Credit Management

CDE, Bharathidasan University, B.Com. (B.M.
), Major Paper-V, CREDIT MANAGEMENT
CENTRE FOR DISTANCE EDUCATION

BHARATHIDASAN UNIVERSITY,
TIRUCHIRAPPALLI – 620 024
Course : B.Com. (B. M.)
Title : Credit Management (Major Paper – V)
Lesson Writer : Dr. B. Kannan, Ph.D.,

Assistant professor
P.G. and Research Department of Commerce
Periyar E.V.R. College (Autonomous),
Tiruchirappalli – 620 023, Tamil Nadu
Phone: 98425 57599, 8248580701
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CDE, Bharathidasan University, B.Com. (B.M.), Major Paper-V, CREDIT MANAGEMENT
UNIT-I
Management is a process of planning, decision making, organizing, leading,
motivation and controlling the human resources, financial, physical, and information
resources of an organization to reach its goals in an efficient and effective manner. Credit
means receiving something of value now and promising to pay for it later, often with a
finance charge added by the lender. Credit management is the process of granting credit,
setting the terms it's granted on, recovering this credit when it's due, and ensuring compliance
with company credit policy, among other credit related functions. The goal within a bank or
company in controlling credit is to improve revenues and profit by facilitating sales and
reducing financial risks. The term credit derived from Latin word “Credo”, which means “I
Belive”. Without the invention of credit, the whole economic progress of the world is not
possible.
Credit Management is founded with the availability of risk and uncertainty to offset
the earnings from lending to a borrower. Credit management is an essential process with
many firms that engages with the business of credit. If the credit giving process done in a
right manner, it ensures that the customer may pay on services delivered. Credit management
is a practice and strategies followed by the organization, in order to make the level of credit at
considerable level to receive profit with low risk. Nelso defines credit management is the
practices followed by organization to manage the sales they make on credit. It becomes
essential part of all the organizations that have credit transactions since some have managed
their credit activities so well that they have zero credit risk. Credit management in the terms
of strategies is used by one to collect and have a control on credit payments from the
borrowers. Credit management is a part of financial management. When credit management
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and credit control is done at par, it will reduce the loss to the organization in the form of Bad
debts. Some firms attempt to get more business by providing more credit. However, it should
have maintain certain level on credit giving, because cost of controlling the credit will
decrease the profit.
Common credit Terms:
It is essential to understand some basic terms used in the credit management system. It
will help the reader in better understanding of the credit management in the forthcoming
sessions.
 Accrued Interest - Interest that has been accumulated since the last loan repayment
 Amortization - The reduction of debt through regular payments, or the reduction in
value of an asset through depreciation
 Balloon Payment - The final payment on a debt, which is much larger than the
standard payments.
 Bankruptcy - The discharge or forgiving of one’s debts by a federal court. There are
different types of official bankruptcy under federal law.
 Collateral - Items of value that are pledged as security for a loan. If the loan is not
paid, the items are forfeited.
 Compound Interest - A method by which interest is calculated on the principal
amount and on the interest that was earned earlier.
 Credit Rating - An evaluation of the credit history of an individual or firm to
determine if worthy of the extension of additional credit.
 Lien - A claim by a creditor or other party against an asset. If an obligation is not
fulfilled, the property may be seized through a court order to satisfy the lien.
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 Mortgage - A type of debt in which the borrower gives the lender a lien against the
property until the funds are paid back. When involving personal property as opposed
to real estate, the term is “chattel mortgage”
 Promissory Note - A written promise to pay a certain sum under terms acceptable to
both the borrower and the lender.
 Collection Costs - Those external costs that have been or will be incurred by HFC in
connection with the recovery of a debt (other than those associated with the physical
sale and realization of specific assets) such as legal and related costs of actions to
discover or gain control of assets, to pursue guarantors etc, and which are chargeable
against the customer in terms of our documentation.
Origin of Credit:
It is easy to understand the revolution of Home Theatre or mobile phone. Home
theatre is the reality of very old film projector and mobile phones are from cable phone.
Development of devices are the advancement of early version of anything. Horse and Cart
replaces Motor Car. Like that credit has transformed from a very long time. Today we enjoy
better transport system but not in 1930s’. So everything has its evolution from the birth.
Same ways while going for credit, it is documents in the ancient civilization of Assyria,
Egypt, and Babylon over 3000 years ago. But it was from the Europe that we look to see real
growth in credit trading as we witnessing today. It is evidence from various literature work,
that merchants travelling from fair to fair, buying and selling around the world before the
period of Globalization. In those days agent is responsible to handle all the buying and selling
