Credit and Collection

ROLE OF CREDIT DEPARTMENT

CREDIT ●​ COLLECTION OF INFORMATION
-​ The trust which allows one party to provide resources to -​ Information warehouse within any company
another party where that second party does not pay the -​ The information collected by a credit department
first party immediately (thereby generating a debt), but can be used by a purchasing department to
instead arranges either to repay or return those resources screen vendors or by the marketing department
(or other materials of equal value) at a later date. to help find new customers.
-​ A contractual agreement in which a borrower receives -​ Enhances the quality of financial analysis
something of value now and agrees to repay the lender -​ It can strengthen a company’s understanding of
at some later date. its customer base and lead to expanding that
-​ The resources provided may be financial (granting loan) base.
or they may consist of goods or services (consumer
credit). ●​ CREDIT ANALYSIS
-​ Encompasses any form of deferred payment. -​ Provides financial protection by determining
-​ Extended by a creditor also known as a lender, to a whether the customer has the ability to pay the
debtor, also known as a borrower. debt. Can be an important factor in sales
decisions depending on a company’s strategic
FUNCTIONS OF CREDIT goals.
●​ Important component of any company’s business
operations. ●​ COLLECTION
●​ Using creative methods necessary to structure -​ While the credit department is responsible for the
transactions so that sales can be approved. The credit enforcement of payment terms, credit terms are a
department can make significant contributions to sales part of a company’s strategic business plan.
and profit maximization. -​ Whether credit terms are restrictive or liberal will
●​ Knowing when and how to accomplish the sale safely. have a direct impact on a company’s strategic
●​ Find the best way to minimize the risk of late payment or business plan as well as on the credit process.
non-payment by customers. -​ Cash forecasting is a natural transition for the
credit department.
CORE ACTIVITIES OF CREDIT
●​ Maximizing sales ●​ CASH APPLICATION
●​ Accelerating cash flow -​ The financial impact of cash application is related
●​ Minimizing bad debt losses to the timing of cash flow and the cost of carrying
●​ Reviewing and approving new accounts a receivable.
●​ Developing and updating credit and collection policies -​ The strategic implication of cost of carrying
●​ Establishing appropriate credit limits and terms of sale for receivables is related to a company’s financial
new and active customers strength and its need for cash flow.
●​ Creating new or appropriate payment terms
●​ Placing accounts on credit hold and releasing orders ●​ DEDUCTION RESOLUTION
from credit hold -​ The financial implication of the cost of carrying
●​ Managing the collection function unresolved deductions or customer disputes
●​ Maintaining current information in the credit file on each impacts a company’s operating costs.
active customer -​ Deduction resolution has very critical strategic
●​ Documenting credit decisions and actions implications because it is directly related to
●​ Performing financial analysis on customer financial customer satisfaction, which in turn, impacts sales.
statements
●​ Researching and resolving disputes and deductions that CREDIT MANAGEMENT
would otherwise delay or prevent payment of accounts -​ It is the process of overseeing and controlling the lending
receivable process to minimize the risk associated with lending
●​ Communicating with other departments within the money to borrowers is known as credit management.
company including order entry, sales and shipping -​ It includes granting credit, establishing the terms of the
●​ Management Reporting agreement, collecting the loaned amount, performing
●​ Safeguarding the company’s investment in accounts due diligence, and more.
receivable -​ An efficient credit management system focuses on
reducing credit risk which could negatively affect the
CREDIT DEPARTMENT cash flow and result in losses.
-​ Involved in the quote to cash process – the process from
order approval to the cash collection. IMPORTANCE OF CREDIT MANAGEMENT
-​ Involves the important task of information collection, ●​ Ensures optimum cash flow
credit analysis, collections and cash application and -​ A business can function only when it has enough
deduction resolution. cash flow for its various activities.
 ●​ Contributes to a good reputation in the industry the loan is for a specific amount of money with the
-​ Reputation is everything for your business. The expectation that it will be paid back by a preset
consistency and commitment with which you pay date. Because this type of credit has a
your suppliers can build your reputation for credit predetermined amount, the loan amount
payment strongly. generally can’t be increased if needed.

