually making contact with your customer,
applicant‘s sales and profits over a certain span
accounts with calls directed to voice mail or left
of time.
unreturned.
 Personal guaranties. giving your It’s part and parcel of a welI-organized
 Changes in customer orders, especially
company additional protection should the credit and collections department to have a
sudden decreases in orders that may signal a
customer‘s business falter. good set of documents for following up on past
decline in your customer’s business.
due accounts, such as a series of demand letters
ready to go out at a moment‘s notice to slow
 When an account is overdue, you must at private stores, such as a UPS Store. When  Whether alternative dispute resolution
implement firm, timely measures to your debtors disappear to parts unknown, is a possible solution
bring the account current. Remind the professionals can often find them and their  Who to include in the suit
customer of the importance of prompt assets.
 What legal theories to Include in the
payment.
Credit reporting and Interchange suit
Collection agencies and collection law services: Many professionals report bad payers  Where to bring the suit
firms abound ready and willing to help you with to credit bureaus and participate in services
 Whether to do it yourself or hire an
billing, tracking down debtors who've gone that exchange credit information about
attorney
missing, finding assets, and your other credit businesses and industries. They can provide you
and collection needs. Whether you have a with additional insight into your active and
problem with a small number of accounts prospective customers.
(perhaps only one) or most or all your accounts
  Meaning of Credit
receivable, you can find professionals capable
of serving your needs. But what kind of Arriving at the Last Resort: Litigating to Credit is a term derived from the Latin
collections professionals do you hire? Where do Recover Delinquent Balances word “credo” meaning to believe, to trust. As
you find them? What should you expect from applied in this course, credit means securing
them? Billing services and early-in collection When all else fails, sue your debtor. But
something of value, whether tangible or
services: These are services that help you right how do you do that, and must you  hire an
intangible, in return for a promise to pay at
at the beginning of the credit process, from the attorney? Not necessarily. In many cases you
some determined future date. Formally
time you provide your goods or services. long can:
speaking, credit is an agreement to pay good or
before any delinquencies occur. Why hire a  File a lawsuit: Prepare, file, and serve a services at a future time. A creditor allows the
professional so early in the game? You may lawsuit on your debtor. debtor to receive goods or services without
prefer to use an outside service instead of hiring immediate exchange of payment and thereby
 Litigate a case: Take a default judgment
and managing your own credit personnel, or assumes a risk of not being paid. But if we can
if your debtor fails to answer. 0r handle
you may prefer to maintain a small, in-house be less formal, perhaps you’ve quipped:
contested litigation if the debtor does file an
staff while the outside company provides the
answer. Dun and Bradstreet, one of the oldest names in
backup you need as your workload ebbs and
flows. For professions that involve complicated  Testify as a witness: Present your case credit and collection industry, defines credit as
forms or billings to insurance companies (such in court. “man’s confidence in man” and sometimes the
as a medical practice), professional document  Collect money postjudgment: Search simplest definition is the best. After all, at their
preparation and form-filing services can really out assets and attach them using the powers of heart, credit transactions are extensions of trust
shine. your judgment. and defaults are the betrayal of trust. Trust
Skip tracing: It's becoming easier for Before you even head to the courthouse, therefore is the fundamental element of credit.
people and even businesses to move around consider developing a litigation strategy to
without leaving much evidence as to where determine:
they’ve gone Phone numbers may remain the
 Whether filing suit is practical and cost-
same, regardless of where a debtor is located.
Crafty debtors hide behind mail drops physical effective
addresses that turn out to be post office boxes
 Classifications of credit Industrial credit- when it is used for business. In second economic function of credit is to make
other words, the debtor expects to accumulate capita available for business purposes which
 
