Introduction to Credit and Collection PDF

INTRODUCTION TO CREDIT Security AND COLLECTION FUNCTIONS OF CREDIT CREDIT Economy in the use of mone The word ”credit” has been derived Helpful...

INTRODUCTION TO CREDIT Security AND COLLECTION FUNCTIONS OF CREDIT CREDIT Economy in the use of mone The word ”credit” has been derived Helpful to production from the Latin word ”credo” which Expansion of bank credit means ”I believe” or ”I trust”, which Benefits to consumers signifies trust or confidence reposed Credit to the government sector in another person. Stability The term credit means, reposing trust or confidence in somebody. CLASSIFICATION OF CREDIT In economics, it is interpreted to The various types of credit may be mean, in the same sense, trusting in classified in many ways. It can be according the solvency of a person or making a to the status of the debtor, according to the payment to a person to receive it time period, and according to purpose. back after some time or lending Others differentiate credit as public or money and receiving of deposits, private credit, monetized or non-monetized etc. credit, and other ways. NATURE / CHARACTERISTICS OF 1. Public And Private CREDIT Public Credit Some characteristics of credit are of prime Includes all grants of credit to governments: importance when extending credit to an National, provincial, municipal, and its individual or to a business enterprise. instrumentalities. Confidence Private Credit Capacity Refers to all grants of credit to non - Security governments: Individuals, partnerships, Goodwill corporations, and other private institutions. Size Of Credit Period Of Credit 2. Secured and Unsecured Secured ELEMENTS OF CREDIT The most acceptable security or collateral is Risk Of Nonpayment land with a title, other forms of assets which Timing are acceptable are stocks, bonds, houses, machines, crops, and other valuable Description: A line of credit secured by the properties. equity in your home. You can borrow and Unsecured repay repeatedly up to a credit limit. Loans are granted without security. Features: Variable interest rates, Example: interest-only payment options during the Character loans-small loans which are draw period. granted to borrowers on the basis of their character. 2. Installment Credit Personal Loans: 3. Purpose Description: Lump-sum loans repaid over a Commercial Credit set period with fixed or variable interest Agricultural Credit rates. Investment Credit Features: Used for various purposes like Consumer Credit debt consolidation, medical expenses, or large purchases. 4. Time Period Auto Loans Short-term Credit Description: Loans specifically for Medium-term Credit purchasing a vehicle, repaid in fixed Long-term Credit monthly payments. Features: Secured by the vehicle itself, TYPES OF CREDIT typically with fixed interest rates. 1. Revolving Credit Student Loans: Credit Cards: Description: Loans for education expenses, Description: Allow you to borrow up to a which can be federal or private. certain limit and repay over time. Interest is Features: Often have deferred repayment charged on the balance carried forward if options while in school and may offer it’s not paid in full. income-based repayment plans. Features: Flexible borrowing, minimum monthly payments, and potential rewards or 3. Secured Credit cash-back benefits. Secured Credit Cards: Home Equity Lines of Credit Description: Credit cards backed by a cash (HELOCs): deposit made by the cardholder, which acts as collateral. Features: Often used to build or rebuild Description: Credit extended by suppliers credit history, with credit limits typically allowing businesses to buy goods and pay equal to the deposit. later. Secured Loans: Features: Typically short-term and helps Description: Loans backed by collateral, manage such as a car, home, or savings account. cash flow. Features: Lower interest rates due to reduced risk for the lender. 6. Specialized Credit Payday Loans: 4. Unsecured Credit Description: Short-term, high-cost loans Unsecured Personal Loans: typically due on the borrower’s next payday. Description: Loans not backed by collateral, Features: Extremely high-interest rates and based on creditworthiness. fees, usually considered a last resort. Features: Higher interest rates compared to Title Loans: secured loans, but no need for collateral. Description: Short-term loans where the Unsecured Credit Cards: borrower’s vehicle title is used as collateral. Description: Credit cards not backed by a Features: High interest rates and fees, and cash deposit or other collateral. the risk of losing the vehicle if the loan is not Features: Based on the borrower’s credit repaid. history and income. LEVEL OF CREDIT 5. Business Credit The "level of credit" can refer to various Business Credit Cards: aspects of credit, including the amount of Description: Credit cards issued to credit available, the creditworthiness of an businesses, often with rewards tailored to