●​ Protects your financial stability THE CREDIT GRANTING PROCESS

-​ Thousands of companies disappear every year ●​ Credit policies and procedures
because of 1 or more invoices which were unpaid ●​ Creditworthiness assessment (credit scoring models,
by their customers. financial analysis)
●​ The role of credit reports
●​ Helps create long-term relationships with customers and
suppliers CREDIT POLICY
-​ Effective credit management helps you weed out -​ A firm specific framework designed by management to
customers who run the risk of non-payment. standardize lending decisions in accordance with the
firm’s risk appetite.
●​ Avoid additional costs of credit -​ Span from a great willingness to extend credit (loose
-​ When you don’t manage credit optimally, you credit) to low or unwillingness to extend credit (tight
become prey to penalties and interest that your credit or no credit)
suppliers may levy. On the other hand, when you -​ Includes the credit application process, types, limits and
don’t receive due amounts from your customers, terms of credit, collection, monitoring and control, and
you would be required to spend additional time risk management.
and money to coerce your customers to pay. -​ The credit policy for the company must be in harmony
with the Goals and Objectives of the company and
Credit Management is crucial for your business. The sooner you should support sales initiatives.
put in processes for credit management, the better it will be for -​ An effective credit policy permits and encourages the
your business. Managing business credit well is nothing short of fullest development of the opportunities in administering
an art. Businesses who get it right can truly ensure that their cash credit.
works for them, while they work for their business.
POLICY vs. PROCEDURE vs. RULE
TYPES OF CREDIT
●​ Revolving Credit ●​ POLICY is a general course of action developed for
-​ Funds can be accessed up to a certain credit recurring situations and designed to achieve established
limit. The account can be continuously borrowed objectives.
from and paid back as long as the account is ●​ PROCEDURE is the actual working steps that should be
open. And if an account holder remains in good followed in an appropriate order to accomplish a
standing, the bank or financial institution may offer desired result.
a credit limit increase. ●​ RULE is a statement that defines or restricts the actions
-​ You can use all the available credit or some of it that credit professionals can take or not take in a specific
at a time. And the balance can be paid back all situation or decision.
at once or incrementally, but you typically have to
make at least the minimum payment to keep the COMPANY DEFINED OBJECTIVES
account in good standing. ●​ Long Term and Short Term
○​ Profit Levels
●​ Open-End Credit ○​ Sales Volume
-​ Open-end credit accounts can be borrowed from ○​ Inventory Levels
and paid back repeatedly. And while there are a ○​ Quality of Service
lot of definitions out there, the factors that
distinguish open-end credit have to do with OBJECTIVES OF A CREDIT DEPARTMENT
payments, interest and credit limits. ●​ Terms of Sale
-​ Open-end credit often doesn’t have an end date, ●​ Training and Development of Credit Personnel
so it’s sometimes considered at ype of revolving ●​ Amount of Capital Committed to AR
credit. But with open-end credit, the amount ●​ Monitor Risk
borrowed is typically paid back in full at the end ●​ Relationship to Sales Dept
of each billing period. And certain types of ●​ Measurement of AR Investment
open-end credit accounts don’t have a
predetermined credit limit. Credit policy should address the authority to do the job,
establish consistent credit
●​ Installment Credit guidelines, and incorporate credit and sales cooperation.
-​ Refers to loans that are paid back by making
equal regular payments—typically on a Handling Exceptions
month-to-month basis and often at a fixed interest ●​ Credit is not black and white
rate. This type of credit is closed-end. This means ●​ Need some flexibility
 ●​ How will exceptions be handled? ●​ What credit reporting agencies and credit reports will be
●​ Who can authorize exceptions? used?
●​ How will they be documented? ●​ Will you require bank references and trade references?
●​ Will you require financial statements?
SCOPE OF CREDIT POLICY ●​ Will you take collateral?
●​ Purpose, Plan, Performance, Performance Measure, ●​ When will you require personal guarantees?
Preparation, Productivity, Positive Results
●​ Organizational Expectations (goals/objectives) Minimizing Carrying Costs of Receivables
●​ Level of Understanding, Limit of Authority ●​ Responsibility and time intervals for follow up of past due
●​ Investment, Impact, Individual Responsibility, Individual accounts
Department Needs ●​ Handling orders
●​ Corporate Goals and Desires, Credibility, Consistency, ●​ Handling deductions
Chain of Command, Cooperativeness ●​ Exchange of credit information
●​ Intentions, Important Points, Instructions, Implementation, ●​ Cash application
Innovation ●​ Handling deductions
●​ Established Ground Rules, Employee Training Manual, ●​ Placing accounts with 3rd party collections
Effectiveness, Employee Input (sales, service) ●​ Bad Debt Write-Offs
●​ Stability, Sensitivity, Support, Security, Standardization, ●​ How will the progress of collections be monitored?
Strategic Planning ●​ Employee travel and expense reports