the amortizations from the purchased items. would otherwise lie idle. Induced by payment
            Some of the morecommon forms of for use of their funds, people save to invest or
         Example: when one purchases a truck to
credit transactions are the following: to lend their money.
be used as a bus or cargo truck
2. Social function. A social function of
1. Charge account- consists in the granting   credit is to evoke for independence of thought
of credit on the mere signature of the and action. Its use obviates the necessity for
Trade credit- when the thing purchased is to be hoarding on the part of those who desire to
customer/client or authorized representative. In
used in connection with the business of the save and leads them to place their funds in
banking,this is commonly known as “clean
obligator, or, without necessarily expecting that institutions where the principal is more secure
loan”.
the purchase price could be accumulated from than are hoardings. This, in turn, provides uses
2. Secured charge account- refers to the
the use of the thing, though it is the business of for capital which people have no means of
extension of credit payable in 30 days like
the debtor from where he expects to secure employing themselves.
charge account- but this time,aside from the
payment. 3. Business promotion. For the business
signature of the client, additional collaterals are
required.         Example: when one purchases a truck for executive, credit performs several functions. It
3. Installment accounts- the account is his bakery business.Or when one borrows from is a tool of business promotion, with which
payable in installments, usually monthly.It is a bank to be used for his business. expand his business by selling to customers who
broken down in isntallment because the want to buy merchandize on credit. Credit also
amount extended issubstantial. gives him the opportunity to manage his
4. Straight loans- loan in the form of business with the funds of others and to adjust
money or equivalent usually granted by banks his volume of capital to the varying needs of
and other financing institutions. The loans may his business.
either be secured or unsecured, payable in  
installments or lump sum depending on the
policies of the lending institution. Why is credit important to the country?
 
1. Credit is an agent of production
Credit may also be classified according to
the use it is availed of as follows: Functions of Credit Credit makes possible the availability of
funds for productive purposes. This is
Consumer credit- when the property or service Credit performs functions which may be
amply demonstrated in the many socially
thus acquired is used for the personal benefit of classified as economic, social and managerial.
oriented loans and credit programs of the
the credit grantee.
national government and the private
1. Economic function. The first economic sector.
         Example: car purchased for personal use,
function is to serve as a medium of exchange in
house, furniture or a loan for construction of
the economy. By the use of credit, transactions  
residential house
can be consummated quickly and easily with
  confidence, without the handling of cash. Risk, 2. Credit develops the saleability of goods
as well as time and effort, is minimized. A and services
 Economic development in the Philippines 6. Credit is a toll for the redistribution of 10. Credit makes it possible to attain
and in the other market-oriented wealth growth and progress
economies of the world probably stagnate
Credit makes it possible for someone More economic activities can be made by
without credit. Because of credit, goods
without financial resources to acquire using credit judiciously.
and services can be moved faster and in
goods and services necessary to earn or
greater quantities between and among  
save to acquire wealth.
people and nations.
  11. Credit elevates the moral standards of
 
people.
7. Credit helps in the creation of business
3. Credit is a liquidity medium Credit elevates the moral standards of
Credit makes possible the organization of people because you have to prove yourself
Credit, to a large extent, has a direct
business firms by providing vital funds trustworthy to be able to obtain funds or
relationship with money as a medium of
necessary for the start-up of any business/ commodities from the creditor
exchange, because credit has the effect of
economic enterprise.
increasing the total amount of money (or What are the negative impact of credit to
liquidity) in circulation in a country. More   people?
money increases the purchasing power of
people. 8. Credit motivates higher business 1. Can be a wedge between people
  standards and practices 2. May motivate for unwise and/or
conspicuous consumption
Credit makes it possible for the consumer
3. May lead to overspeculation/over
4. Credit is a medium of capital formation to acquire more goods and avail of more
expansion
services. Credit therefore contributes by
Business today grow and continues to grow 4. Credit causes dependence on others
improving business standards by providing
by relying on credit for the accumulation of 5. Lack of credit is one big reason for
manufacturer or sellers with the initiative
capital. stagnation/ retrogression of people
to improve the quality of their products or
B
  service in the hope of boosting sales.
Credit as Sales Tool in Business
 
5. Credit complements the monetary
system             When a customer abuses credit, you may
9. Increases purchases power be tempted to tighten up your policies so that
This is best exemplified by the Bangko customers must have perfect paying habits to
The additional liquidity provided by loan or
Sentral’s credit instruments such as its qualify for any credit extension. However, the
credit to debtors, correspondingly
certificate of indebtedness (CBCI’s, various more you restrict credit, the more your sales
increases the purchasing ability. Purchasing
government securities and bonds and volume drops off. Don’t lose track of the
power in economics, refers to your ability
similar instruments issued by the private importance of credit as a sales tool,moderate
to buy goods and services.
sector. your temptations,and be prepared to take some
  risk.
 
