GROUP 2
Introduction to
Crredit
Management
FM 201 Credit and Collection
Table of
Contents
Risk associated with lending
01
Cridit Department as a profit
02
center
03 Functions of the Credit Department
04 The CCredit Manager
05 Test of CCredit Department Operations
Credit Management
Effective credit management is crucial for a
company’s financial stability. It involves
identifying, managing, and controlling risks
inherent in the credit process to ensure sound
lending practices and minimize losses.
RISKS ASSOCIATED WITH
LENDING
the potential that events, expected or
unexpected may have an adverse impact on
earnings or capital
Credit Risk Interest Rate Risk Liquidity Risk
The risk of borrowers The impact of The ability to convert
failing to repay their changing interest loans into cash when
loans. This can be rates on loan revenue. needed. Managing
Companies should liquidity involves
managed through
tracking loan
sound underwriting, identify borrowers
commitments, borrower
proper loan sensitive to rate
usage, and ensuring
structuring, and fluctuations and loans meet market
continuous develop strategies to standards.
monitoring. mitigate risks.
Transaction Risk Compliance Risk Reputation Risk
Arises from Ensuring Poor credit
weaknesses in loan adherence to management,
disbursement and regulatory limits on inefficient loan
administration processes, or legal
loans, preventing
processes, including issues can damage a
legal liabilities from
system failures, company’s reputation
inadequate controls, or improper lending among investors,
human errors in loan or collection customers, and the
documentation. practices. community.
Borcelle
Credit Department as a Company
Profit Center
Traditionally, the credit department was seen as
a cost center focused on managing receivables.
However, modern management views credit as
a profit center that evaluates receivables as an
investment, emphasizing profitability over mere
sales support. Instead of asking how credit can
help sales, businesses should consider how
credit can contribute to overall profits.
Borcelle
Credit Department as a Company
Profit Center
Extending trade credit involves committing
company resources, and while it initially
impacts sales, its ultimate goal should be
profit maximization.
Establishing a credit policy that optimizes
returns on receivables is challenging but
essential for gaining top management’s
recognition.
The Credit and Collection
Unit
A credit and collection unit can start small and expand
as credit sales grow. A proper system should be in place
from the beginning, as timely collection depends on
effective credit processing. While credit (evaluation and
extension) and collection (account recovery) are
interrelated, the challenge arises in deciding whether
to separate these functions. Combining them may lead
to ethical risks, while separating them increases
operational costs.
The Credit and Collection
Unit
In the Philippines, banks and financial institutions
typically have separate personnel for credit and
collection. Another key issue is determining who makes
the final credit decision. In family-owned businesses,
higher officials or family members often have the final
say, while larger corporations may delegate this to a
credit committee. As credit operations expand,
deciding who holds this authority becomes
increasingly critical.
The credit department handles
all matters related to credit
sales, adjusting its functions to
suit the nature of the business.
Key responsibilities include:
1. Gathering and Analyzing 2. Credit Checking and 3. Filing and Recording
Credit Information Authorization
Collecting data Verifying Maintaining
on applicants and documents and and updating
assessing their
approving credit credit records
creditworthiness
using financial
through authorized for future
and non-financial personnel or
reference.
analysis. committees.
5. Collection
4. Credit Adjustment 6. Other Functions
Correspondence
Modifying Sending Exchanging credit
credit terms, information with
reminders and
other
limits, or follow-ups to organizations and
extensions ensure timely providing relevant
based on payments. data to other
policies. departments.
Borcelle
Company
The Credit Manager
The credit manager plays a vital role in
overseeing a company's credit function,
which can range from simple credit
approvals to broader financial and sales
strategies. The level of management
required depends on how credit is
perceived within the organization.
Qualities of a Good Credit Manager
(The Cardinal Cs)
Competence & Capability – Understands company goals, policies, and
responsibilities.
Communication – Effectively conveys ideas, delegates tasks, and prepares
reports.
Constructiveness – Focuses on granting credit rather than denying it.
Creativity – Adapts to changing conditions and finds innovative solutions.
Conscientiousness – Dedicated, cooperative, and coordinated in work.
Consistency – Makes fair, policy-aligned credit decisions.
Certitude & Celerity – Acts with accuracy and speed.
Qualities of a Good Credit Manager
(The Cardinal Cs)
Contact – Maintains strong internal and external relationships.
Cost-consciousness – Minimizes expenses in credit management.
Character – Demonstrates integrity, reliability, and resilience.
Confidence – Gains customer trust and fosters mutual respect.
Considerateness – Values customer relationships and extends assistance.
Computer Literacy – Understands basic IT and digital tools.
Congeniality & Courage – Handles pressure with firmness and professionalism.
Common Sense – Uses logical judgment in decision-making.
Credit executives use various
quality tests to evaluate the
efficiency of credit operations.
These tests ensure thorough
investigation, cost-effectiveness,
and timely decision-making.
Measuring Credit and Collection Results – Regular
calculation of ratios and percentages helps track changes
and achievements.
Setting Standards and Goals – Statistical records establish
benchmarks for credit and collection performance.
Comparing Performance Over Time – Yearly records help
assess progress and identify trends
Individual Performance Evaluation – Comparison
between employees improves efficiency.
Industry Benchmarking – Comparing figures with other
firms ensures competitiveness.
Forecasting Future Trends – Past records help predict
credit sales and collection trends.
Comprehensive Overview:
Borcelle
Company
Key Credit Department
Performance Metrics
To ensure financial stability and business
growth, credit departments must monitor
and evaluate their performance using
various key metrics.