ESTABLISH CREDIT POLICY Internal Reports

-​ Because Credit Policy affects the company as a whole, it ●​ Aging Report
is usually formulated by top management ●​ Over the credit limit report
-​ It must be in harmony with the goals of the company ●​ Reports to monitor unearned discounts, deductions,
-​ It must be trained to more than the credit department unpaid service charges, credits.
●​ Reports to track accounts placed with outside collection
STEPS FOR ESTABLISHING CREDIT POLICY agencies or attorneys
●​ What is the normal collection process? ●​ Bad Debt write-off report
●​ What authority does the credit staff have? ●​ Travel and Expense reports
●​ What is the credit department’s mission?
●​ How do we evaluate customer credit? Minimizing Bad Debt losses
●​ How do we minimize risk? ●​ Conversion of an open account to a note
●​ Customer counseling
CREDIT POLICY FOCAL POINTS ●​ Collection agencies
●​ Development of an optimal level of sales ●​ Use of outside attorneys and lawsuits
●​ Minimize the carrying costs of receivables ●​ Customer bankruptcy, bulk sales and assignments for the
●​ Minimizing bad debt losses benefit of creditors
●​ Credit department organization and cost containment ●​ Authorization for accounts written off to bad debt

DEVELOP OPTIMAL LEVEL OF SALES Credit Department Organization and Cost Containment
●​ When do you need credit applications? ●​ Formal organization chart that defines positions and
●​ Expected time to make a credit collection authority of each credit department associate
●​ How will decisions be communicated? ●​ Hiring guidelines
●​ Who will establish and maintain credit files? ●​ Educational requirements by position
●​ Who can authorize credit limits, raise limits, lower limits? ●​ Experience requirements by position
●​ Training and development guidelines
TERMS OF SALE ●​ Performance review criteria
●​ What will the terms be? What terms does your industry ●​ Promotion and termination guidelines
use? ●​ Credit department and budget guidelines
●​ Who will communicate them internally and to the ●​ Collection policy that reduces borrowing costs and
customer? generates cash flow
●​ Who will apply and monitor discount charge-backs?
●​ Who will apply and monitor late payment service Influences on Credit Policy
charges? ●​ Competition
●​ How will requests for extended terms be handled and ●​ Classes of customers
who can authorize them? ●​ Financial standing of the company
●​ What happens if a customer files bankruptcy? ●​ Length of terms
●​ Blanket Order approval ●​ Type of merchandise
●​ Orders that go on hold because the customer is past due ●​ Price range of merchandise
or over their credit limit ●​ Profit Margins
●​ Economic Conditions
CREDIT INVESTIGATIONS
●​ Sign off policy for approvals or denials
IMPLEMENTING CREDIT POLICY -​ If a company offers credit to a customer, there is a
●​ Communication of Policy both inside and outside Credit risk that the customer may not pay their invoices.