 
   2. To minimize costs and bad debt losses
3. To attain profit or income objectives
As with anything else in sales,
4. For control and evaluation
sometimes creativity and flexibility land the
sale. You probably haven’t given it much  
thought, but you can be very creative when
Factors to consider in formulating credit and
extending credit to your customers. The
collection policies
following factors play into the use of credit as
sales tool:

Implementing your written credit policy

General policies of credit and collection  
              When you implement your written credit
            Depending on the factors affecting your policy, remember the two keys to success:
product or service, you can either have:
1. Adopt or formulate a written plan that
1. Liberal credit policy complemented by you and your employees use as a guide
strict collection policy 2. Keep the policy up to date. Make
2. Strict credit policy complemented by changes, both as needed and when needed,
liberal collection policy based upon unique situations.
3. Liberal credit policy with a liberal  
collection policy
There must always be plans to guide the Customizing your credit policy to meet your
4. Strict credit policy complemented with
conduct of business in all operating units of a needs
strict collection policy
company. In reality, however, the majority of
business have not deliberately developed credit A liberal credit and collection policy means  
and collection policies and procedures. If there loose or lax policies while a strict credit and             Extending credit involves more than just
is such a system, the policies and procedures collection policy is tight policy. giving your debtor some time to pay the debt.
used only evolved and developed after years of You can customize credit to meet the needs of
operation. This inordinate reliance on
your company or of your customers.
experience and not on fundamentals
aggravated by inexperience, is risky and costly.  
Objectives of establishing credit policies: Providing a discount
 
1. To maximize sales
            Discounting credit rewards prompt Adjusting credit terms to the quality of the rewarded by receiving your best practice and
payment, and you can offer it as an alternative customer’s paying habits credit terms.
or in addition to any price reductions the
   
customer may earn. The two forms of discount
serve different purposes: the price             Better customers earn better credit Setting credit terms based upon interests and
reduction tells your customer you appreciate terms. No surprise there. Extending favourable late fees
him, and the credit discount rewards him for credit terms when you have minimal risk is a
paying quickly. Although most customers prefer  
good business strategy. Customers appreciate
a price reduction to a credit discount, both are the vote of confidence, and you generate             As an alternative to adjusting credit
useful for building relationships with good loyalty. A win-win situation. terms, some lenders prefer to provide equal
customers. credit terms to most who apply. As problem
arise with a particular customer, they may add
contractually imposed late fees and interests or
Adjusting the level of your accounts receivable cut off credit altogether.

   

            Textbook receivable turnover (collection Avoiding discriminatory practices

time) may be 30 days or so, but many factors  
affect your collection rate. When your
Adjusting credit extension to your industry receivables reach a level of being             There are certain laws that impose strict
uncomfortably high or aging is uncomfortably guidelines that you must follow in the extension
 
