FIMA 30063 Credit and Collection PDF

FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Week 2 - OVERVIEW OF CREDIT Definition Nature/Characteristics Elements Function...

FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Week 2 - OVERVIEW OF CREDIT Definition Nature/Characteristics Elements Functions Classifications and Kinds Importance Loan Considerations Cs of Good and Bad Credit At the end of the lesson, the student is expected to: ▪ Recall and discuss basic credit principles ▪ Identify the sources and roles of different forms of credit and the responsibilities of different providers of credit ▪ Recognize the importance of credit to individuals, businesses and economy ▪ Explain the factors to consider in loan extension CAF - Department of Financial Management PUP, Sta. Mesa 10 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio OVERVIEW OF CREDIT CREDIT The ability to obtain things of value in exchange for a promise to pay at a determinate future time (debtor’s viewpoint) Willingness to accept the debtor’s promise based on trust and confidence (creditor’s viewpoint) SIGNIFICANCE OF CREDIT Credit plays a very important role in our present-day economy. It has changed not only the outward physical appearance of big and small communities but also the way of life and the standard of living of modern countries. The extent in the use of credit is also great that it determines the level of political, economic and social life of people today. This is so because credit when properly utilized in right proportion, promotes the functions of the regular medium of exchange. The use of credit allows the possible production of goods. When business opportunities appear and businessmen forecast profitable market possibilities, businessmen are willing to expand credit. As business opportunities decline, the need for credit also declines because the financial burden accompanying it increases. Credit plays an important role in the distribution of goods. The role of credit is to provide financial means for businessmen who take advantages of market opportunities in both domestic and foreign markets. It is also important that we must also recognize the endeavors of both the governmental and the private businesses to promote full employment. The increase in the production of goods and services, which will automatically increase employment of labor, will greatly depend on the businessmen’s forecasts of market expectations. Such increase in demand for the product will definitely be influenced by consumer’s desire and their ability to fulfill their desire. Consumer’s credit is a vital link between production and distribution. It allows consumers to buy goods and services beyond their ability to buy or what they can actually afford. CAF - Department of Financial Management PUP, Sta. Mesa 11 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio ELEMENTS OF CREDIT 1. Trust From the origin of the word credit which is creditum, meaning trust, it is evident that the first consideration in granting credit would be the presence of trust and confidence. 2. Futurity A distinct aspect which sets apart cash transaction from a credit transaction is the element of time or futurity. Whether the time is an hour, a day, a month or a year does not matter, provided that payment is after the specified lapse of time. 3. Risk Since the creditor has only to rely upon the debtor’s future performance, there is the element of risk. This is due to the uncertainty of payment of the possible reduction of payment. CHARACTERISTICS OF CREDIT 1. It is bilateral or a two-party contract Every debtor has his corresponding creditor; creditor his corresponding debtor. The creditor demonstrates his faith in his debtor by transferring title or ownership of the goods or services solely on his debtor’s promise to pay for them later. In turn, the debtor binds himself to pay and the same time recognizes the right of the creditor to collect from his the price of goods and services transferred to him. 2. It is a personal contract When a loan is extended, the debtor’s character is the primary basis. Although the debtor’s willingness to pay may be beyond question, another personal element must be considered…his ability to pay 3. It is a pecuniary contract In order to protect the rights of both parties, the debtor must know the exact amount of his obligations and the creditor must also know the extent of his claims. The most accurate way of measuring these magnitudes is thru the use of a reliable standard of deferred payments which is money expressing such debts or clams by the price involved. CASES WHERE CREDIT TRANSACTIONS ARISE Deferred payment for goods and services. Money loans For services rendered where individuals receive their wages or salaries after rendering their respective labor and talents or sometimes workers may render their services after receiving their money ahead of time. CAF - Department of Financial Management PUP, Sta. Mesa 12 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio ADVANTAGES OF CREDIT 1. Allows the immediate use of goods and services Use now pay later so to speak. This is especially helpful for big-ticket items such as house and lot, furniture, car, education which few people can afford to shell out cash for. t2. Shopping convenience Credit and charge cards allow us to shop and travel without having to carry large amounts of cash. 3. Provides a temporary solution to unexpected financial difficulties 4. It is an agent of production It is an accepted fact that idle funds do not help the economy. With the use of credit, these idle funds are channeled to productive activity. Those people with excess funds deposit them in banks which in turn lend them to businessmen to enable them to produce more goods. 