Extending Credit - PowerPoint Presentation

Slide1

Extending Credit To Your Customers

Establish Effective Credit and Collection PoliciesSlide2

Advantages

of

Trade Credit In Your Business

Encourage

customers to

buy more

Improve customer loyalty and

build good

customer

relations;

Make

your customers less sensitive to price and more focused on the services you

offerSlide3

Advantages

of

Trade Credit In Your Business

You can factor or finance receivables

Well designed accounts receivable management policies impress potential creditors and investors Slide4

Disadvantages

of Trade

Credit

Accounts receivable often constitute a significant portion of assets.

Receivables may not be highest quality given firm’s recent financial condition.

Controlling the accounts receivable process demands the development of policies that are compatible with an enterprises profit, liquidity and market share

.Slide5

Accounts Receivable Policy

Granting credit is actually the practice of making an investment in your customers.

You

have to decide what customers are worthy of that investment

.

If

you do a cost/benefit

analysis and

make

the

important

decision to extend

credit you need

to

establish

procedures for credit and collecting accounts. Slide6

Accounts Receivable Policy

Let’s begin with the Acceptance Rejection Model linked to Excel

The Acceptance/Rejection Costs model serves as a framework for evaluating decisions on changing credit policies;Slide7

Accounts Receivable Policy

Since the accounts receivable policy has a broad impact, it must be managed carefully and assessed frequently

.Slide8
Slide9

Accounts Receivable Aging

Problems in individual accounts can be detected through analysis of your receivables by aging.

A

receivables aging divides each customer's account into amounts that are 0-30 days old, 31-60 days old, 61-90 days

old

.Slide10

Number of Days Outstanding

Amount

Percent

0 - 30

30 -4 5

45 – 60

60 – 90

90 or more

Total

$45,000

$11,000

$6,500

$3,200

$1,900

$67,900

66.27%

16.64%9.57%4.71%2.80%100.00%Slide11

Aging Schedule of Accounts ReceivableSlide12

The

Credit Check:

Scope and Details

Phase One: Review Customer Financial Statements

Phase Two: Follow Through Receivables

Key

Points

Examination

of receivables: classification of accounts and aging.

Obtain

credit reports and

checkings on

largest accounts.

Verify

receivables. Compute collection period for each account. Slide13

Scope

and Details

Classify accounts into acceptable and unacceptable categories

.

Before acceptance into borrowing base need measurements of receivable management:

Average

Collection

Period

The

delinquency

ratio = past

due receivables over credit

sales

The

bad debt ratio

: = write-offs

over net

receivablesSlide14

Scope

and Details

Check files of past due accounts.

Review

recent correspondence and collection efforts.

Review

large positions

.Slide15

Review Accounts Receivable Policy In DetailSlide16

Broad Picture

Consider sound credit policy issues

Quality standards

Terms

Limitations

Instruments and payment methods

Explore collections and credit insurance as well as internal and external financing options Slide17

Broad Picture

Effective procedures for credit approval, collection, processing payments and past due accounts are identified

Proper evaluation is emphasized

analytical methods to improve the accounts receivable policy. Slide18

Internal and External Constraints

Accounts receivable policy requires careful evaluation of potential impact on:

sales volume

cash management objectives and procedures;

direct and indirect costs of receivables management; and

customer

relations.Slide19
Slide20

Credit Policy

Factors that influence credit policy:

Ability to finance the credit policy.

Costs of financing receivables estimated to determine which approach is feasible;

Industry credit terms.

Terms tend to be alike throughout industry. However, if enterprise has a superior product or service, consider more restrictive credit terms than industry average; Slide21

Credit Policy

Competitive issues.

credit policy often limited by competitor and customer

reactions Slide22

Credit Policy

The size of customer base and relative risk profile of customers.

Credit policy take into account major, high-risk customers and the weighting that should be given to them in relation to the total customer

base Slide23

Credit Policy

Sales volume

If a new or changing credit policy is expected to increase sales volume, ability to meet customer demand considered;

Late payments and defaults.

As a firms credit policy is eased, late-payment and default risk usually increase; Slide24

Credit Policy

Sovereign risk and credit policy on export sales.

Export sales credit policy consider political, economic, and local practices

. Slide25

Credit Quality Standards

To evaluate overall credit quality, five Cs of credit are considered. Each is weighted relative to its importance to the enterprise and the availability of information for constructing probability estimates. Slide26

The Credit Report

Corporate summary financial statements

key ratios

appropriate trend analyses

Credit history showing

payment timing

credit limit

legalSlide27

The Credit Report

Customers credit quality ratings reassessed on a regular basis, particularly major customers whose default could have serious financial consequences for the seller.