long, tighten credit terms at least to marginal of credit. For example, a spouse of a credit
            The unique circumstance of your accounts. When receivables reach critical levels, applicant cant be required to sign a personal
industry, the nature of your goods or services, adjust terms for all customers. guaranty if the applicant would have otherwise
and the frequency of your deliveries or bills all qualified for the extension of credit.
tie into your credit decisions.  
     Let us start this lesson with a short narration
  Setting credit extensions based upon ability of of an incident that happened to a compadre not
customers to pay long ago:
            Consider for example, perishable goods.
Deliveries of food items are usually handled on                           One day, about a year ago, while
a very short leash, with very short credit terms.             Although two customers may be paying my said compadre and I were shopping in one
Time to object to product quality (spoiled milk) according to terms (promptly), the customer of the malls, a sweet smelling lady breezed by.
is intentionally kept very short. When a product with the strongest financial strength or longest Per our calculation, she was “36-22-36.” My
should be inspected immediately upon receipt, time in business may be entitled to more compadre was smitten right there and then,
don’t give the customer a long opportunity to leeway on credit extension. Certainly, within and he said: “This is the girl for me.” So,
object to its condition. In contrast, some reason, reward a good customer who always through the help of another mutual friend who
industries work on (and expect) very long credit pays her bills on time despite a spotty balance happened to know her, and after a whirlwind
terms. sheet. But a promptly paying customer with a courtship, they eloped and got married in
strong financial condition or longevity should be Cainta, Rizal. A week after their honeymoon, my
 
compadre came to me with a sullen face and Many start-ups and small to medium notices and liens are just a few tools that
confided to me: “Padre, natanso. I thought it businesses do not “need” a credit department. construction industry business can use to
was 36-22-36, yon pala….22-22-22, puro Escolta In these cases credit management tasks are mitigate the chance for bad debt.
pala. usually assigned to one person within the
business, generally the CFO or Controller. Their
            This is the anecdote of the Compadreng Other goals of the credit department
job is to keep the accounts receivables low. As
Natanso include stream-lined payment and billing
the business starts to grown and revenue
increases, the job of collections and credit processes making it easier for clients to pay and
            Well, to many who are engaged in credit
management will (hopefully) become too much pay timely. This can be helped by automating
selling or other forms of credit extensions, they
for one person to handle efficiently. client reminders to pay when a debt is past due.
are often natatanso. A salesman calls a
prospect living in a big mansion, apparently
well-to-do and “big time.” So, without much Relationship of Credit Department and Credit
When this occurs, a company needs to
ado, he is offered the goods, with the least Policy
create a credit department. Credit departments
down payment and the best credit terms. When
work in conjunction with the sales department
collection time comes, the account could not be There is a natural relationship between
to make sure that the sales extended on credit
collected. the credit department and the company’s credit
are going to credit worthy customers who will
            In any firm engaged, whether primarily pay in a timely manner. Often times friction is policy. While many times the credit policy is
or incidentally, in credit extensions in the form created between these two departments – sales implemented before the credit department is
of loans, investments or instalments, the want the sale no matter what, and credit established, the credit department is tasked
creation of a Credit and Collection unit becomes departments are tasked with only allowing sales with making sure those procedures are
an important need, and its expansion should be that will end up being paid. A good CFO or complied with. When the credit department is
in proportion to increase activities which come Controller will have these departments work established, then the credit policy may need to
with the growth of the company’s credit sales together harmoniously. be revised to fill the bigger and expanding role
volume or loan portfolio. of credit in the organization.

Credit Department Goals of a Credit Department

For example, the credit department will
A company will need to start likely be where the sales contract, personal
departmentalizing when it begins to grow or There are a few important goals that
every credit department should have within a guarantee, and other initiating documents for
has grown. A credit department is one of the new clients are located. It’s also the department
first departments which will become needed as company structure. The obvious few are the
reduction of bad debt and the increase of timely that will institute the collections process when
revenue grows and credit is extended to clients the debt is going bad.
new and old. The types of transactions specific payments by new and current customers. Bad
to your company will determine how rigorous debt plagues all companies from large to small.
your company needs to be in the development Contribution of Credit department
of its credit department. There are a number of steps that the
credit department need to implement with the             There is increasing sense of awareness
sales staff to reduce the occurrence of bad today on the part of top management where
Why Does a Company Need a Credit
debt. Securing a personal guarantee or letters the credit department could greatly contribute
Department?
of credit, and sending or filing preliminary on other areas, namely:
             The late Mr.Placido R. Real, Jr., many 3. Aggressive attitude capable of
time president of the CMAP, has described the maintaining persistent and continuous follow
essential qualifications and characteristics up of the credit and collection problems
which a credit man must possess: 4. Analytical mind
5. Academic experience and/or indicated
interest should be in the subject areas related
to credit
6. Personal ambition necessary to achieve
committed goals
 