Department
●​ Assignment of Responsibility or Authority FIVE C’s OF CREDIT
●​ Establishing Procedures, Job Descriptions
●​ Credit History
CREDIT PROCEDURES MANUAL ●​ Capacity to Repay
-​ Should cover rules, regulations and procedures ●​ Capital
necessary for consistent department operation. ●​ The loan’s conditions
-​ Credit Manual may be a separate book or part of a ●​ Associated collateral
general company instruction manual.
-​ Some companies have established departments
TYPES OF CREDIT POLICY responsible for assessing the credit risks of their current
●​ LOOSE CREDIT and potential customers.
-​ Represents a greater willingness to extend credit -​ Technology has allowed businesses to quickly analyze
to grow the business; a strategy to take on higher data used to determine a customer's risk profile
credit risk and reap the rewards.
-​ Example: Granting credit to below-average credit TOOLS FOR CREDIT RISK MANAGEMENT
profiles with worse risk ratings more limited access ●​ Credit Scoring Models
to capital weaker capacity ●​ Risk Identification Models
●​ Compliance Monitoring
●​ FLEXIBLE CREDIT ●​ Risk Management Software
-​ Represents a willingness to extend credit ●​ Data Visualization
depending on circumstances. It’s generally a ●​ Portfolio Diversification
neutral strategy that does not aggressively grow or ●​ Other Important Tools
restrict access to credit for clients.
-​ Examples: granting credit to a broader range of CREDIT SCORING MODELS
average credit profiles with a process for -​ use historical data and financial indicators to assign
exceptional approval to policy for clients that may numerical scores, indicating the likelihood of a borrower
fall outside a diverse risk range. defaulting on a loan.
-​ To assess a borrower's creditworthiness and predict their
●​ TIGHT CREDIT ability to repay debt.
-​ Generally means less willingness to extend credit
to support revenue growth. This is a strategy of RISK IDENTIFICATION MODELS
restraint often implemented to limit credit losses -​ to identify and assess potential credit risks, including
and/or replenish capital. those related to individual borrowers and the overall
-​ Example: only granting credit to above-average portfolio.
credit risk, such as better risk ratings, greater -​ analyze data to detect patterns and indicators that
access to capital, and more robust capacity. suggest a higher risk of default or other credit-related
issues.
●​ NO CREDIT
-​ This is an unwillingness to extend credit, as a COMPLIANCE MONITORING
company is highly risk-averse or has no business -​ To ensure that credit risk assessment and management
case to support the cost/benefit of extending practices comply with regulatory requirements and
credit. industry standards.
-​ Examples: cash only business with slim margins and -​ Monitoring systems track lending activities, identify
insufficient capital to extend trade credit. potential violations, and trigger alerts when necessary.