5. Credit gives fluidity to wealth Because of the presence of secured loans, credit turns fixed assets into current assets. For example, one can get as a loan a certain amount in cash by using a real property as collateral for the loan. 6. Credit supplement the monetary system The circulation of checks representing bank credit tends to supplement the monetary system by providing other media of exchange. DISADVANTAGES OF CREDIT 1. It costs money Purchases paid for over time cost more – often much more than cash 2. It encourages overspending Credit makes impulsive buying easy. Some consumers go deeply into debt buying items they don’t need for the simple reason that they haven’t used up their credit line yet 3. It ties up future income Credit purchases mean less disposable income in the futures 4. It may result in losses If you fail to make payments on time, you may lose the merchandise. For loans that require collateral, you could lose valuable property CAF - Department of Financial Management PUP, Sta. Mesa 13 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio 5. Liberal credit can lead to over-expansion or over-speculation When a business is booming, credit is given fully. This further boosts prosperity. People become extra confident and forgot the possibility of depression. They will be riding on the crest of prosperity. When business suddenly slumps, they are caught unaware and will have to marshal funds to pay their debts. 6. The government that borrows heavily may have to curtail important projects when most necessary CLASSIFICATIONS AND KINDS OF CREDIT As to maturity Short-term - payable within one year Medium-term - payable from one to five years Long-term - payable for more than five years Call-loan - with indefinite maturity, payable immediately upon the demand of the creditor As to source Public - granted by government institutions Private - granted by commercial enterprises, banks and other financial institutions As to payment of interest Ordinary - interest is paid together with the principal on maturity date Discount - interest is automatically deducted from the principal at the time it is granted As to method of release Lump-sum - the principal is given once to the debtor Installment - the principal is broken down in staggered releases As to source of payment Self-liquidating - repayment will come from the income derived from the use of the principal Non-self-liquidating - repayment will come from the personal income (salary) of the debtor CAF - Department of Financial Management PUP, Sta. Mesa 14 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio As to purpose Agricultural - granted to finance agricultural needs such as for irrigation system, acquisition of seeds, fertilizers, and others Commercial - used to finance short-term working capital needs such as payment of maturing accounts and purchase of inventories Industrial - granted to finance long-term capital needs such as expansion expenditures and acquisition of fixed assets Real estate - used to finance the acquisition and improvement of real estates Personal or consumer- granted to individuals to facilitate the consumption of goods and services As to loan user Agricultural - farmers, fishermen and others engaged in agricultural activities Commercial - wholesalers, retailers, importers, insurers and brokers Industrial - manufacturers, processors, and others engaged in the production of goods Public Utility - franchise holders and operators of public utilities Real Estate - developers, brokers, contractors, condominium owners, purchasers of lots and persons contracting, repairing or renovating their houses Export - exporters Services - companies and persons rendering professional, educational, medical, recreational services such as schools, hospitals, sports club, law firms and accounting firms Personal or consumer - persons who will use the loan for medical, education or emergency needs or for the acquisition of consumer goods such as household equipment and appliance As to security Secured - credit issued with collateral Unsecured - credit issued without collateral, also known as character or clean loan Loan accommodations on a clean basis is usually granted to persons, firms, entities and corporations whose credit worthiness, based on the evaluation of the 5 Cs of credit is highly favorable based on the standards set. The financial capacity, cash flow, liquidity, business CAF - Department of Financial Management PUP, Sta. Mesa 15 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio profitability and stability of the borrower should be able to justify an accommodation, the repayment of which is solely dependent upon the strength and capability of the borrower. LOAN CONSIDERATIONS Purpose It is important that the purpose for which the loan will be used be productive to enable the borrower to repay the obligation incurred. It should also be useful to the community so it will contribute to the economic development of the region. Speculative loans are frowned upon. Type and size of loan Lending involved risks, hence the need to diversify the loan portfolio as a means of spreading the risks. Due consideration should be given to the amount involved because the larger the amount, the greater the aggregate risk. Maturity It must always be kept in mind that the longer the time, the greater the risk. Maturity of the loan should therefore be patterned to the duration of the financing needed by the borrower. Security To reduce the risks involved in lending, collaterals such as real estate, shares of