The Credit Manager Additionally, for the credit manager, he
  must have a professional grasp of the
subject matter pertinent to the activity he
            When a business organization sells on supervises. He should be a financial
credit, the administration of that credit executive of experience, acumen and
becomes, on some level, a management initiative, able to capably represent his
function. The type and extent of management company and function to the management
required is not the same in different types of of the customers as well as within his
institutions nor is it always handled in the same company.
way in comparable organizations. The level of
management required for the administration of Credit men, with the possible exception of a Applying the C’s of credit
credit in a firm is determined, more than few who have been privileged to be schooled  
anything else, by the concept of credit abroad, never had the opportunity of learning             Any decision to extend credit to a
prevailing there. In some instances, credit is their craft in college or in university. Even the customer is loosely based on what are
viewed as a simple function of approving credit credit men of the highest local multinational commonly referred to as five C”s of credit
transactions. Little real management activity is companies learned the tricks of the trade not or credit criteria. Most books use 4 C’s.
involved here. In other cases, as the concept from scholastic training but directly from the Other books use two more C’s. These
broadens, the credit function embraces sales university experience. concepts may seem vague, and sometimes
and finance policy and other top management   they are more of a gut check than
strategy. The management of credit then something you can objectively measure, but
becomes a responsibility of a higher order and             In sum, the good credit manager must they provide a reality check on whom to
calls for talent equal to the task. This task is possess the following essential characteristics: trust and when to trust them.
handled by a credit manager.
1. Poise, necessary to relate well with
 
customers and an understanding of business
The Cardinal C’s of credit men psychology
2. Good articulation, to effectively
  communicate in a variety of media- phone and
personal interview
             According to Investopedia, the first C commonly offered with lower interest rates and
more specifically refers to credit history: a better terms compared to other unsecured
borrower's reputation or track record for forms of financing.
repaying debts. This information appears on the
Determining capacity
borrower's credit reports. Generated by the
three major credit bureaus—Experian,             Capacity is the sufficiency of cash flow to
TransUnion, and Equifax—credit reports contain cover debt. The ability of a business to pay debt
detailed information about how much an generally fluctuates depending on budgeting
applicant has borrowed in the past and whether skills and the steady flow of enough cash to
they have repaid loans on time. These reports cover debts as they mature and become due.
also contain information on collection accounts
and bankruptcies, and they retain most  
information for seven to 10 years.             Capacity measures the borrower's ability
  to repay a loan by comparing income
against recurring debts and assessing the
Evaluating collateral borrower's debt-to-income (DTI) ratio. Lenders
calculate DTI by adding together a borrower's
 
Assessing character total monthly debt payments and dividing that
            Collateral refers to personal and real by the borrower's gross monthly income. The
            properties that are used to secure a credit lower an applicant's DTI, the better the chance
obligation. It serves 2 purposes: first: as a of qualifying for a new loan. Every lender is
            The first and the most important C
should not be called simply as character but motivation for the borrower to pay the loan and different, but many lenders prefer an
second, for the property to be sold should the applicant's DTI to be around 35% or less before
more appropriately as “credit character”. The
simple word character has broad connotations. borrower be unable to pay. approving an application for new financing.
In a much narrow sense, “credit character”    
refers to a person’s attitude towards credit,             Collateral can help a borrower secure
which excludes many other things.  
loans. It gives the lender the assurance that if
            the borrower defaults on the loan, the lender Examining capital
can get something back by repossessing the
            A person’s credit character refers to his collateral. Often, the collateral is the object one  
mental disposition and his persona values in is borrowing the money for: Auto loans, for             Capital refers to the borrowers
relation to credit commitments. In short, his instance, are secured by cars, and mortgages resources. Lenders also consider any capital the
willingness to pay manifested by his reputation are secured by homes. For this reason, borrower puts toward a potential investment. A
in consistently meeting his obligations. collateral-backed loans are sometimes referred large contribution by the borrower decreases
Customers who lack character should be to as secured loans or secured debt. the chance of default. Borrowers who can place
required to provide more proof that they are a down payment on a home, for example,
worthy of credit. They are generally considered to be less
risky for lenders to issue. As a result, loans that typically find it easier to receive a mortgage. 
  are secured by some form of collateral are  
Reacting to conditions give? The answer varies by business and necessary to obtain current financial
industry. So you track credit information, apply statements.
 