RISK ASSESSMENT AND CREDIT ANALYSIS RISK MANAGEMENT SOFTWARE

●​ Evaluating Customer Credit Risk -​ To provide a comprehensive platform for managing
-​ CREDIT RISK - the probability of a financial loss credit risk, including assessment, monitoring, and
resulting from a borrower's failure to repay a loan. reporting
-​ refers to the risk that a lender may not receive the -​ Sophisticated risk analysis, stress testing, scenario
owed principal and interest, which results in an modeling, and data visualization capabilities.
interruption of cash flows and increased costs for
collection. DATA VISUALIZATION
-​ Credit risk can describe the chance that a bond -​ To present credit risk data in a clear and concise
issuer may fail to make payment when requested manner, allowing for quick identification of trends and
or that an insurance company will be unable to patterns.
pay a claim. -​ Dashboards, heatmaps, and other visual tools that help
-​ EXAMPLE: When lenders offer mortgages, credit decision-makers understand and address risks.
cards, or other types of loans, there is a risk that
the borrower may not repay the loan.
PORTFOLIO DIVERSIFICATION Extending credit to your customers can be a way of attracting
-​ To reduce overall credit risk by spreading investments new business and building loyalty amongst existing customers.
across a wider range of borrowers and industries. The terms under which you agree to extend this credit are set
-​ By diversifying the portfolio, the impact of any single out in the invoice, including the date upon which payment is
borrower's default is minimized. due. The invoice credit terms form the terms and conditions of
the transaction.
OTHER IMPORTANT TOOLS
COMPONENTS OF CREDIT TERMS
●​ Risk Governance ●​ Credit period
●​ Risk Quantification -​ the due date for payment
●​ Credit Metrics Model -​ The shortest credit period is “Net due upon
●​ Credit Reports receipt,” which means the invoice must be paid
●​ 5 C’s as soon as it has been received and checked.
One of the most common credit periods for a
IMPACT OF BAD CREDIT ON THE BUSINESS small business is “Net 30”. This means that the
●​ BAD CREDIT invoice must be paid in full within the net period,
-​ low credit score and is characterized by late or 30 days from the date of the invoice.
irregular payment records and substantial
outstanding debt. ●​ Discount terms
-​ Many businesses try to mitigate this risk by offering
●​ Rejection of loans and funding incentives, encouraging customers to settle their
-​ A poor credit score signifies greater risk and invoices promptly.
reduced creditworthiness, leading lenders and -​ EXAMPLE: you may decide to offer 1% off a
creditors to potentially refuse loans or credit lines. customer’s invoice if they settle it within 10 days,
Investors consider a poor financial history a red rather than the 30 days indicated on the invoice.
flag, making it harder to secure investment In this case, the discount would be presented as
follows:
●​ Higher interest rates -​ 1/10
-​ Although funding might be attainable, it usually -​ n/30
comes with increased interest rates and more
stringent loan conditions. These may involve ●​ Late payment penalties
shorter repayment timelines, greater collateral -​ one way of limiting the credit risk, avoiding bad
demands, or more frequent payment schedules, debts and the need to turn to a collection
all of which elevate the total borrowing cost and agency.
can adversely affect profitability -​ It is important to research and understand the
relevant regulations which apply to your industry,
●​ Reduction in trade credit depending on your geographic location.
-​ A poor credit score may lead suppliers to limit or
withdraw trade credit, impose stricter contract ●​ Payment methods
terms, or require upfront payments. Since trade -​ specify acceptable payment methods. This may
credit is crucial for managing cash flow, such include check, bank transfer, credit card and
changes can disrupt cash flow and operational mobile payment options. Discounts for payment in
flexibility, and potentially strain long-standing cash can also be offered. The key is to make
supplier relationships. payment easy for the customer while reducing the
risk of non-payment.
●​ Higher insurance premiums
-​ In some cases, insurers use financial information to FACTORS INFLUENCING CREDIT TERMS
determine premiums. A poor credit record can ●​ Industry norms
lead to higher insurance costs for the business. -​ Understanding your industry is essential to building
a strong, successful business. It is important to
●​ Damaged reputation understand the accepted payment terms in your
-​ Having a poor credit record suggests financial industry. This allows you to align yourself with
mismanagement, which can significantly hurt the customer expectations, but also to potentially
business’s reputation and strain its relationships identify where your competitors may have left a
with customers, suppliers, and potential partners. gap in the market.

CREDIT TERMS AND AGREEMENTS ●​ Cash flow considerations

●​ Setting credit terms (payment schedules, interest rates) -​ credit terms necessarily have an impact upon
cash flow, as you will have to wait longer for the
Credit terms - the length of time you give customers to pay for cash to flow into your business. If not managed
your goods or services. carefully, this could result in cash flow shortages.
Early payment discounts and overdue payment
 penalties can encourage prompt payment and ●​ Lender’s policies
reduce the impact on cash flow.
-​ A line if credit is open-ended, implying that spending and
●​ Customer relationships repaying money is cyclic. While it offers flexibility, it can
-​ extending credit can attract new business. If all also lead to over expenditure.
else is equal, but you offer flexible credit terms and -​ Exceeding your credit limit affects the credit score since
your competitor does not, this might just tip the it implies severe repayment inability and overextended
balance in your favor. debts.

