THE DEVELOPMENT OF CREDIT

Pre-Spanish Time
The Philippines had been trading with foreign countries such as China, Japan, Sumatra, India, Arabia, Siam,
Borneo, Java, the Moluccas and other East Indian islands, when the Spanish conquerors arrived. The barter system then
was used in the conduct of trade with the foreigners. The Filipinos exchanged their native products, such as cotton,
pearls, betel nuts, sinamay fiber, and the like with the foreigners, for porcelain, silk, ivory. Filipino traders were famous
for their honesty and excellent credit record.

Spanish Time
During the initial years of Spanish rule, free trade was encouraged. The goods of the Far East were marketed to
America through Manila and then through Acapulco, Mexico. Manila was still then the center of trade and commerce in
the Orient. Subsequently, however the Spain adopted a policy of trade restrictions in the prevailing concept of
mercantilism in Europe. A product of mercantilistic policy in the Philippines was the Galleon Trade. Most of those who
participated in the galleon trade secured their loans from the pias.

American Era
Agriculture remained undeveloped under the Spanish regime. The American government, however gave priority
to its development. The American administrators introduced a better banking and credit system to promote economic
development, especially in the rural areas. Among the credit programs of the government was the organization of the
first agricultural bank in 1908 for the benefit of the farmers. In 1915 the Rural Credit Law was enacted to complement
the agricultural cooperatives, particularly credit associations in every town all over the country.

• Rice and Corn Fund was established providing 1 million for loans to the farmers` credit cooperatives.
• Philippine National Bank was established in 1916.
• The organizations of rural banks and agricultural credit associations were encouraged by the government.
• Only seven credit associations and two rural banks were actually organized.

The failure of the credit program was caused by a combination of several factors:
1. Farmers did not have steady income due to the destruction of their crops by natural calamities.
2. They were exploited by the landlords who give them unfair share in the harvest. Thus, it was really possible for
them to pay their loans.
3. The negative attitudes of the borrowers toward their debts influenced their refusal to settle their financial
obligations.
4. They considered their loans as another form of dole outs and therefore they did not feel the responsibility of
paying the government lending institutions.

Under the Republic

The scars of World War II were still conspicuous when the Philippines became a republic on July 4, 1946. It
was a period of reconstruction and rehabilitation. The national economy and the people greatly needed money for
business and economic development. In response to the credit needs of the country, the Rehabilitation Finance
Corporation was established on October 29, 1946.

In 1958, the Rehabilitation Finance Corporation became Development Bank of the Philippines. A very significant
improvement in the financial system was the establishment of the Central Bank of the
Philippines in 1949. Since then, monetary policies have been fashioned to improve production, employment and quality
of life of the people, especially in the rural sectors where poverty has been more widespread. In later years the
government encouraged the organization of savings and loan associations, rural and cooperative banks.

Credit is a term derived from the Latin word credo – meaning, to believe, to trust. As applied to this subject, credit
means securing something of value, whether tangible or intangible, in return for a promise to pay at some determined
future date. The first principle therefore of credit is: Do not give Credit to anybody you do not trust. Trust is the
fundamental element of credit.
Lambino, Syd Airol M.
BSBA FM-3B
Business Research
Others define credit as follows:
1. Credit is purchasing power (Mill)
2. The essence of credit is confidence on the part of the creditor in the debtor`s willingness and ability to pay his
debt. (Holdsworth)
3. Credit may be called a “short sale” of money (Johnson)
4. Credit is a “sale of trust”
5. The exchange of an actual reality against a future probability (Le Vasseur)
6. Credit may be defined as the power time in return for investment or services at a future date. (Bullock)
7. Credit is the personal reputation a person has, in consequence of which he can buy money, or goods, or labor,
by giving in exchange for them a promise to pay at a future time. (Mac Leod),
8. Credit is the power to obtain goods or services by giving a promise to pay money (or goods) on demand or at a
specified date in the future. (Johnson)
9. A credit is the present right to a future payment. (Mac Leod)

Advantages of Credit
1. Credit facilitates and contributes to the increase in wealth by making funds available for productive purposes.
2. Credit saves time and expense by providing a safer and more convenient means of completing transactions.
3. Credit helps expand the purchasing power of every member of the business community – from producers to the
ultimate consumer.
4. Credit enables immediate consumption of goods thereby providing for an increase in material well-being.
5. Credit helps expand economic opportunities through education, job training and job creation.
6. Credit spreads progress to various sectors of the economy.
7. Credit makes possible the birth of new industries.
8. Credit helps buying become more convenient for customers.

