Name: Betiola, Rachelle Ann

Canilang, Julius Ceasar

Duarte, Mary Lyn
Flores, John Robin
Instructor: Rolando P. Custodio
Subject/Code: Credit and Collection/ FME 204
Date of Submission: March 29, 2020
Title: “The Significance of Credit in Business towards improvement of working Capital”

INTRODUCTION

What comes to your mind when you heard the word credit? Suppose you were in a store
and saw something really great that you wanted - a shirt, new shoes, candy - but you didn’t have
enough money to buy it. So, what did you do? You begged your parents to buy it and take the
money from your next allowance. That’s credit! Or, while at a restaurant you realize you forgot
your wallet. Your friend pays for your meal and you pay her back when you find your wallet.
That’s credit, too! The concept of credit is nothing new and it is one of the universally used by
all kinds of people from all walks of life. So, what exactly is credit? Credit is receiving
something of value now with the promise to pay for it later. Credit stems from trust; credit comes
from the Latin word “crede” meaning trust. This trust helps to build your reputation and increase
your chances of borrowing more in the future.

The credit has three usage, these are credit transaction, credit standing and credit
instrument. The credit transaction is an exchange of present value for a promise to pay money at
a specified time in the future. It is a transaction by the terms which the payment of the goods or
services will be made in the future date. Credit standing is the record of a person or company
relating to the payment of debts: Late payments can be seriously affecting your overall credit
standing. It is also the credit score you got on how you pay the credit you owe while credit
instrument is a document that serves as evidence of debt.

The advantage of credit is it plays major part in our economy, the transfer of goods from
producer to consumer is a lot faster and it benefits not only the consumer but also the economy.
However, massive credit can lead to bankruptcy and imbalance of financial system of the
economy. If you are in need of money for an essential item or to help make your life more
manageable, it’s a good thing to familiarize yourself with the kinds of credit and loans that might
be available to you and the sorts of terms you can expect.

Working capital is the difference between a company’s current assets such as cash,
account receivable, and inventories of raw materials and finish goods and its current liabilities
such as account payable. The working capital is a measure of company’s liquidity, operational
efficiency and its short-term financial health. If a company has substantial positive working
capital, then it should have the potential to invest and grow. If company’s current assets do not
exceed its currents liabilities, then it may trouble growing or paying back creditors, or even go
bankrupt.

The working capital has four main components. First is the cash management which of
one of the important components of current assets. It is needed for performing all the activities of
a firm from buying of raw materials to marketing of finished goods. Therefore it is essential for a
firm to maintain an adequate cash balance.

The other components of working capital are receivable management. The term
receivable is defined as any claim for money owed to the firm from customers arising from the
sale of goods or services in normal course of business. The term account receivable represents
sundry debtors of a firm. It is one of the significant components of working capital next to cash
and inventories. Inventory management is one of the components of the working capital by
which inventory constitutes a major part of total working capital efficient management of
inventory results in maximization of earnings of the shareholders. And last but not the least
components of the working capital is the account payable management. The payables or creditors
are one of the important components of working capital. Payables provide spontaneous source of
financing of working capital. Payable management is very closely related with the cash
management. Effective payable management leads to steady supply of materials to a firm as well
as enhances its reputation.
BODY

After we had learned about what credit, working capital and their relationship is, we will now
discuss about the types and other information referring to it. As we move further, there are nine
categories of credit namely; Trade credit, Bank credit, Agricultural credit, Character loan credit,
Retail credit, Factoring credit, Investment credit, Government credit and Export credit.

The first category of credit is Trade credit, it is known as the largest use of capital for a
majority of all businesses and it is commonly used as a source of short-term financing. Trade
credit is the credit extended by one trader to another when the goods and services are bought on
credit, it also facilitates the purchase of supplies without immediate payment. Companies
frequently offer trade credit to their customers as part of terms of a purchase agreement but
sometimes credit is not granted to those who has financial instability and difficulty because it
requires reasonable amount of financial standing and goodwill.