●​ Risk assessment LEGAL ASPECTS OF CREDIT AGREEMENTS

-​ Before you extend credit terms to any customer, it ●​ Credit Agreement
is strongly advised that you check their -​ a legally binding contract documenting the terms
creditworthiness. of a loan, made between a borrower and a
lender.
DETERMINING CREDIT TERMS -​ used with many types of credit, including home
●​ Cash flow analysis mortgages, credit cards, and auto loans.
-​ You need to analyze your cash flow situation to -​ can sometimes be renegotiated under certain
ensure you can afford to offer your customers circumstances.
credit. By offering credit, you are showing your
customers that your business is stable and that you LEGALLY BINDING CONTRACT
predict it will continue to be so in the future. -​ A credit agreement is a contract, meaning it's a legally
enforceable agreement between a borrower (the party
●​ Discount structure receiving credit) and a lender (the party providing
-​ The aim of a credit policy is to ensure payment on credit).
time. You can take several measures to maximize -​ Both parties are obligated to fulfill the terms outlined in
your chances of being paid on time, including the agreement.
discounts for prompt payment and penalties for -​ If either party fails to meet their obligations, the other
late payment. These discounts and penalties, set party can seek legal recourse.
out in the credit terms, are designed to ensure
your credit terms are respected. TYPES OF CREDIT AGREEMENT
●​ Loans (car, student, personal)
●​ Credit scoring ●​ Credit cards
-​ Ensuring your customers are creditworthy is the ●​ Mortgages
cornerstone of a solid credit policy. Checking your ●​ Lines of credit
customer's credit reports, credit history and credit
score can help you build up a picture of how likely KEY ELEMENTS OF A CREDIT AGREEMENT
they are to pay their invoices and set an ●​ Loan Amount
appropriate credit limit. -​ The total amount of money being borrowed.

UNDERSTANDING CREDIT LIMITS AND CREDIT LINES ●​ Interest Rate

●​ CREDIT LINE -​ The percentage charged for borrowing the
-​ Establishes a predetermined borrowing limit that money.
you can access from a financial institution. You
can borrow and repay the money up to the credit ●​ Repayment Schedule
line at any point in time. -​ The timeline and method for repaying the loan,
including the frequency and amount of
●​ CREDIT LIMIT payments.
-​ Represents the maximum amount you can borrow
and use. The exact credit limit you get depends ●​ Fees
on your credit profile and the lender. -​ Any additional charges associated with the loan,
such as origination fees, late payment fees, or
Is the credit line the same as the credit limit? prepayment penalties.
-​ No, a credit limit is not the same as a credit line. A credit
limit is the maximum amount you can use via a financial ●​ Collateral (if applicable)
product or service. On the other hand, a credit line is a -​ Assets pledged as security for the loan, which the
credit facility that allows you to withdraw funds up to a lender can seize if the borrower defaults.
specific limit and repay as per the terms decided
between you and the lender. ●​ Default Provisions
-​ Clauses outlining the consequences of failing to
What determines the credit limit? meet repayment obligations, such as acceleration
●​ Earnings/salary of the loan or foreclosure.
●​ Source of income
●​ Credit report
 ●​ Consumer Rights
-​ Protection for the borrower, including the right to
dispute errors, access information, and seek legal
remedies. (Consumer Act of the Philippines
(Republic Act No. 7394))
LEGAL REQUIREMENTS FOR CREDIT AGREEMENTS

●​ Full disclosure
●​ Good Faith
●​ Creditworthiness Assessment
●​ Consumer Protection Loans