Disadvantages of Credit
1. Credit, at times, encourages speculation.
2. Credit also tends to contribute to extravagance and carelessness on the part of people who obtain it. Since the
person who obtains credit is not using his own money but is using the money of other person, he is therefore
charged with an obligation of the highest order. Many do not understand such social responsibility. As such
many fail to appreciate that trust.
3. Because of credit, many entrepreneurs resort to over expansion. Failure to generate expected income can only
cause a collapse which affects the nation`s economy.
4. Owing to the observation that business can be expanded or contracted rapidly through the use of credit,
businessmen are not only susceptible but eventually succumb to an air of confidence or pessimism. Credit causes
one businessman to be dependent upon others. In order to extend credit, he must have faith in other businessmen
and also in the future. Thus, it follows that if credit relations become strained, man business recession may set
in.

CLASSES AND KINDS OF CREDIT

1. The classes and kinds of credit according to its purposes are:

a. Commercial credit, which includes the promise to pay off businessmen for the funds they borrowed in
the purchase of goods for productive or profitable ventures. These are the merchants, distributors and
manufacturers.
b. Agricultural credit, which includes the promise to pay off farmers and farm organization for the funds
they borrowed in the acquisition of farm inputs.
c. Investment credit, the promise to pay off individuals or business firms for the loans they obtained in
buying capital goods.
d. Consumer credit, constitutes all the obligations to pay off people for the money they borrowed for
consumption purposes.
e. Speculative credit, a type of credit which is used for dealing in securities or goods with the intention of
making a profit through favourable price changes.
Lambino, Syd Airol M.
BSBA FM-3B
Business Research
 f. Export credit, in some form and to some extent is always involved in all sorts of transactions for which
cash is not paid on or before shipment of goods out of country.
g. Industrial credit, is intended for financing the needs of industries like logging, fishing, manufacturing
and others, and which involves big amounts of money.
h. Real Estate credit, when credit is secured purposely for construction, acquisition, expansion or
improvement of real estate properties, it is termed as real estate credit.

2. Short-term credit is a loan which is payable in less than one (1) year while long term credit is a loan whose
maturity is from five (5) years or more and intermediate credit is a loan which matures only in more than a year
but less than five years.
3. The following can be used as collateral: land, stocks, bonds, machines, houses, crops and other valuable
properties.
4. Loans, whether secured or unsecured, are risk inherent although the former is less risky. Although secured loans
are backed by collateral, creditors prefer to have cash rather than a property or set which still needs to be
converted into cash.
5. The following are considered private sectors of the economy: individuals, partnerships, corporations and other
private institutions. A public credit includes all grants of credit to government whether national, provincial,
municipal and its instrumentalities while in private credit refers to all grants of credits to non-government.

Topic 2: Practices and Procedures (Credit Application and Credit Investigation)

The first activity in the Credit Department as it starts the actual operation of its function is the credit application. A credit
department must have a credit application form for use by its prospective customer/client. In fact, as a matter of policy,
no credit extension, however large or small, should be approved and released, unless the customer/client has at least
filled up a credit application form. This is essential because the duly filled up credit application provides the credit
department.
1. With initial credit information on which to base its credit decision, if credit decision has to be made, for some
reason or another, without further credit investigation;
2. Information on which to further interview the applicant (the process of credit interview will be discussed more
thoroughly in succeeding chapters); and,
3. With some “leads” on which to start his credit investigation process

