INTRODUCTION.pdf

INTRODUCTION Establishing appropriate credit policies and collection procedures is vital to the success of any small business. You must decide what types of credit to offer, or even if offering credit is right for your business. Credit and collections are for many small employers what changin...

INTRODUCTION Establishing appropriate credit policies and collection procedures is vital to the success of any small business. You must decide what types of credit to offer, or even if offering credit is right for your business. Credit and collections are for many small employers what changing diapers is for many parents: although everyone agrees it's essential, no one really wants to do it (but they're sure glad they did after the fact). As a result, many small business owners put off creating a credit and collection policy until they absolutely have no other choice. As their customer base builds, and more and more customers want to pay by credit, they realize that they need to open up a credit card account or offer credit terms. Or they ignore those few customers who don't pay their bills, until the few grow into many, and suddenly they realize that they need to spend time collecting overdue accounts. The problem with this approach is that small businesses that don't plan ahead frequently end up spending a lot more of their time fixing the trouble than they would have taken if they had spent a little more time thinking about their credit policy beforehand. And, in countless cases, a poorly planned credit policy has ruined what was otherwise a thriving business. To better serve your business and your customers, we'll guide you through the process of setting up a credit and collection policy. No one wants to spend all of their time collecting debts (unless, of course, you're in the debt collection business). Your time is much more productively spent doing what you do best—running your business. But if you just spend a little bit of time thinking about your credit policy early on, you can save yourself time and money down the road. The success of your business may depend upon it. Understanding Your Credit Options Many people will tell you that, as a business owner in today's economy, you don't have any choice but to offer credit to your customers. They'll tell you that credit is as essential to business success as oxygen is to breathing. Well, they're mostly right. But it's not an absolute rule for every business, particularly for smaller businesses with fairly small customer bases. Don't fall into the trap of thinking that you should offer credit just because everyone else does. As you'll see as you go through this discussion, trying to collect from those who don't pay you can be extremely time-consuming, costly, and frustrating. Should You Offer Credit to Your Customers? Your decision on whether to extend credit to your customers won't involve a lot of complex analysis. It'll be based mostly on good common sense. If the benefits of offering credit, such as increased sales, outweigh the costs of offering it, such as the risks and costs of nonpayment, you should offer it. If not, you shouldn't. Just don't forget that if you extend credit freely and don't get paid, it won't matter how much new business you generate. Abiding by the Guiding Principles In deciding on a credit policy, you should be guided by the following principle: If you can demand cash up front, and your customers are willing to give it to you, that should be your policy. If that's not possible, follow this principle: Get as much of your payments up front and in cash as possible. In other words, extend credit only if business conditions demand it. Be sure to consider the factors that will come into play in determining the likelihood that you'll have to offer credit. And you'll need to figure out which types of credit are best for you, if conditions will demand it for your business, as they do for most others (particularly those that sell mostly to other businesses). There are several from which to choose: credit cards, checks, and a wide variety of credit terms (payable in 30 days; half in cash up front, the other half on delivery; 10 percent down, the remainder within 60 days; etc.). Factors to Consider When Deciding Whether to Extend Credit As mentioned before, extending credits isn't for everyone—but it is smart for many small businesses. Here's a look at some of the factors that should play a role in your decision whether to offer credit to your customers, and under what terms and conditions. Following Your Industry If the custom in your industry is to provide credit, you may have no choice but to offer it. If you own a fast-food restaurant, you probably can get away with requiring full payment in cash. But if you're a consultant or a lawyer, you may lose business if you don't extend credit. An angle you should consider is whether you can gain an advantage over your competitors by offering credit where the industry custom is not to offer it. Can you make more money by letting your customers buy a hamburger with a Visa card? If you can, perhaps you should. If the type of business you're in is one where credit plays an essential role, you also may have no choice but to offer credit. For example, if you sell your goods through the mail, you'll probably have to extend credit to your customers. Knowing Your Customers Consider these examples of knowing your customers to determine a credit policy:  The more dependent you are on repeat customers, the more likely it is that you'll extend credit to them. If your business is catering, you may be more likely to extend credit than if your business is in the tourism sector.  The better you know your customers, the more likely it is that you'll extend credit to them. If your business is consulting, you're more likely to offer credit than if your business is palm reading.  