stocks, receivables, machineries and equipment, inventories and others should be required. Interest Several factors should be considered in establishing the rate such as the cost of funds and the account relationship of the borrower with the lender. Loan Liquidation Repayment of the loan should be discussed thoroughly with the borrower and carefully considered when the loan is made to avoid possible trouble later. Failure to repay the loan on time impairs the liquidity of the lender’s loan portfolio and increases the risk THE TEN COMMANDMENTS OF CREDIT: THE Cs OF GOOD AND BAD LOANS The Cs of Good Loans One of the first thing examiners and lenders is the five Cs of credit. They are the tried and true rules of good loan-making, consisting of character, capacity, conditions, capital and collateral. The five Cs represent the “Thou Shall” commandments of lending. CAF - Department of Financial Management PUP, Sta. Mesa 16 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Character – Thou shalt make sure that the company or person you are lending to is of outstanding character. Character refers to the borrower’s payment habits and attitudes, that is, his willingness to pay. Capacity – Thou shalt be sure that the company or person you are lending to have the capacity to repay the loan. Capacity refers to the borrower’s ability to pay as reflected in his cash flows. If the borrower is not making money or generating a positive cash flow, odds are there will not be enough money to pay off its debt. In general, borrowing customers have only three sources to draw upon to repay their loans: (a) cash flows generated from sales or income, (b) the sale or liquidation of assets, or (c) funds raised by issuing debt or equity securities. Any of these sources may provide sufficient cash to repay a loan. However, lenders have a strong preference for cash flows as the principal source of loan repayment because asset sales can weaken a borrowing customer and make the lender’s position as creditor less secure. Moreover, shortfalls in cash flow are common indicators of failing businesses and troubled loan relationships. Capital – Thou shalt make sure that the borrower is adequately capitalized. Capital refers to the borrower’s net worth position relative to his outstanding debts. This provides a cushion for any losses that may occur and helps to keep the lender from ending up in bankruptcy court haggling over the remains of a dead company. Conditions – Thou shalt underwrite all loans understanding that business and economic conditions can and will change. Conditions refers to economic factors which may affect the borrower’s line of work or industry and how changing economic conditions might affect the loan. A loan can look good on paper, only to have its value eroded by declining sales or income in a recession or by the high interest rates occasioned by inflation. The lender cannot predict the future, but being alert will allow him to react to deteriorations in the market quickly, rather than reacting at the bottom of a downturn. CAF - Department of Financial Management PUP, Sta. Mesa 17 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Collateral – Thou shalt make sure that collateral does not drive lending decisions. Collateral refers to any asset which may be pledged against the debt. Credit factors should always be the primary consideration. Having a tangible (that is, seizable) asset backing up each deal means that if something goes wrong, the loan is covered. The traditional five Cs of credit should be thought of as commandments: Do this, check this, look for that. These rules have worked fairly well in the past, but in recent years, lenders have learned a few more Cs: the five Cs of bad credit. The Five Cs of Bad Credit It is necessary to add the five Cs of bad credit – the five things to guard against. Consider these the “Thou Shalt Nots” consisting of complacency, carelessness, communication, contingence and competition. Complacency One of the important lessons to be drawn from the past couple of years is to guard against complacency. Many lenders have said something like, “I don’t need to worry about the borrower, he has always paid us on time.” That is an incorrect assumption. Overemphasis on past performance is another concern. The old adage that past success does not guarantee future is very true. But it was ignored. How many lenders said, “The last three loans were paid as agreed. Why worry about this one?” Over reliance on large net worth is yet another concern. “I know him, I know his family. They have borrowed from us for years, he wouldn’t default on me.” The next thing the lender knows – he or she is sitting in bankruptcy court wandering what happened. Old loan officers forgot the bad times. It was easy to delude themselves into thinking that they would see another recession, that things would keep booming. As unfortunate as it is, the business expansion and recession is not going to go away. What about the new loan officers who have only seen the good times? When they do not know what the bad times look like, it is hard to maintain that healthy level of skepticism that they need to be good lenders. What experienced lenders need to emphasize to new lenders is the danger of good times. The danger is that bad times always follow. CAF - Department of Financial Management PUP, Sta. Mesa 18 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Carelessness It was easy to say, “Don’t worry about the loan covenants or documentation. I’ll get it later.” Well later is here, and there are a lot of loans out there with improper documentation, incomplete financials, inadequate loan covenants, and no one knows