Documentation Required for Processing a Loan Application

1. Individual/Single Proprietorship
a. A certified photocopy of its trade name or style registered with the Bureau of Domestic Trade
b. Mayor`s Permit
c. License to engage in business issued by the City or Municipality
d. Income Tax Returns for the preceding year and official receipt of payment; and
e. Latest audited/unaudited financial statements
2. Partnership
a. A certified photocopy of its trade name or style registered with the Bureau of Domestic Trade
b. Copy of articles of partnership, duly registered with the Securities & Exchange Commission
c. Latest audited/unaudited financial statements of the partnership
d. Income tax returns for the preceding year of each member of the partnership
e. License to engage in business issued by the City or Municipality
f. Resolution of the partnership authorizing the negotiation of the loan and authorizing the partner to sign for
and in behalf of the partnership
g. Curriculum Vitae or personal information.

Lambino, Syd Airol M.

BSBA FM-3B
Business Research
 3. Corporation
a. a certified photocopy of its trade or style registered with the Bureau of Domestic Trade and the SEC
b. copy of Articles of Incorporation and By-laws, duly registered with the SEC
c. Latest audited financial statements
d. Certified list of stockholders of the company as of date of application, to include the following:
• Name of its stockholders
• Nationality
• Number of shares subscribed
• Amount subscribed
• Amount paid on subscription
e. Certified list of incumbent officers
f. Curriculum vitae or personal information sheet of the officers
g. Board Resolution (with Corporate Secretary`s Certification) authorizing the filing of the application and
authorizing the person to undertake the application
h. License to engage in business issued by the City or Municipality

List of Financial Ratios

Here is a list of various financial ratios. Take note that most of the ratios can also be expressed in percentage by
multiplying the decimal number by 100%. Each ratio is briefly described.
Profitability Ratios
1. Gross Profit Rate = Gross Profit ÷ Net Sales
Evaluates how much gross profit is generated from sales. Gross profit is equal to net sales (sales minus sales returns,
discounts, and allowances) minus cost of sales.
2. Return on Sales = Net Income ÷ Net Sales
Also known as "net profit margin" or "net profit rate", it measures the percentage of income derived from dollar sales.
Generally, the higher the ROS the better.
3. Return on Assets = Net Income ÷ Average Total Assets
In financial analysis, it is the measure of the return on investment. ROA is used in evaluating management's efficiency
in using assets to generate income.
4. Return on Stockholders' Equity = Net Income ÷ Average Stockholders' Equity
Measures the percentage of income derived for every dollar of owners' equity.
Liquidity Ratios
1. Current Ratio = Current Assets ÷ Current Liabilities
Evaluates the ability of a company to pay short-term obligations using current assets (cash, marketable securities, current
receivables, inventory, and prepayments).
2. Acid Test Ratio = Quick Assets ÷ Current Liabilities
Also known as "quick ratio", it measures the ability of a company to pay short-term obligations using the more liquid
types of current assets or "quick assets" (cash, marketable securities, and current receivables).
3. Cash Ratio = (Cash + Marketable securities) ÷ Current Liabilities
Measures the ability of a company to pay its current liabilities using cash and marketable securities. Marketable securities
are short-term debt instruments that are as good as cash.

Lambino, Syd Airol M.