the five C’s and carefully consider your
            An excellent practice to follow when customer’s situation and industry trends. You  
extending credit is to consider the general set up a system to gradually extend credit to
conditions of your industry, as well as overall customers who are newly formed or are just 2.       Customer Supplied Information
economic conditions. The conditions of the new to you. You watch out for red flags that
loan, such as its interest rate and amount of indicate trouble ahead. There is no better source of information
principal, influence the lender's desire to about the operation and financial
finance the borrower. Conditions can refer to Gathering and using vital credit information to condition of the business than the
how a borrower intends to use the money. determine your risk business itself. Therefore, it is
Consider a borrower who applies for a car loan reasonable to expect that direct contact
or a home improvement loan. A lender may be             Your customer suddenly wants to double with a customer can provide the credit
more likely to approve those loans because of or triple credit purchases. Your sales man with available financial details,
their specific purpose, rather than a signature department wants an increase in business, but banks and trade references and other
loan, which could be used for anything. your credit department is going to have to deal information of importance of the credit
Additionally, lenders may consider conditions with any credit headaches that result. Whether exposure, and the degree of the
that are outside of the borrower's control, such you are evaluating a new customer or a large cooperation which can be obtained
as the state of the economy, industry trends, or order, conducting a routine periodic review, or from the customer.
pending legislative changes. responding to concerns about a customer that
is slowing down in its paying habits, you need  
Every extension of credit is a risk. Some your customer’s financial information to
customers are worthy of more risk than others. evaluate credit. 3.       Bank Information
Deciding whether or not to extend credit is a
tricky business—it’s really an art more than a             There are multifarious sources from Banks are usually quite knowledgeable
science. Much of the process is rooted in your which a credit investigator could find and about marginal companies. The larger
instincts to ward a customer and conditions in secure these credit information. Some of these banks in the metropolitan areas have
general. sources are the following: files which contain a wealth of
information. Having obtained the name
            The core concept is not complicated: 1.       Salesman’s Report of the customer’s bank by means of
Some customers are better credit risks than direct inquiry or by noting the bank on
others are because their financial condition, The company’s first contact with a new which his checks are drawn, the credit
age, payment history, industry, quality of customer is the salesman. If all goes manager or representative is in a
management or willingness to provide liens or well, the salesman will have the most position to secure from the bank
guarantees make them more likely to pay for frequent contacts with an established further helpful information.
their purchases. customer. It is therefore necessary that
salesmen should be trained to submit  
            But after you trust a customer enough to credit application on all prospective
extend credit, how much credit should you and/or new customers and when 4.       Credit Interchange
 Direct interchange of information is also CMAP sends out to its members court customers pose too much risk and should not
one of the most valuable sources of and SE listings. There, you will find get credit. So what does a high risk customer
information. The credit analyst should customers with cases in court and look like? Here are some warning signs:
not overlook the possibility of directly corporations newly organized, those
exchanging ledger and other pertinent with increased capitalization and those
information with credit representatives which are dissolved.
of other concerns known to be
supplying the customer under review.  