individual or business, or the type of credit business spending. being used. Here’s a breakdown of these Features: Useful for managing business different levels: expenses and building business credit Business Loans: 1. Credit Limits Description: Loans provided to businesses Credit Card Limits: for expansion, equipment, or other needs. Description: The maximum amount you can Features: Can be short-term or long-term, borrow on a credit card. and may be secured or unsecured. Trade Credit: Levels: Can range from a few hundred to Description: Credit that allows ongoing several thousand dollars, depending on borrowing and repayment within a credit creditworthiness and the issuer’s policies. limit, such as credit cards and lines of credit. Loan Amounts: Levels: Includes various credit cards and Description: The maximum amount you can lines of credit with different limits and terms. borrow through loans (personal, auto, Installment Credit: student, etc.). Description: Loans that are repaid over a Levels: Vary widely based on the type of fixed term with regular payments, such as loan, the lender’s criteria, and the auto loans, personal loans, and mortgages. borrower’s financial situation. Levels: Varies based on loan amount, interest rate, and repayment term 2. Creditworthiness Secured vs. Unsecured Credit: Credit Scores: Description: Secured credit requires Description: A numerical representation of collateral (e.g., secured credit cards, auto your creditworthiness, typically ranging from loans), while unsecured credit does not 300 to 850. (e.g., unsecured personal loans, credit Levels: Generally classified into ranges like cards). poor (300-579), fair (580-669), good Levels: Secured credit generally offers (670-739), very good (740-799), and higher credit limits and lower interest rates excellent (800-850). compared to unsecured credit. Credit Ratings: Description: Ratings assigned to individuals 4. Credit Stages or businesses by credit agencies to reflect Initial Credit: their creditworthiness. Description: The beginning stage of credit, Levels: For businesses, ratings may range where individuals or businesses start from high investment-grade (e.g., AAA) to building their credit history. speculative (e.g., BB). For individuals, Levels: Often involves secured credit cards ratings are more typically expressed as or small loans. credit scores. Established Credit: Description: A stage where a credit history 3. Types Of Credit is established, and the individual or Revolving Credit: business has a track record of borrowing and repaying credit. Levels: Includes higher credit limits and Technology has supported the development more favorable terms for loans and credit of the financial service industry and reduced cards. the cycle of money to the shortest possible Prime Credit: duration. A number of financial institutions, Description: A high level of creditworthiness including banks have started online characterized by a strong credit score and services. The growth of innovative retail favorable terms. products offered by banks is increasing Levels: Access to the best rates and terms sharply. for credit products. Debit Cards Subprime Credit: Credit Cards Description: A lower level of Housing Loans creditworthiness characterized by a lower Auto Loans credit score and higher risk. Personal Loans Levels: Often associated with higher interest Educational Loans rates and less favorable credit terms. Loans Against Securities Consumption Loans For The 5. Credit Utilization Purchase Of Durables Credit Utilization Ratio: Hybrid Loan Products Description: The ratio of your credit card balances to your credit limits. CREDIT PROVIDERS Levels: Maintaining a lower credit utilization Credit providers are companies or entities ratio (e.g., below 30%) is generally seen as that offer a range of financial solutions to favorable and can positively impact credit consumers. These solutions include loans, scores. credit cards, goods and services on credit and overdraft facilities. ★ Understanding these levels helps you navigate your credit options 1. Banks more effectively, whether you’re A bank is an organization licensed to applying for new credit, managing take deposits and extend loans. existing credit, or seeking to improve Banks are financial institutions your creditworthiness. where people and organizations can borrow and invest money. INNOVATIVE CREDIT PRODUCTS 2. Credit Unions  A credit union is a non profit financial Ways to check your credit: institution that’s owned by the Payment History people who use its financial Used credit vs. available credit products. Types of credit card Credit unions are an alternative to New credit banks in that they provide financial products and services, but the IMPORTANCE OF CREDIT money is normally put back into the When consumers and businesses local community. can borrow money, economic transactions can take place 3. Utility Companies efficiently and the economy can Most utility