The second category is Bank credit, Commercial bank are authorized to provide a variety
of financial services which includes loan, saving accounts and others, but the primary functions
of banks is to accept deposits and lend of funds. Most loans granted by commercial banks to
businesses are made for one year or less. Banks also lending business working capital on short-
term basis, with maturities up to five years. Unlike Trade credit, Bank credit is the total amount
of credit available to a business or individual from a banking institution. A business or
individual’s bank credit depends on the borrower’s ability to repay the loan and the total amount
of credit available in the banking institution in other words the approval of the credit is
determined by a borrower’s credit rating, rating, income, collateral, assets and pre-existing debt.
In bank credit, there are two types namely; secured and unsecured where each one has its own
fees, interest rates, terms and conditions, and regulations. Fees include the amount borrowed plus
interest and other charges. Some fees are required, such as interest rates, while some are
optional, such as credit insurance; and some are based on specific events, such as late payment
fees. Usually, the most acceptable security or collateral is land with a title and the other form are
of security are stocks, bonds, house, machines, crops and other valuable properties while
unsecured loans are granted without security.

The third category is Agricultural credit, Credit is required in every type of business and
agriculture is not exception to it. The need to agricultural credit, however, becomes all the more
important when it moves from traditional agriculture to modern agriculture. The farmers,
therefore, need credit to increase productivity and efficiency in agriculture. This need is
increasing over the years with the rise of fertilizers, mechanization, and rise in prizes. There are
two types of agricultural credit; short-term credit and long-term credit. Short term credit for the
purchase of seeds, fertilizers, pesticides, bullocks and other casual expenses while long term
credit comprises of sinking well, land levelling, fencing and permanent improvements on land
purchase of big machineries.

The fourth category is Character loan credit, it is a loan made because of lender’s faith in
the borrower’s reputation and credit. Character loan credit is a type of unsecured loan and it is
often called signature loans, because they are secured only by the borrower’s signature. It tends
to occur in small towns where local bankers know the borrowers personally. To be qualified for a
loan, the applicants typically need to demonstrate outstanding credit history, character, and
financial integrity.

The fifth category is Retail credit, it is a type of consumer credit but with more specific
purpose. A retail credit line generally is a credit card for use at a particular store. Through the use
of credit cards there a lot of advantages like the convenience, instant cash, purchase protection,
low cost loans and others.

The sixth category is Factoring, Factoring is the sale of account receivable in exchange of
cash of a company or an individual to a financing company called factor at substantial discount.
Factoring helps the business converts its receivables immediately into cash instead of waiting for
the due dates of payment by the customers. In addition, it also allows the Business to
immediately build up their cash flow and pay outstanding obligations. The factor gains
ownership of the accounts receivable and has access to the detailed records of the receivables.
Therefore, factoring helps companies free up their capital that is tied up in accounts receivable
and also transfers the default risk associated with the receivables to the factor.

The seventh category is about Investment Credit, it refers to the promise to pay by the
individuals or business firms for the loans they obtained in buying fixed assets such as
machineries, lands, and construction of plants and factories.
 The eight category is Government Credit that usually happens when the government
issues an instrument such as Bonds or Treasury Bonds to the public to raise a fund or budget
needed for the financing of the government projects such as public roads, infrastructure, public
health, or any national projects designed for improving the country.

Lastly, Export Credit is a loan given to a person or company that has exported goods
while they are waiting for the payment from the buyer. In the same way as trade credit expect to
the procedures and documentations. Governments provide officially supported export credits
through Export Credit Agencies in support of national exporters competing for overseas sales.
Such support can take the form either of official financing support, such as direct credits to
foreign buyers, refinancing or interest-rate support, or of pure cover support, such as export
credits insurance or guarantee cover for credits provided by private financial institutions. ECAs
can be government institutions or private companies operating on behalf of governments.

How important is Credit in improving working capital? Credit is a tool that can be used
for good but may be problematic if you don't know how to use it effectively. Using Credit
reliably and earning good credit scores can help you build wealth and allow you to do business
with companies, but you can get into trouble if you don't understand how credit works. When
consumers and businesses can borrow money, economic transactions can take place efficiently
and economy of the business can grow. In contrast to working capital, this type of financing
which is credit or a loan, it finances the company's everyday operations through, (1)Working
Capital Loans, (2)Cash Flow Loans; and (3)Short-Term Business Loans. These loans are not
used to buy long-term assets or investments and are, instead used to provide the working capital
that covers a company's short-term operational needs. Those needs can include costs such as
payroll, rent, debt payments, and other essential expenses needed to finance the operations of the
business.