Comprehensive Overview:
Borcelle
Company
Key Credit Department
Performance Metrics
These performance indicators help credit
managers assess how well the
department is achieving its objectives—
balancing maximum sales with minimal
credit losses—while maintaining financial
discipline.
Bad-Debt Loss Index
This index measures the percentage of total credit sales lost due to unpaid
debts, indicating the efficiency of credit risk management.
It is calculated as:
Bad Debt Loss Index = (Bad Debts Incurred ÷ Total Credit Sales) × 100
A higher index suggests weak credit policies or poor collection efforts, while a
lower index indicates strong risk assessment and effective collection strategies.
One challenge is the lack of uniformity in calculation across businesses:
Some firms measure bad debts against total sales, while others consider only
credit sales.
There is also variation in the time an overdue account is classified as a bad
debt. Some businesses write off bad debts quickly, while others hold them
for months before doing so.
This metric should be analyzed in conjunction with collection performance to
get a clearer picture of credit policy effectiveness.
Credit Sales Index
The credit sales index helps businesses understand what portion
of their total revenue is dependent on credit sales.
It is computed as:
Credit Sales Index = (Credit Sales ÷ Total Net Sales) × 100
A high percentage means a company relies heavily on credit
transactions, increasing financial risk.
A lower percentage may suggest strict credit policies, potentially
limiting sales growth.
Businesses use this index to track trends over time and adjust
credit policies accordingly.
Collection Performance Metrics
Efficient accounts receivable management
ensures that credit sales are converted into cash
as quickly as possible, maintaining business
liquidity and financial stability. A company's
ability to collect receivables directly impacts its
cash flow, working capital, and profitability. The
following key metrics help assess how efficiently
the credit department is handling collections:
A. Collection Percentage
Measures how much of the receivables due at the start of a period have been collected.
Formula: (Collections Made ÷ Receivables at Beginning of Period) × 100
A higher percentage indicates strong collections; a lower percentage signals potential cash
flow issues.
B. Receivables Turnover Ratio
Shows how often receivables are collected within a period.
Formula: (Total Credit Sales ÷ Average Receivables Outstanding)
A high turnover rate means faster collections; a low rate suggests delayed payments or
lenient credit policies.
C. Days Sales Outstanding (DSO)
Estimates the average time customers take to pay.
Formula: (360 ÷ Receivables Turnover)
Lower DSO means faster collections; higher DSO may indicate weak collection efforts or
customer delays.
How These Metrics Work Together
These three measures—Collection Percentage, Receivables Turnover, and DSO
—should be analyzed together for a complete view of collection performance.
For example:
If collection percentage is declining but DSO is increasing, this suggests that
receivables are aging poorly and stricter collection policies may be needed.
If turnover is high but collection percentage is low, it might indicate that
newer accounts are paying on time, but older accounts are not, requiring
targeted follow-ups on delinquent accounts.
If DSO is stable but turnover is decreasing, it may indicate that sales are
declining, rather than collections worsening.
Regular tracking of these metrics helps credit managers adjust policies,
ensuring a healthy balance between offering credit and maintaining strong
cash flow.
Number of Accounts Opened
This metric reflects the company's focus on
expanding its customer base through credit
offerings. A higher number of new accounts
suggests growth and expansion in credit
services.
When analyzed alongside the acceptance
index, it helps determine if the company is
being too lenient or too strict in approving
credit applications.
Acceptance Index
Measures the proportion of credit applications that are
approved:
Acceptance Index = (Applications Accepted ÷ Applications
Submitted) × 100
A high acceptance rate may indicate lenient credit policies,
potentially leading to higher credit risk.
A low acceptance rate suggests overly strict policies, possibly
restricting sales growth.
Tracking changes in this index helps determine if adjustments
to credit policies are necessary.
Past Due Index
Tracks the proportion of outstanding accounts that are overdue,
helping detect trends in late payments:
Past Due Index = (Total Past Due ÷ Total Outstanding) × 100
A rising past due index suggests that customers are taking longer
to pay, which could lead to increased bad debts.
It is important to calculate this index both in number of overdue
accounts and total overdue amount, as one large overdue account
can distort the overall picture.
Monitoring this index over time helps determine whether
collection efforts need to be strengthened.
Aging of Accounts
This test provides a detailed breakdown of receivables based
on how long they have been outstanding, typically categorized
as:
Current (Not Due)
30 Days Past Due
60 Days Past Due
90+ Days Past Due
Over 1 Year Past Due
The longer an account remains unpaid, the lower the likelihood of
collection. Businesses use this data to prioritize collection efforts
and adjust credit limits.
An aging report can also highlight potential fraud or poor credit
decisions that need immediate action.
Aging of Accounts
This test provides a detailed breakdown of receivables based
on how long they have been outstanding, typically categorized
as:
Current (Not Due)
30 Days Past Due
60 Days Past Due
90+ Days Past Due
Over 1 Year Past Due
The longer an account remains unpaid, the lower the likelihood of
collection. Businesses use this data to prioritize collection efforts
and adjust credit limits.
An aging report can also highlight potential fraud or poor credit
decisions that need immediate action.
Cost Analysis
Evaluates the total cost of running a credit department, which
includes:
Bad debt losses (unrecoverable amounts).
Wages and salaries of credit and collection employees.
Fees for credit reports and information services (used to
assess creditworthiness).
Equipment and software costs for credit management.
Third-party collection fees when external agencies are
used.
Understanding these costs helps businesses optimize credit
operations and ensure that the benefits of extending credit
outweigh the expenses.
Businesses can also compare credit costs against sales growth
to assess whether credit policies are cost-effective.
Thank you
for listening!