supplies (water, gas, grow. Credit allows companies electricity and telecoms) are access to tools they need to produce provided on a credit basis. the items that their customers buy. A business that couldn‘t borrow 4. Pawnshops might be unable to buy the machines Pawnshops in the Philippines allow and raw goods or pay the you to borrow money using your employees it needs to make jewelry, gadgets, vehicles, or products and profit. Credit also appliances as collateral. makes it possible for consumers to purchase things they need. 5. Government Agencies The PH government offers loan 5 CS OF GOOD CREDIT programs through different The five C's of credit is a system used by departments to support the needs of lenders to gauge the creditworthiness of individuals, businesses, and potential borrowers. communities. 1. Character — the applicant's credit history. 6. Licensed Moneylender 2. Capacity — the applicant's Any individual or organization who debt-to-income ratio. has obtained a credit license can be 3. Capita — the amount of money an described as a licensed applicant has. moneylender. 4. Collateral — an asset that can back or act as security for the loan. 5. Conditions — the purpose of the loan, the amount involved, and OBJECTIVES OF CREDIT MANAGEMENT prevailing interest rates. Credit management is concerned mainly with using the bank‘s CREDIT AND ITS ROLE IN resources both productively and FINANCIAL MARKETS profitably to achieve preferable 1. Facilitates Economic Activity economic growth. 2. Risk Management Safeguarding customer risk, settling 3. Economic Growth outstanding balances, and improving 4. Price Discovery and Efficiency cash flow are three key objectives of 5. Financial Stability credit management that are 6. Credit Types and Instruments imperative to founding profitable success. FINANCIAL MARKETS Refer broadly to any marketplace where securities trading occurs, including the stock market, bond market, forex market, and derivatives market. Financial markets are vital to the smooth operation of capitalist economies. CREDIT MANAGEMENT Credit management is defined as your company’s action plan to guard against late payments or defaults by your customers. An effective credit management plan uses a continuous, proactive process of identifying risks, evaluating their potential for loss, and strategically guarding against the inherent risks of extending credit.  CREDIT POLICIES, higher margins, as they can absorb PROCEDURES AND SYSTEMS potential losses better than lower-margin items. CREDIT POLICY Credit policy is a firm-specific Payment Terms: framework, designed by Offer favorable payment terms for management, to standardize lending higher-margin products to encourage sales decisions in accordance with the while applying stricter terms for firm’s risk appetite. lower-margin items. A credit policy is a set of guidelines that a business establishes to Risk Assessment: determine how it grants credit to Assess customer creditworthiness based on customers. It outlines terms of credit, their purchasing behavior, particularly eligibility criteria, and procedures for regarding higher-margin products. assessing creditworthiness, ultimately aiming to manage Incentives: financial risk and ensure timely Provide incentives for customers to payments. purchase higher-margin items, possibly through discounts or favorable financing CREDIT POLICY BASED ON PRODUCT options. MARGINS A credit policy based on product margins CREDIT POLICY BASED ON CHANGING involves setting credit terms and limits that ECONOMIC CONDITIONS reflect the profitability of different products. A credit policy based on changing economic Here’s how it typically works: conditions involves adjusting credit terms and strategies in response to economic Margin Analysis: indicators, such as inflation rates, Evaluate the profit margins of various unemployment levels, and market demand. products. Higher-margin products may allow Key aspects include: for more lenient credit terms since they offer better returns. Risk Assessment: Regularly evaluate customer Credit Limits: creditworthiness in light of economic shifts, Set higher credit limits for products with tightening credit during downturns and Lifecycle Assessment: potentially loosening it during growth Evaluate the lifecycle of products to periods. anticipate obsolescence, adjusting credit terms as products approach the end of their Terms Adjustment: life. Modify payment terms, such as lengthening repayment periods during tough times to Shorter Credit Terms: support customers, while tightening them Implement shorter payment terms\ for items when the economy is robust. that are likely to become obsolete quickly, reducing the risk of unpaid debts. Monitoring Indicators: Stay informed about economic trends to Inventory Management: proactively adapt credit policies, ensuring Monitor inventory closely to identify alignment with market conditions. slow-moving items, offering discounts or revised