where to find the information because the officer responsible is no longer working for the company. Ant it is all because someone was careless. Inadequate Loan Documentation – A lien needs to be filed on some assets. “Don’t worry, I’ll file it next week,” the officer says. When next week comes, the officer finds out that another lien was filed between last week and today. Instead of being the first lien holder, the company is now second. Lack of Current Financial Information – Statements are not updated, appraisals are not completed, and before the lender knows it, a strong real estate developer has negative net worth and her property, which is the collateral for her loan, has declined 50% in value. Many lenders do not even know when this happens because they have not looked at the financials in a year and a half. Lack of Protective Loan Covenants – Careless lenders sometimes do not put language into the loan agreement that requires a closely held borrower to keep. Information Not Kept in Files – This is such an easy trap to fall into that everyone is guilty of it to some degree. Many lenders do not document calls or conversations, and the next thing they know they are trying to reconstruct conversations from two years ago because their company is taking the customer to court to recover a loan. Or worse yet, they are being taken to court in a lender liability suit over something they supposedly promised to do. It is easy to avoid these situations – just write the information down. Communication Poor communication, up and down the line is deadly. Unclear Credit Quality Objective – Management must be clear on credit quality objectives. Loan policy is written to provide standards for acceptable and unacceptable loans, but problems arise when no one follows the policies. Upward Communication – Let’s say the front line does not communicate upward. If the officer is meeting the customer, he or she probably knows that a problem exists in a certain industry well before anyone else. Many times, though, the officer will assume that if he or she knows about a problem, everyone knows about it. But that is not true. There must be upward communication. CAF - Department of Financial Management PUP, Sta. Mesa 19 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Unclear Communication by Regulators – In the past, regulators did not always communicate concerns early enough or consistently. Contingencies Competition is probably the most important of the five Cs of bad credit. Lenders started to make decisions because of what the lender down the street was doing, rather than concentrating on the merits of the loaning front of them. They decided to do whatever it took to win business. Unfortunately, that meant making credit standards as loose as, or loser than, everyone else’s. Competitive Euphoria – Lenders decided they were not going to lose deals, no matter what. If a borrower said he could get a loan at prime + 1 at a bank down the street, the banker up the street would offer prime + ½. “I am not going to lose this deal to anyone” was the way to look at it. Maybe the banker wanted to fully collateralize the deal, but the borrower was also negotiating with someone else. So instead, the banker went for 50% collateralization to get the business. The banker’s attention was not on loan characteristics, it was squarely on the competition. The fifth and final C of bad credit is beware of doing whatever it takes to win. Thou shalt not be swept away by competition. CAF - Department of Financial Management PUP, Sta. Mesa 20 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Week 3 - Introduction to Credit Management Objectives Risks Associated with Lending Structure and functions of Credit and Collection Unit/Department Qualities of a credit man At the end of the lesson, the student is expected to: ▪ Recognize the relevance of an effective and efficient credit management to the provider and user of credit ▪ Identify the risks associated with lending ▪ Discuss the principles for the management of credit risk ▪ Explain the functions performed by each personnel in the credit and collection department ▪ Describe an ideal credit man based on the qualities he must possess CAF - Department of Financial Management PUP, Sta. Mesa 21 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio CREDIT MANAGEMENT Effective management of the loan portfolio and the credit function is fundamental to a company’s safety and soundness. Credit management is the process by which risks that are inherent in the credit process are managed and controlled. RISKS ASSOCIATED WITH LENDING Risk – the potential that events, expected or unexpected may have an adverse impact on earnings or capital Credit Risk The risk of repayment, i.e., the possibility that an obligor will fail to perform as agreed. The first defense against excessive credit risk is the initial credit-granting process – sound underwriting standards, an efficient, balanced approval process and a competent lending staff. Management of credit risk, however, must continue after a loan has been made for sound initial credit decisions can be undermined by improver loan structuring or inadequate monitoring. Interest Rate Risk The level of interest rate risk attributed to the lending activities depends on the composition of the loan portfolio and the degree to which the terms of the loan expose the revenue stream to changes in rates. As part of the management process, borrowers whose loans have heightened sensitivity to interest rate changes should be identified and strategies to mitigate the risk should be developed. Liquidity Risk As part of liquidity planning, an overall liquidity