BSBA FM-3B
Business Research
 4. Net Working Capital = Current Assets - Current Liabilities
Determines if a company can meet its current obligations with its current assets; and how much excess or deficiency
there is.
Management Efficiency Ratios
1. Receivable Turnover = Net Credit Sales ÷ Average Accounts Receivable
Measures the efficiency of extending credit and collecting the same. It indicates the average number of times in a year a
company collects its open accounts. A high ratio implies efficient credit and collection process.
2. Days Sales Outstanding = 360 Days ÷ Receivable Turnover
Also known as "receivable turnover in days", "collection period". It measures the average number of days it takes a
company to collect a receivable. The shorter the DSO, the better. Take note that some use 365 days instead of 360.
3. Inventory Turnover = Cost of Sales ÷ Average Inventory
Represents the number of times inventory is sold and replaced. Take note that some authors use. Sales in lieu of Cost of
Sales in the above formula. A high ratio indicates that the company is efficient in managing its inventories.
4. Days Inventory Outstanding = 360 Days ÷ Inventory Turnover
Also known as "inventory turnover in days". It represents the number of days inventory sits in the warehouse. In other
words, it measures the number of days from purchase of inventory to the sale of the same. Like DSO, the shorter the
DIO the better.
5. Accounts Payable Turnover = Net Credit Purchases ÷ Ave. Accounts Payable
Represents the number of times a company pays its accounts payable during a period. A low ratio is favoured because it
is better to delay payments as much as possible so that the money can be used for more productive purposes.
6. Days Payable Outstanding = 360 Days ÷ Accounts Payable Turnover
Also known as "accounts payable turnover in days", "payment period". It measures the average number of days spent
before paying obligations to suppliers. Unlike DSO and DIO, the longer the
DPO the better (as explained above).
7. Operating Cycle = Days Inventory Outstanding + Days Sales Outstanding
Measures the number of days a company makes 1 complete operating cycle, i.e. purchase merchandise, sell them, and
collect the amount due. A shorter operating cycle means that the company generates sales and collects cash faster.
8. Cash Conversion Cycle = Operating Cycle - Days Payable Outstanding
CCC measures how fast a company converts cash into more cash. It represents the number of days a company pays for
purchases, sells them, and collects the amount due. Generally, like operating cycle, the shorter the CCC the better.
9. Total Asset Turnover = Net Sales ÷ Average Total Assets
Measures overall efficiency of a company in generating sales using its assets. The formula is similar to ROA, except that
net sales is used instead of net income.

Lambino, Syd Airol M.

BSBA FM-3B
Business Research
Leverage Ratios
1. Debt Ratio = Total Liabilities ÷ Total Assets
Measures the portion of company assets that is financed by debt (obligations to third parties). Debt ratio can also be
computed using the formula: 1 minus Equity Ratio.
2. Equity Ratio = Total Equity ÷ Total Assets
Determines the portion of total assets provided by equity (i.e. owners' contributions and the company's accumulated
profits). Equity ratio can also be computed using the formula: 1 minus Debt Ratio.
The reciprocal of equity ratio is known as equity multiplier, which is equal to total assets divided by total equity.
3. Debt-Equity Ratio = Total Liabilities ÷ Total Equity
Evaluates the capital structure of a company. A D/E ratio of more than 1 implies that the company is a leveraged firm;
less than 1 implies that it is a conservative one.
4. Times Interest Earned = EBIT ÷ Interest Expense
Measures the number of times interest expense is converted to income, and if the company can pay its interest expense
using the profits generated. EBIT is earnings before interest and taxes.
Valuation and Growth Ratios
1. Earnings per Share = (Net Income - Preferred Dividends) ÷ Average Common Shares
Outstanding EPS shows the rate of earnings per share of common stock. Preferred dividends is deducted from net income
to get the earnings available to common stockholders.
2. Price-Earnings Ratio = Market Price per Share ÷ Earnings per Share
Used to evaluate if a stock is over- or under-priced. A relatively low P/E ratio could indicate that the company is under-
priced. Conversely, investors expect high growth rate from companies with high P/E ratio.
3. Dividend Pay-out Ratio = Dividend per Share ÷ Earnings per Share
Determines the portion of net income that is distributed to owners. Not all income is distributed since a significant portion
is retained for the next year's operations.
4. Dividend Yield Ratio = Dividend per Share ÷ Market Price per Share
Measures the percentage of return through dividends when compared to the price paid for the stock. A high yield is
attractive to investors who are after dividends rather than long-term capital appreciation.
5. Book Value per Share = Common SHE ÷ Average Common Shares
Indicates the value of stock based on historical cost. The value of common shareholders' equity in the books of the
company is divided by the average common shares outstanding.

Lambino, Syd Airol M.

BSBA FM-3B
Business Research