credit terms to encourage sales Flexibility: before obsolescence sets in. Maintain flexibility in credit offerings to respond quickly to changes, helping protect Customer Education: cash flow and minimize risk. Inform customers about the risks of investing in soon-to-be-obsolete products, Communication: helping them make informed purchasing Engage with customers to understand their decisions. challenges and adjust credit terms accordingly, fostering loyalty and Dynamic Pricing: maintaining relationships. Adjust prices and credit limits based on the product’s remaining market viability, CREDIT POLICY BASED ON PRODUCT ensuring alignment with its current value. OBSOLESCENCE A credit policy based on product CREDIT PROCEDURE obsolescence addresses the risks A credit procedure is a systematic process associated with products that may lose that a business follows to evaluate and value or relevance over time. Key manage credit applications and accounts. elements include: Application Review: Assessing customer credit applications for Educate staff on the company’s credit necessary information and documentation. policies, including evaluation criteria and risk management strategies. Credit Evaluation: Analyzing the customer’s creditworthiness Analytical Skills: using credit reports, financial statements, Provide training on analyzing credit reports and other relevant data. and financial statements to assess customer creditworthiness. Decision Making: Determining whether to approve or deny Decision-Making Processes: credit based on established criteria. Teach staff how to make informed credit decisions based on established guidelines. Terms Setting: Establishing the terms of credit, including Communication Techniques: limits and payment schedules. Train on effective communication with customers regarding credit terms, Monitoring Accounts: expectations, and collections. Regularly reviewing customer accounts for payment behavior and adjusting terms as Technology Utilization: necessary. Familiarize staff with any software or tools used for credit management and monitoring. Collections: Implementing procedures for managing late Ongoing Education: payments or defaults, including follow-up Encourage continuous learning about and recovery efforts. industry trends, regulatory changes, and best practices. CREDIT PROCEDURES TRAINING THE CREDIT STAFF CREDIT SCORE Training credit staff on credit procedures A credit score is a number between involves several key components. 300–850 that depicts a consumer's creditworthiness. The higher the Understanding Policies: score, the better a borrower looks to potential lenders.  The credit score model was created creditworthiness, such as income, by the Fair Isaac Corporation, also debt-to-income ratio, and past known as FICO, and it is used by delinquencies. financial institutions. While other credit-scoring systems exist, the Data Preprocessing: FICO score is by far the most Clean and preprocess the data, addressing commonly used. missing values and normalizing data as needed. FICO SCORES RANGE FROM 300 TO 850: Model Selection: 800+ is exceptional. Choose a modeling technique, such as 740 to 799 is very good. logistic regression, decision trees, or 670 to 739 is good and represents machine learning algorithms. the median credit score range 580 to 669 is below average. Training the Model: 579 or less is poor. Split the data into training and test sets, using the training set to develop the model. CREATING CREDIT SCORING MODEL Creating a credit scoring model involves Validation: several steps: Validate the model’s performance using the test set, assessing metrics like Define Objectives: accuracy, precision, and recall. Determine the purpose of the model, such as predicting default risk or optimizing credit Implementation: decisions. Deploy the model within the credit decision-making process and monitor its Data Collection: performance regularly. Gather relevant data, including historical customer information, payment behaviors, Refinement: and credit history. Continuously refine the model based on new data and feedback to enhance its Feature Selection: predictive power. Identify key variables that influence FAIR ISAAC CORPORATION  (FICO MODEL) The FICO model, developed by the Fair Isaac Corporation, is a widely used credit scoring system that assesses an individual's creditworthiness. It ranges from 300 to 850, with higher scores indicating lower risk. Key components of the fico model: Payment History (35%): Tracks on-time payments versus late or missed payments. Credit Utilization (30%): Measures the ratio of current debt to available credit limits. Length of Credit History (15%): Considers the age of credit accounts and overall credit history. Types of Credit (10%): Looks at the variety of credit accounts, such as credit cards, mortgages, and installment loans. Recent Credit Inquiries (10%): Accounts for recent requests for new credit, which can indicate risk if excessive.