How business deal or make transaction through credit to improve working capital. As
mentioned from the above statement, different kinds of industries have their specific type of
loans. Trade credit and commercial bank credit have been two important sources of funds for
financing working capital needs of companies, apart from the long term source like equity
shares. However, more stringent credit policies followed by banks, tightening financial discipline
imposed by them, and their higher cost, led the companies to go in for new and innovative
sources of finance. As the new equities market has remained in a subdued condition and investor
interest in the equities has almost vanished during recent years, corporate have raised larger
resources through debt instruments, some of them being for a short period as 18 months.
Working capital requirements can be financed from both internally generated resources (selling
current assets) and externally acquired alternatives (borrowing or securing current assets).
Mostly firms borrow on the strength of their current assets and the major sources of funds
include trade credits, accruals, short-term bank loans, collateral papers, commercial papers and
factoring accounts receivable. Therefore, loans are simply corporate debt borrowings that are
used by a company to finance its daily operations. As mentioned above on categories of credit,
different industries applies for a loan to maintain and improve the working capital, and cover the
day-to-day expenses of the business for a short period of time because sometimes companies do
not have adequate cash on hand or asset liquidity to cover day-today operational expenses and
this will secure a loan for this purpose. Many companies do not have stable or predictable
revenue throughout the year. Factoring is the sale of account receivable in exchange of cash of a
company or an individual to a financing company called factor at substantial discount. Factoring
helps the business converts its receivables immediately into cash instead of waiting for the due
dates of payment by the customers. Factoring, also allows the business to immediately build up
their cash flow and pay outstanding obligations. The factor gains ownership of the accounts
receivable and has access to the detailed records of the receivables. Therefore, factoring helps
companies free up their capital that is tied up in accounts receivable and also transfers the default
risk associated with the receivables to the factor.

According to Jean Murray that every business needs money to operate. And sometimes a
business needs more money - when starting up or expanding. A working capital loan or line of
credit is a good way to get money for your business and your up-and-down needs for money. A
working capital loan is simply a loan that will give you this working capital. Working capital
loans are used to help businesses function on a day-to-day basis. You might say that working
capital is the life-blood of a business. No blood and the business stops going. That's a little
dramatic but it emphasizes its importance. For many new businesses, having enough working
capital means the difference between the success and failure of the business.
 Having enough working capital for your business to function day-to-day is most
important during the start-up phase. At this point, you may have a negative net working capital,
because money is going out faster than it's coming in. And you may decide you need a loan to
cover your expenses while you work on getting to a positive working capital position.

At business start-up, when bills must be paid but there is little money available because
you are just beginning to bring in money from sales. At these times, you may be able to get a
temporary working capital line of credit, which allows you to draw on the credit line as
necessary to meet cash flow shortages. 

At times of change, growth, and expansion, when your business is moving forward and
you need cash temporarily to finance that expansion. In these cases, you may want to consider a
loan or line of credit from a lender with whom you already do business. 

According to Chelsea Krause, there can be many different reasons to get a working
capital loan depending on your business and industry; First is the Inconsistent Cash Flow, If the
customers take a long time to pay invoices or your inventory takes a long time to turn over, the
business’s cash flow will suffer. Inconsistent cash flow can make it tough to pay bills on time
and run your business. A working capital loan gives you access to cash when you need it. Second
is the Seasonal Sales Fluctuations wherein working capital loans can come in handy for seasonal
businesses that need to pay business expenses while sales are slow. For example, a boat tourism
company may take out a working capital loan in the winter to help cover expenses during the off-
season. Seasonal businesses might also use working capital loans to purchase inventory before a
holiday rush to prepare for increased sales. Third is the Business Growth Spurts, It’s no surprise
that start-ups and young businesses can have difficulty making ends meet. Working capital loans
help new businesses cover everyday expenses, pay their employees, hire new employees, and
invest in growing and marketing their businesses. Fourth is New Business Opportunities,
Nothing is worse than passing up on a huge business opportunity because you don’t have the
funds.
A working capital loan can help you purchase new equipment, invest in training, or give
you the resources you need to expand your business and take advantage of opportunities when
they arise. Working capital loans can also allow you to take on projects that are a good
investment in the long run but may not have an immediate payoff and the last is Cash Cushion, If
your business doesn’t have much wiggle room for unanticipated expenses, working capital can
act as a sort of cash cushion or emergency fund that helps ensure that your business can deal with
the unexpected.