strategy should include the identification of those loans that may be easily converted to cash. A loan’s liquidity hinges on such characteristic as its quality, pricing, scheduled maturities and conformity to market standards for underwriting. Loans are also a source of liquidity when used as collateral for borrowings. Liquidity is also affected by the committed amount to lend and the actual amount that borrowers draw against those commitments. There should be systems to track commitment and borrower usage. Knowledge of the types of commitments, normal usage levels and historically high usage levels are important in assessing whether available liquidity will be adequate for normal seasonal or emergency needs. Transaction Risk In the lending area, transaction risk is present primarily in the loan disbursements and credit administration processes. The level of transaction risk depends on the adequacy of information systems and controls, the quality of operating procedures and the capability and integrity of employees. For example, an increased credit risk may be incurred when information systems failed to provide adequate information to identify concentrations, expired facilities, or CAF - Department of Financial Management PUP, Sta. Mesa 22 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio stale financial statements. At times, losses may be incurred because of the failure to perfect or renew collateral liens, to obtain proper signature on loan document or to disburse loan proceeds as required by the loan documents. Compliance Risk Lending activities encompass a broad range of compliance responsibilities and risks. For example, a bank must observe limits on its loans to a single borrower, to insiders and to affiliates. It may also become the subject of borrower-initiated “lender liability” lawsuits for damages attributed to its lending or collection practices. Reputation Risk When a lender experiences credit problems, its reputation with investors, the community and even individual customers usually suffers. Inefficient loan delivery systems, failure to adequately meet the credit need of the community and lender-liability lawsuits are also examples of how reputation can be tarnished because of problems within its lending division. CREDIT DEPARTMENT AS A PROFIT CENTER More and more top managements are treating the credit department not merely as a cost center, but as a profit center as well. The traditional concept is that the credit management is for policing of receivables. The emerging view today is that credit management is tasked with the job of subjecting the investment in receivables to the test of profitability just as we test every other investment. The old approach to “what can credit do for sales” should be discarded and ask the broader, more important question” what can credit do for profits.” When trade credit is extended, you are committing some of the resources of the firm. Credit has its initial impact on sales but the ultimate goal should be to increase profits. The credit executive is presented with unlimited challenge to his abilities. The concomitant establishment of credit policy that will maximize net return from investment in receivable is the most difficult job but, if successfully pursued, top management would not fail to accord it the importance it deserves. The Credit and Collection Unit A credit and collection office does not have to be an elaborate one. In fact, it may be started with one or two personnel with adequate background in such work, gradually increasing the personnel in proportion to the volume of credit sales and its consequent increase of amount and number of receivables. The important thing to remember is that from the very beginning when a first credit, loan or investment is made, a credit and collection system should be in effect. It is an axiom in credit that collection is only as good as the credit processing and that the older an account becomes the harder it is to collect. It is important therefore that collection dates should be properly noted immediately and followed up accordingly. And this can be done only if a credit and collection system is in effect. CAF - Department of Financial Management PUP, Sta. Mesa 23 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Credit and collection are two different activities, though they are closely interrelated. The first refers to the processing, evaluation and extension of credit and the latter refers to the activities related to collection of accounts. When credit and collection activities are still small, problem starts when credit business becomes voluminous. The problem that will control top management is: Should credit function be separated from the collection function? Or more, briefly stated should the same set of personnel handle both credit and collection function as their collective responsibility? Or should these functions be separated? The decision will narrow down to the basic question: How trustworthy are the members of the staff? Concentration of both credit and collection functions in one and the same person or set of personnel is a source of great temptation. On the other hand, a centralized setup will minimize, if not totally eliminate, ‘buck-passing’ of responsibilities would be an easier job. Then, there is the consideration of operating costs. This is especially true if credit extensions are not limited to the immediate territory of the firm and its environs but extend to the provinces or even nationwide. Operating costs would sometimes dictate that a company’s provincial credit representative performs both credit and collection functions. The ultimate decision