The bigger your customers are and the more buying power they have, the more likely it is that they'll dictate to you whether you offer credit. If your business is selling goods to IBM, you're more likely to offer whatever means of payment IBM wants than if your business is selling lemonade to the neighbors. Also, the wealthier your customers are, the more likely it is that you'll extend credit to them. Considering Your Location The more economically depressed the area surrounding your business is, the less likely it is that you'll extend credit to your customers (assuming you sell goods and services to people in the community). If your business is selling shoes in a poor area of town, you're less likely to extend credit than if you sell shoes in a wealthy area. Measuring Your Transaction Size The larger your typical transaction is, the more likely it is that you'll have to extend credit. If you sell your own oil paintings at art fairs, your customers will probably expect to be able to pay by credit card. On the other hand, if you sell ice cream cones at art fairs, your customers should expect to pay in cash. Assessing Your Financial Condition The stronger your financial condition and the better your cash flow, the more likely it is that you'll extend credit. If your cash flow is poor, and you cannot afford to carry much credit, then you'll be less likely to extend credit than if your financial condition were stronger. MODULE I. The Fundamentals of Credit and Collection. I. What is Credit and Collection?  Credit and collection are two related but distinct concepts in the field of finance. Credit is the process of providing a loan, in which one party transfers wealth to another with the expectation that it will be paid back in full plus interest. In credit and collection, collection refers to the process of collecting payments from debtors. Companies achieve this through several methods, depending on the delinquency levels. It’s important to remember that collection itself does not necessarily imply late payments. It refers only to the process of collecting the money owed. Also, credit collection refers to the debt recovery process of unpaid and pending credit loans from the consumer in debt. Credit and Collection management (CCM) is a suite of integrated business applications that extends to a company’s accounts receivable and accounting system to facilitate credit management and collections processes. Credit management focuses on preventing uncollectible accounts (bad debts), minimizing late payments, and reducing credit risk, while Debt Collection involves pursuing payment of debts that are past due. The job duties of a credit and collection manager involve overseeing credit and collections operations for a company or organization. In this, career, your responsibilities include running credit checks on each customer, client, or vendor to assess the risk involved in a loan, credit, or other financial agreement. 1. What Credit is? Credit is the privilege of using someone else’s money for a period of time. That privilege is based on the belief that the person receiving credit will honor a promise to repay the amount owed at a future date. In this arrangement, the dairy farmer is getting his wool today. However, he is paying for it over a period of 3 months. Image reference: Credit - definition and meaning - Market Business News Credit is an arrangement to receive cash, goods, or services now and pay for them later. This is the easiest and simplest definition (Personal Finance – Kapoor, Dlabay, and Hughes, 2nd ed) Credit is defined in many ways. In business, credit is viewed differently. To a lender it connotes trust on the borrower’s capacity and willingness to pay. To the borrower, it is the ability to obtain goods or services in exchange for a promise to pay. In this module, credit is defined as a transaction involving the transfer of goods, services, funds, property or rights, thereby creating an obligation on the part of those who receive them, that must be complied with in the future. This definition indicates an exchange between 2 parties: the first party providing the goods, services, funds, property, or a right and the second party, who receives any of them, will have the obligation to comply with this obligation by promising to pay for them in cash, in kind or to return the thing borrowed. These parties, respectively, are generally called the creditor and the debtor. Other synonymous terms are lender in lieu of creditor, and borrower for debtor. CREDIT IN FINANCE A credit contract is a legal agreement whereby one party loans funds to another. The terms of the contract specify the amount lent, the payback date and the interest rate on the loan. In other words, a credit is a contract of a loan or delayed payments of funds or goods. Credit can also refer to the borrowing capacity of an enterprise or individual. The term is often used to mention the terms and conditions of a postponed payment option, while the word credit also denotes the period that is offered for deferred payment. 2. Basic elements of credit 1. Trust and confidence-The essence of credit is confidence on the part of the creditor. Motivated thus by his/her faith in his/her fellowmen, the creditor parts with things of value in the expectation that he will be paid in the future. Perspectives on public trust in business and finance Trust is a basic element for the well-functioning of institutions, including governments, markets, businesses, and for society more broadly. The concepts of public trust have been considered by a range of authors, including by Kenneth Arrow, Douglass North, Francis Fukuyama, and Robert Putnam, among others, who explore the importance of public trust for the functioning of institutions, markets, and commerce (see Arrow, 1999; Fukuyama, 1995; Putnam, 2000). Arrow suggests that virtually every commercial transaction has within itself an element of trust, as transactions conducted over a period of time have an element of uncertainty. He argues that much of the economic backwardness in the world can be explained by the lack of mutual confidence (Arrow, 1972). Fukuyama illustrates how societies with high social capital from public trust are more able to efficiently pool resources – labor, capital, ideas and innovations – to generate economic growth and progress, have low levels of corruption, and maintain level playing fields. According to Hawley