Consider credit migration

probabilitiesSlide28

The Credit Report

Consider amount of credit granted and used, the industry class, and general economic conditions.

Management should also regularly review critical factors chosen like financial factors and weighting assigned to each factor Slide29

Credit Period

The credit period is length of time credit is granted (for example, from invoice date to due date), and is normally established according to an industry standard

.Slide30

Credit Period

The credit period has direct impact on cost of financing receivables and on collection risk. An enterprise may elect to deviate from the industry standard for one or more reasons:

to obtain a competitive advantage

to reflect the enterprises classification of customer quality

or to adjust to longer-term economic or business changes.

.Slide31

Payment Terms

Credit terms normally specified on contractual documents, or on customer invoice or statement.

Cash before delivery (CBD) or cash on delivery (COD) required when buyer classified as poor credit risk.

In cases of an unknown or one-time customer, certified check may be required when order is placed, or before goods or services delivered

. Slide32

Payment Terms

Cash terms permit buyer payment period of about five to 10 days and used for high-turnover or perishable goods.

Invoice terms often stipulate net due date and discount date calculated from various starting dates: invoice, delivery, or client acceptance dates.

The terms may be quoted, for example, as 2/10, net 30 meaning a payment discount of 2% is given if the invoice is paid within 10 days. Full payment is required after 10 days but within 30 days. Slide33

Payment Terms

Watch Consignment sales

require holder of the goods to pay the supplier only when the goods sold.

Supplier retains ownership of goods until sold and may reclaim them or take legal action in cases of default.

The holder must maintain segregated inventory and sales records, and provide a periodic inventory reconciliation. Slide34

Discounts and Surcharges

Cash discount policies may be established for a number of reasons:

to conform to the industry norm

to stimulate sales

to expedite receipt of cash Slide35

Credit Limits

Credit limit categories codify total credit granted to customers in each credit quality classification.

credit limits regularly reviewed.

Periodic reassessments simplified by automatically reassigning customers to a higher credit limit level after specified period of satisfactory payment experience. Slide36

Credit Limits

Credit factors used to calculate single numerical value to assign credit limits and payment periods to different customers.

Credit score tempered by informed management judgment because accept-reject decision implicitly includes economic trade-offs: to minimize rejection of an acceptable credit customer (with loss of future business) versus to accept a poor credit risk (and resulting debt losses)Slide37

Credit Instruments

Written payment contracts agreed to by the enterprise and customers.

Instruments range from simple invoices to formal credit arrangements.

When selecting an instrument to be used consider industry standards, market norms, and buyer risks.Slide38

Payment Methods

Example: Electronic Funds Transfer

Factors to consider when determining possible payment methods are:

provisions of the Federal Currency Act concerning legal tender;

standard trade practices;

cost of processing;

cash flow implications; and

impact on collection risk.Slide39

Collection Policy

The collections policy should specify:

the employees directly responsible for maintaining the policy;

cash management techniques to be used to optimize cash inflow (including prompt invoicing);

a statement routine and payment processing method;

a detailed procedure for handling past-due accountsSlide40

Credit Insurance

Collection risk can be reduced by purchasing credit insurance, thus shifting some of the risk of bad debt losses to a third party.

Risk level has to be high enough to warrant the insurance premium.

For example, receivables concentrationSlide41

Overdue Accounts

Following is action of mid-sized firm:

request prompt payment of the account;

withhold approval or refuse to ship further goods (or provide service) until past due payments are made;

withhold approval until partial payment is made; or

refuse further credit.Slide42

Overdue Accounts

When partial payments required, policy should specify whether payments applied to oldest amounts outstanding, to smallest outstanding invoices (a process called shorting), or largest overdue amount.

payments should be made against specific invoices where possible.Slide43
Slide44

Phase Three:

Evaluation of Sales Policies

A detailed analysis of the borrower's sales records are essential during the initial audit.

Typical methods will reduce sales into categories that include:

Geographic analysis where sales are separated by location. Determine geographical distribution of sales and concentration.

Product analysis. Size of package, and grade.

Class of trade.

Price.

Method: mail, telephone, direct selling.

Terms: cash or charge.

Order size.Slide45
Slide46

Phase Four:

Product Analysis and Product Policies

Product Policies should be reviewed and generally include:

Sales volume,

Type and number of competitors,

Technical opportunity,

Patent protection,

Raw materials required,

Production load,

Value added

Similarity to major businesses

Effect on other products.