would lie on the shoulder of top management, which should consider all these circumstances. It is pertinent to point out the general practice, as it actually exists in the Philippines today. As a general rule, banks, and other allied lending institutions maintain separate sets of personnel for credit and collection. No explicit studies or explanations have ever been made why this is so. Another big problem that confronts top management in the matter of organizing the credit and collection unit is the question of who will make the final credit decision. Credit managers in some companies, although the title has been bestowed on them, do not make the final credit decision. Theirs are merely recommendatory, the final decision being reserved to a higher official. The reason is that many companies are family-owned and that, therefore, the investors feel a lot secure if the final credit decisions are made by such higher official usually a member of a family- owner. In fact, many credit extensions started merely as accommodation to relatives and friends of the family-owner, gradually expanding to other outsider. Some big outfits with national presence delegate final credit decisions to a “Credit Committee” composed of senior executives. With the expansion of the credit activities, the problem of who should making the final decisions becomes a very critical matter. Functions of the Credit Department All matters related to credit sales and occasionally anything that touches upon credit are among the functions of the credit department. The functions enumerated follow the general aspects of credit managements. Each particular type of business usually suits the activities of its credit department to the nature of its business. Gathering credit information – Through the credit investigators, the credit department gathers information about the applicant from direct and indirect sources. Sometimes information for policy formulation is also gathered. CAF - Department of Financial Management PUP, Sta. Mesa 24 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Analyzing credit information – All the information gathered is sent to the credit analyst who is in charge of applying the standard tests and measurements for performance. The non-financial data are critically subjected to analytical tools to determine the creditworthiness of the debtor. Credit checking and authorization – Once the analysis is undertaken, verification is made of the applicant’s papers and the proper authorization for credit is given by the authorized officer or committees as the case may be. Filing and recording – A record of the transaction is made and the credit folder of the applicant is prepared and filed. From time to time, the file or records, or both, whichever is the case, are updated. Credits adjustments – Adjustments are made in accordance with discount or net credit period, or both. In the case of banks, this may pertain to increasing or decreasing the credit lines, or perhaps extensions. Collection correspondence – Credit granting does not end with the approval of the application but with its collection. When the credit has been granted, collection follow- up, reminders, and other correspondence are sent to the debtor. Other functions – Other functions, which may fall within the jurisdiction of the credit department, are the exchange of credit information with other organizations and the dissemination of credit information to valued customers in case of banks. Credit information may also be used by other departments of the organization. THE CREDIT MANAGER When a business organization sells on credit, the administration of the credit becomes, on some level, a management function. The type and extent of management required is not the same in different types of institutions not is it always handled in the same way in comparable organizations. The level of management required for the administration of credit in a firm is determined, more than anything else, by the concept of credit prevailing here. In some instances, credit is viewed as a simple function of approving credit transactions. In other cases, as the concept broadens, the credit function embraces sales and finance policy and other top management strategy. The management of credit then becomes a responsibility of a higher order and calls for talent equal to the task. This task is handled by a credit manager. Credit positions vary according to the importance given to the position by top management. They are identified by countless different titles representing the graduations of authority and combinations of responsibility. On the officers’ level, the credit position may be known as Financial Vice President; in lower echelons, the position is designated as Credit CAF - Department of Financial Management PUP, Sta. Mesa 25 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Manager, Assistant Treasurer, General Credit Manager, Branch Credit Manager, Loans Manager, Credit Man, Credit Correspondent, and many other similar titles. Qualities of a Credit Man (The Cardinal CS of a Credit Man) Competence and Capability He should know his areas of responsibilities. He must be aware of institutional viewpoints and correspondingly acts in behalf of the institution as a whole. He should know and understand the goals, objectives and policies of the company, of the other departments in the organization; of his own department which is credit. He must have a clear understanding of what the end points of his efforts are and should be. Communication He must have the ability to effectively convey his ideas. This includes the preparation of reports and correspondence and also the