and Kirby, trust in institutions (including corporations) derives from the capacity of these institutions to fulfil a commitment (Hawley, 2014), pp.1-20; Kirby et al., 2018), pp.75-129). Three observations are relevant to qualify trust in the financial system and commerce. First, some commitments are explicit while others are implicit, and eliciting implicit commitments is required to build trust. Second, some commitments are legally enforceable, while others are not. It follows that, while compliance matters, restoring or enhancing trust requires moving beyond compliance. Third, trust combines different levels of aggregation, from the trustworthy corporation to trust in a particular industry (e.g. the financial system) and trust in a set of social institutions (including government). From these conceptual studies, one can infer that the sharp deterioration of public trust in governments and private-sector institutions that engage in capital formation and commerce calls for the careful consideration of possible policy responses and actions. 2. Futurity – There is always a future time involved regardless of whether it is an hour, a day, a month or even years. 3. Risk – The risk involved would be the uncertainty faced by the creditor, whether he gets paid in full, in part or not at all. The degree of risk involved would be measured by the other factors. The risk could be minimized when the loan is secured. 3. Understanding Credit Law in the Philippines: Legal Rights and Responsibilities Popular Legal Questions and Answers Questions Answers 1. What are the laws that govern credit The laws that govern credit transactions in the transactions in the Philippines? Philippines include the Civil Code of the Philippines, the Consumer Act of the Philippines, and the Truth in Lending Act. 2. What are the rights of borrowers under Borrowers have the right to be informed of the terms Philippine credit law? and conditions of the credit transaction, the right to dispute inaccurate information in their credit report, and the right to fair and non-discriminatory treatment from creditors. 3. Can creditors in the Philippines impose high Yes, but there are regulations in place to protect interest rates on loans? borrowers from excessively high interest rates. Creditors must comply with the maximum interest rates set by the Bangko Sentral ng Pilipinas. 4. What are the consequences of Defaulting on a loan can leads to legal action by the defaulting on a loan in the Philippines? creditor, negative impact on the borrower’s credit score, and potential loss of collateral pledge for the loan. 5. Are there laws in the Philippines that protect Yes, the Consumer Act of the Philippines prohibits consumers from predatory lending practices? unfair and unconscionable lending practice, such as deceptive advertising and fraudulent scheme. 6. Can a borrower in the Philippines dispute Yes, borrowers have the right to dispute inaccurate errors in their credit report? information in their credit report. They can request the credit bureau to investigate and correct any errors. 7. What are the legal requirements for debt Debt collectors must comply with the Fair Debt collection in the Philippines? Collection Practices Act, which prohibits abusive, deceptive, and unfair debt collection practices. They must also respect the borrower’s privacy and refrain from harassment.  8. Can creditors in the Philippines seize a Yes, creditors can seize a borrower’s property borrower’s property to satisfy a debt? through legal means if the borrower defaults on a secured loan. However, they must follow proper legal procedures and obtain a court order. 9. What are the legal remedies available to Borrowers can file a complaint with the Bangko borrowers in the Philippines in case of creditor Sentral ng Pilipinas or seek legal assistance to stop harassment? creditor harassment. They may also be entitled to compensation for damages caused by creditor harassment. 10. Is it legal for creditors in the Philippines to No, creditors are prohibited from engaging in engage in unfair debt collection practices? unfair debt collection practices under the Fair Debt Collection Practices Act. These practices include using threats, coercion, or false representations to collect a debt. CIVIL CODE OF THE PHILIPPINES: Book IV Title XI-XVI (Credit Transactions) TITLE XI LOAN GENERAL PROVISIONS Article 1933. By the contract of loan, one of the parties delivers to another, either something not consumable so that the latter may use the same for a certain time and return it, in which case the contract is called commodatum; or money or other consumable thing, upon the condition that the same amount of the same kind and quality shall be paid, in which case the contract is simply called a loan or mutuum. Commodatum is essentially gratuitous. Simple loan may be gratuitous or with a stipulation to pay interest. In commodatum, the bailor retains the ownership of the thing loaned, while in simple loan, ownership passes to the borrower. (1740a) Article 1934. An accepted promise to deliver something by way of commodatum or simple loan is binding upon parties, but the commodatum or simple loan itself shall not be perfected until the delivery of the object of the contract. (n) 4. Users of credit Who are the users of credit and why they borrow? 1. General Consumers: Credit is used by ordinary people to buy things like a house, a car, a television, and vacations. Consumer credit is a system that allows people to borrow money or take on debt and pay it back over time. Credit allows customers to purchase goods or assets without having to pay cash at the time of purchase. 2. The Government: They borrow money at the national, provincial, and municipal levels to provide goods and services to citizens, such as building schools, hospitals, highways, and airports, and paying employee salaries. 3. Businesses: A business’s lifeline is having access to business credit. It allows the owners to get the capital they need to expand, cover day-to-day expenses, buy inventory, hire more people, and keep cash on hand to cover the cost of doing business. 5. Characteristics of Credit