  8.       Securities and Exchange

Commission
5.       Credit Reporting Agencies
Copies of the Articles of Incorporation
The service of one or more agencies or and By-Laws could be secured from this
bureaus can be availed of by the credit government agency. By checking these
department of the company. The sources carefully, the credit
mercantile agency report usually representative can confirm information
attempts to cover all the major factors about which there may be doubt and Creating Credit Ratings
in the credit decision. When properly can obtain other useful information            
analysed, information which can be regarding his customers.
secured from this source may be You know what information to collect
sufficient to eliminate the need for   to help you decide whether to extend credit.
further investigation. You know how to assess risk based upon your
knowledge of your customers. With that
9.       Miscellaneous Sources
  information in hand, you can use your
customer’s creditworthiness factors to assign
Daily newspapers, Accountants and
them credit ratings based upon their risk of late
6.       Interchange Bureaus Attorneys are also important sources of
payment or default.
information.
The ledger interchange bureau of the  
Credit Management Association of the             With computerization, all the data and
Starting with a credit application
Philippines (CMAP) is a source of credit information gathered could be compiled
information regarding the manner in and stored in a credit data bank for future             The process of creating a credit rating
which a customer meets his trade references. starts with accumulating information. Thus,
obligations. when a customer first applies for credit, you
Spotting warning signs of a high risk customer should have it complete a formal application.
 
              The first activity in the Credit department
as it starts the actual operation of its function is
7.       Court and SEC listings             Regardless of how much profit you have the credit application. A credit department
built into your products or services, some
 must have a credit application for use by its  They may have failed to form a legal interviewer should prepare for such an
prospective customer/client. In fact, as a matter business interview.
of policy, no credit extension, however large or  The owners may be well known as  
small, should be approved and released, unless crooks
the customer/client has at least filled up a Preparing for the interview
 Their financial information may reflect
credit application form
distress
   They may have burned their bridges
Purpose of Credit application: with other vendors, and their credit references
may reveal bad credit
1. Provide the credit department with  They may not want to draw a credit
initial credit information on which to base its report on them
credit decision  They may not want you to know that
2. Provide information on which to further their business is brand new
interview the applicant
 They may have bad banking relations
3. Provide with some “leads” on which to
start credit investigation process  They may not ant to disclose their
addresses or other personal information to
  make it harder for you to chase them when
Components of an effective credit application they don’t pay their bills

            An effective credit application contains:

Credit Interview
 
            Another good practice would be to make
it a point, as much as possible, to interview the
Beware of customers who won’t complete the applicant himself. The interview may be
application conducted either at the time the credit
            What if your customer refuses to sign a applicant applies for credit, or later if, and when
credit application? These customers often have credit investigation has been found to be
something to hide: necessary before the extension of the credit or
loan. Just like any human activity, the
   The work of a credit investigator may be
divided into three major functions:
Credit qualities to investigate
1. Gathering of credit information
   The following outline presents some of the 2. Analysis of credit information; and
Credit Investigation more important factors to which attention 3. Dissemination of credit information
should be given in a credit investigation. In
            A credit investigation is a procedure some investigations, all those points should be  
undertaken by a financial institution to vet a checked fully; in other investigations, certain The Credit Investigator will be primarily
potential client’s ability to pay back a loan. points may not need to be checked carefully concerned with the first and third functions,
Failure to pass this procedure means since they may have little bearing on the risk. while the second is primarily the responsibility
disapproval of a loan. of the credit analyst; if there is such a person in
           
            The credit investigator plays the role of the Creditor’s office; otherwise, it shall be
an aide or ally to the sales/ treasury function.             For applicants, the following credit performed by the head of the credit
Around this, revolve his usefulness, function information should be secured and verified: department.
and responsibility. Basically, he determines the  
facts in connection with the credit
worthiness of credit customers or credit Inspection and Appraisal of Real and Personal
applicants by gathering data on the standing of Property
an individual or the condition of a business  
concern.
                Inspection and/or appraisal of property
are conducted when they are offered or
required for a secured credit. This phase of the
 credit work goes hand in hand with the credit 2. Economic or investment value- the alternatives to the traditional collection of
investigation process. value which the property’s net earning power accounts receivable are:
will support based upon capitalization of net
  Purchasing Credit Insurance
income
            The object of appraisal and the duty of 3. Comparative or exchange value- the  
the appraiser, is to evaluate the property being value indicated by actual sales of comparable
properties in the market             Credit insurance, also referred to as
offered as collateral, fairly and on the basis of
trade credit insurance, is offered by insurance
its full cash value at a given point in time. There
  companies and some government export credit
are some drawbacks in arriving at the fair and
agencies. This insurance usually covers a fixed
equitable computation of value. The most that Basic Approaches to value
percentage of the accounts receivable. In other
an appraiser can do is to be as close as possible
  words, if the customer fails to pay a bill, your
to the prevailing values of properties in the area
insurance company reimburses you for a
so he can approximate value, in cash, for the
1. Cost Approach- a valuation method portion of that unpaid bill.
property being offered as security for the credit
sought. based on the principle that a prudent purchaser
 