delegation of duties and the corresponding authority to subordinate. Constructiveness He must be positive and constructive in his approach to both credit and collection management. He must find a way by which credit can be granted and in the process free himself of the negative image of one concerned with finding a way by which credit should be denied. Creativity He must keep pace with changing times and changing conditions. He should constantly pursue creative answers to new questions. He must be able to put old ideas together to solve a new problem. Conscientiousness He must be devoted and dedicated to his job. He must be a strong proponent of cooperation and coordination in the entire organization. Consistency He must be consistent in making credit decisions. He must have a consistent performance which is consistent with company goals and objectives. He must not unnecessarily deviate, nor completely veer away from policies and guidelines to accommodate friendships and other personal consideration. Certitude and Celerity He must not only act with certainty and accuracy but also with swiftness and speed. Contact He must have good contact, good public relations both within and outside the organization. It is particularly needed in gathering and verifying credit information. CAF - Department of Financial Management PUP, Sta. Mesa 26 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Cost-consciousness He knows how to minimize cost in credit evaluation, remedial account management and others. Character He must have character integrity, reliability and sometimes need to be a “character” to cope with clients who turn out to be “”characters”. Confidence He must be trusted by the debtor to have reciprocity of confidence between the credit man and the customer Considerateness He must have regard for other’s feelings. It is incumbent upon the credit man to extend assistance to the customer. Computer literate He must have at least some basic knowledge of computers and the ins and outs of information technology. Congeniality, charming personality, courage He should be cool and calm and deliberate, but certainly firm and uncompromising when he encounters pressures. Common Sense TESTS OF CREDIT DEPARTMENT OPERATIONS Credit executives have been diligent in seeking and applying quality tests to the credit that they are asked to accept. They have discovered that their investigations must be sufficiently complete to uncover all unfavorable information and to permit proper analysis, must be reasonable from a cost point of view, and must be done with sufficient speed to enable a decision to be reached without causing dissatisfaction. Credit management’s responsibility to the firm, the debtor and society having been recognized and the objectives of credit department operations having been clearly stated, the next step should be to measure the attainment of these objectives – to test the manner in which the credit department is meeting its responsibility. The tools or indexes are designed to provide credit management with some means for testing the efficiency of its credit operations. These tools help credit managers determine whether their departments are bringing about maximum sales and minimum losses. These tests are valuable in many important ways. 1. The periodic calculation of ratios, percentages and other figures is necessary to measure credit and collection results CAF - Department of Financial Management PUP, Sta. Mesa 27 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Unless this is done, there is no way of knowing just what has been accomplished and what changes have occurred in each of the various aspects of the firm’s credit business. 2. Keeping these statistical records makes it possible to set up standards or goals to shoot at in each phase of the credit and collections activity Without standards, there is no basis for judging accomplishments 3. Accumulation of records kept on the same basis from year to year enables to compare current credit and collection performance with that of previous periods and to determine the progress made. 4. If the firm’s credit business is large enough to require the time of more than one person, comparisons often may be made between different individuals. 5. May compare results shown in the firm’s figures with those reported by other firms. 6. The records may be used in forecasting future trends in credit sales volume, collections and other aspects of the business. Bad-Debt Loss Index The bad-debt loss index was one of the first tests to be developed and still is one of the tests most generally used by credit managers. The relationship is generally shown by dividing bad debts incurred during a period by total credit sales during the same period (bad debt loss/total credit sales) There is little uniformity in calculating this proportion. Some firms calculate the percentage of bad debts to total sales; others calculate the percentage of bad debt to credit sales. There is no uniform practice as to the time when an account is classified as bad debt. A big margin of error exists because some account may be written off as bad debts shortly after they become overdue, while others may be carried for many months before they are eventually written off. Consequently, a substantial portion of the bad debts recorded for a given year may have resulted from a credit decision or collection procedures in the preceding year. Yet they are compared with credit sales in the current year and conclusions drawn from the ratio are applied to the current year’s credit and collection policies. CAF - Department of Financial Management PUP, Sta. Mesa 28 