credit management
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TABLE OF CONTENTS
Terms of payment
Credit policy variables
Credit evaluation
Credit granting decision
Control of accounts receivable
Credit management in India
TERMS OF PAYMENTS
Cash Terms
Open Account
Credit Period
Cash Discount
Billing
TERMS OF PAYMENTS
Consignment
Bill of Exchange
Letter of Credit
Credit Policy Variables
Credit Standards
Credit Period
Cash Discount
Collection Effort
Credit Standards
∆RI = [∆S (1 – V) - ∆S bn] (1 – t) -k ∆I
Where ∆RI = Change in residual income∆S = increase in salesV = ratio of variables costs to salesbn = bad debt loss ratio on new salest = corporate tax ratek = post tax cost of capital∆t = increase in receivables investment.
Credit Period
∆S *ACP * V 360
∆S/360 = average daily change (increase) in sales. The divisor here can with
equal justification be 365, rather than 360
ACP = average collection perid
Cash Discount
∆RI = [∆S (1 – V) - ∆DIS] (1 – t) + k∆I
Where ∆S = Increase in sales V = ratio of variable cost to sales k = cost of capital ∆I = savings in receivables
investment ∆DIS = increase in discount cost
Collection Effort∆RI = [∆S (1 – V) - ∆BD] (1 – t) + k∆I
Where ∆RI = Change in residual income ∆S = Increase in sales V = ratio of variable cost to sales∆BD = increase in bad debt cost
t = tax rate k = cost of capital
∆I = savings in investment in receivables
Credit Evaluation
Type I Error : A good customer misclassified as a poor credit risk.
Type II Error: A bad customer misclassified as a good credit risk.
TRADITIONAL CREDIT ANALYSIS“Five C’s of credit” CharcterCapacityCapitalCollateralConditionSources of informations about five c Financial statement Bank referencesExperiences of firm
Numerical Credit Scoring Identify factors relevant for credit evaluation Assign weights to these factors Rate the customer on various factors using suitable rating
scale. Multiply weights with the rating scale. Add all score to get consumer rating index Based rating index classify customer
Factor FactorWeight
Rating FactorScore
Past Payment 0.30 4 1.20
Net Profit Margin
0.20 4 0.80
Rating Index
2.00
Discriminant AnalysisThis technique is employed to construct
better risk index.e.g. ABC company manufacture some product
for industrial customer, they take two financial ratio into consideration, namely return on Equity and Current ratio.Current Ratio
Return on Equity
+ + + +
+ +
+ +
O
OO
O
OO
O
O+
CREDIT GRANTING DECISIONP=Probability that customer pays his dues1-P=The Probability that Customer can not
Pays his dues.Revenue=Revenue from sale Cost =Cost of good sold
FormulaP(Rev-cost)-(1-P)CostExample ABC company is considering offering credit to
a customer.the probability that customer would pay is 0.8 and the probability that customer would default is 0.2.The revenue from sale would be Rs 1200 and cost would be Rs.800
Sol:- 0.8(1200-800)-0.2(800) = 160
REPEAT ORDERFORMULA{ P1(Rev1-cost1)-(1-P1)Cost1 }+P1{ P2(Rev2-cost2)-(1-P2)Cost2 }
SOLUTION{0.9(2000-1500)-0.1(1500)}+0.9{0.95(2000-1500)-0.05(1500)= 660
CONTROL OF ACCOUNTS RECEIVABLES
Two methods for that
Days’ sales outstanding
Ageing schedule
Days’ sales OutstandingMonth Sales Receivables
January 150 400
February 156 360
March 158 320
April 190 310
May 170 300
June 180 320
DSO= Account receivable Average daily salesQuarter First 320 = 62 days (150+156+158)/90Second 320 = 54 days (190+170+180)/91
Ageing ScheduleIn days Receivables
0-30 35%
31-60 40%
61-90 20%
>90 5%
Collection of Matrix
January February March
Collection
Of payment
13 20 24
Whether the Collection is improving stable or reduced .
CREDIT MANAGEMENT IN INDIACredit Policy
Credit Analysis
Control of Receivables
Room for Improvement