will pay more than what it will cost him to
  acquire an equally desirable substitute site, and Factoring
to build similar improvement of equal
            Inspections are conducted for various  
desirability and utility.
reasons: ranging from ascertaining the
2. Income Approach- a method of             Instead of insuring your accounts
existence of the property, the true nature of the
evaluation based on the principle that value receivable, you may decide to simply sell them.
property, its location, condition, and estimating
tends to be set by the present worth of the Your factor determines which accounts
its real value vis-à-vis the one submitted by the
rights to future net benefits that may be receivable it wants to purchase and at what
debtor to the creditor.
derived from ownership. discount. For example, if a customer owes you
  3. Market Data Approach- this method of P10,000, your factor may offer you 8,500 for the
valuation is based on the principle that no account. You get your money when you sell the
What is an approach to value? property is worth more at a given date than the accounts receivable regardless of when (or
  amount of money necessary to purchase a whether) your customer pays. You gain quick
similar property of like kind with equal utility payment with no credit risk, but you lose the
            An approach to value is a method based and desirability. amount of the discount.
on factual data by which an indicated value is
evolved.    
     
The three facets of value: Considering Options to Reduce Risk Knowing when to insist on a personal guaranty
   
1. Cost value- the current cost of
reproduction or replacement of a property ,             You don’t want to wait and see whether             In the credit industry, rejection typically
depreciation from all causes your customers pay their bills. The two leading follows when an applicant’s net worth does not
justify the extension of credit for the mount
requested. One way to extend credit to    Marginal customers
applicants who fall into this category is to  Customers that may be facing economic
Considering Letters of credit for a Risky
request that the customer obtain a guaranty of hardship
Customer
payment from either a person or another
 Customers in countries where collection
company.  
is notoriously difficult
With a guaranty of payment, you can collect             Remember when you were a kid, and
 
payment from the guarantor without first trying your friend promised you a peso if you would
Simply put, a letter of credit is an
to collect from the primary debtor. jump into the deep end of the pool? You could
escrow arrangement. Remember in
With guaranty of collection or performance, not trust your friend’s promise, so you had your
your BFI that an escrow account is an
you must first attempt to collect from the big brother hold on to the money to make sure
account which can only be withdrawn
primary debtor before you can collect from the you get paid if you made the big dive. Well,
upon the fulfilment of an obligation.
guarantor. what if you could minimize your risk for your
sales by having a third party hold the loot and
           
pay off when your service is rendered or your
Maximizing your leverage: Filing Liens for product is delivered in good order? Check out
protection the letter of credit.
 
            When a customer does not pay,
sometimes you just want to pretend the sale
never took place. You want to go out to your
customer’s location and take your stuff back.
When goods are sold on open account, the
option is not available unless the customer
voluntarily returns the merchandise. That is
why liens were invented. A lien provides
security in the sense that if you don’t receive A letter of credit is a financial tool that protects
payment for the item you sold, you have the both the seller and the buyer by involving a
right to take it back. middleman who holds the money and verifies
            the documents. The middleman is usually a
major bank or financial institution. Sometimes
            To secure the assets, you and the debtor two banks are involved, the seller’s bank and
first enter into a security agreement, setting the buyer’s bank.
forth your rights to the collateral securing the
transaction. You then file a financing  
statement, a formal notice to other potential             Letters of credit are very effective tool to
creditors of your lien, with the appropriate ensure payment with:
government office.
 New customers