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Credit Sales Index In all business enterprises it is important to know what percentage of total sales is represented by credit transactions. This percentage or index is computed by dividing credit sales by total net sales. (credit sales/total net sales) Collection Percentage, Days to Collect and Turnover of Receivables These tests are included under one heading because they are simply different ways of stating a similar fundamental relationship. The collection percentage, which is one of the most commonly used credit control indexes is determined by dividing the total amounts collected during a period by total receivables outstanding at the beginning of that period (collections made during period/receivables outstanding at beginning of period). Another criterion of credit management efficiency is how it uses capital invested in accounts receivable. The rate of receivables turnover is found by dividing the total sales by the average receivables outstanding (total credit sales/average receivables outstanding). The seasonality of the business is important in determining how to compute the average of the receivables outstanding. The activity of the investment in receivables may be expressed as a rate or in terms of the number of days required for one turn of the accounts. The latter can be computed by dividing 360 days by the receivables turnover rate (360 days/receivables turnover rate). Collection percentages, when decreasing show an accumulation of poor accounts or a slackening of collection efforts before the bad conditions become inevitable. These measures of credit activity should enable credit management to detect the effects of unsound policies. As with the other indexes, these figures should be compared with those for previous months and with those for the same month of as many preceding years as possible. Such an accumulation of figures over a period of years helps the credit manager to recognize seasonal trends that should be considered in any analysis. Likewise, comparisons with similar firms give some indication of the subject firm’s relative standing. As with the other indexes, this information is valuable when broken down into the types of credit accepted. These indexes reflect only averages; certain accounts may be falling behind in payments at the same time that overall collection tests disclose a favorable picture. CAF - Department of Financial Management PUP, Sta. Mesa 29 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio Number of Accounts Opened The credit department’s activity is reflected by the number of new accounts it opens during the period in question. This figure indicates the extent to which the business emphasizes credit service and whether or not it is alert to opportunities for attracting new trade. The number of new accounts opened may also measure the effectiveness of credit publicity. This figure, together with the acceptance percentage, measures the leniency or strictness of the business’s credit policy. Acceptance Index A measure of growing importance is the index or percentage showing the proportion of applicants for credit that are accepted. (applications accepted/applications submitted) This index varies considerably, depending on the firm’s line of business, the leniency or strictness of its credit-granting policies, and the stage of the business cycle. Past Due Index This test of credit management measures the proportion of all past due accounts, in amount or in number. This ratio should be figured in both number and amount because computing both formulas could give a very different picture if one large account is severely past due versus several small accounts past due. It is computed by dividing the total past due by the total outstanding (total past due/total outstanding) When this index is computed for several successive periods, it serves as a barometer indicating whether the general trend of poor pay is up or down. If this percentage increases faster than it should at any given time, credit management can take steps to curb the trend or bring it back to its normal position (which can be ascertained from record maintained over a period of years) Aging of Accounts This test is a detailed analysis of accounts – such as not due, 30 days past due, 60 days past due, and over one year past due. It stems from the fact that there is a direct and important relationship between the length of time that an account has been outstanding, the rate of collection, and the probable net loss from bad debts. Aging of accounts can be supplemented CAF - Department of Financial Management PUP, Sta. Mesa 30 | P a g e  FIMA 30063 - CREDIT AND COLLECTION By: Bernadette M. Panibio with a detailed itemized list of overdue accounts, showing both the name and present statues of such accounts. A list of this kind is valuable in authorizing additional requests. Cost Analysis Any final summation of the result of credit department activities should include cost figures. Credit management can make sounder policy decisions if it has accurate knowledge about the cost of operating a credit service and carrying receivables. Bad debts give one such measure, but losses from bad debts are only one item in the credit department’s operation. The expense of operating a credit department often exceeds all bad-debts losses. Wages and salaries of people employed in credit and collection activities are then most important single category of credit expense. Other expenses include fees and dues for credit information, rental or purchases of equipment and charges for outside collection services CAF - Department of Financial Management PUP, Sta. Mesa 31 | P a g e