on behalf of travelling buyer and sellers. For that a contract was created in the name of
Cambium Contract with all details included.
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It is agreed that in 1253 a buyer from Genoa purchased English cloth in France and
agreeing to pay four month later for the purchase. But logic of bulk purchase and discount
was not induced.
The term credit means, reposing trust or confidence in somebody. In economics, it is
interpreted to mean, in the same sense, trusting in the solvency of a person or making a
payment to a person to receive it back after some time or lending of money and receiving of
deposits etc. In other words, the meaning of credit can be explained as, A contractual
agreement in which, a borrower receives something of value now and agrees to repay the
lender at some later date. The borrowing capacity provided to an individual by the banking
system, in the form of credit or a loan. The total bank credit the individual has is the sum of
the borrowing capacity each lender bank provides to the individual.
Definitions on Credit
Prof. Kinley: “By credit, we mean the power which one person has to induce another
to put economic goods at his deposal for a time on promise or future payment. Credit is thus
an attribute of power of the borrower”.
Prof. Gide: “It is an exchange which is complete after the expiry of a certain period
of time”. Prof. Cole: “Credit is purchasing power not derived from income but created by
financial institutions either as on offset to idle income held by depositors in the bank or as a
net addition to the total amount or purchasing power”.
Prof. Thomas: “The term credit is now applied to that belief in a man’s probability
and solvency which will permit of his being entrusted with something of value belonging to
another whether that something consists, of money, goods, services or even credit itself as
and when one may entrust the use of his good name and reputation”.
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Vasant Desai: “To give or allow the use of temporarily on the condition that some or
its equivalent will be returned”.
Characteristics of Credit:
Important characteristics of credit are discussed below:
1. Confidence:
Confidence is very important for granting or extending any credit.Withous trust and
confidence one can’t lend it. It is all about repayment of debts is the confidence which lender
should have on the debtor.
2. Capacity:
Borrower should have the capacity to repay what he receives as credit. Willingness
and capacity is to be considered. If a person does not have adequate capacity to repay the
loan, now it become riskier for the lender. Capacity of the borrower to repay the debt is also
very crucial thing to be considered. Before granting or extending any advance, creditor
should evaluate the borrower’s capacity.
3. Security:
At the time of lending the loan, lender should get security in turn. At the time of non-
repayment of loan or debt, security can be availed to get back the loan amount given to the
borrower. One has to ensure the right security is attached to the debt and lender should ensure
property about the debtor. The availability of credit depends upon property or assets
possessed by the borrower.
4. Goodwill:
If the borrower has good reputation of repaying outstanding in time, borrower may be
able to obtain credit without any difficulty.
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5. Size of credit:
Generally small amount of credit is easily available than the larger one. Again it also
depends on above factors.
6. Period of credit:
Normally, long term credit cannot easily be obtained because more risk elements are
involved in its security and repayments.
Types of Credit:
The credit assistance provided by a banker is mainly of two types, one is fund based
credit support and the other is non-fund based. The difference between fund based and non-
fund based credit assistance provided by a banker lies mainly in the cash out flow. Banks
generally allow fund based facilities to customers in any of the following manners.
1. Cash credit:
Cash credit is a credit that given in cash to business firms. A cash credit account is a
drawing account against a fixed credit limit granted by the bank and is operated exactly in the
same manner as a current account with all overdraft facilities. It is an arrangement by which,
a bank allows its customers to borrow money up to a certain limit against tangible securities
or share of approved concern etc. cash credits are generally allowed against the hypothecation
of goods/ book debts or personal security. Depending upon the nature of requirement of a
borrower, bank specifies a limit for the customer, up to which the customer is permitted to
borrow against the security of assets after submission of prescribed terms and conditions and
keeping prescribed margin against the security. It is on demand based account. The
borrowing limit is allowed to continue for years if there is a good turnover in account as well
as goods. In this account deposits and withdrawals may be affected frequently. In India, cash
credit is the most popular mode of advance for businesses.
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2. Overdraft:
A customer having current account, is allowed by the banks to draw more than his
deposits in the account is called an overdraft facility. In this system, customers are permitted
to withdraw the amount over and above his balance up to extent of the limit stipulated when
the customer needs it and to repay it by the means of deposits in account as and when it is
convenient. Customer of good standing is allowed this facility but customer has to pay
interest on the extra withdrawal amount.
3. Demand loans:
A demand loan has no stated maturity period and may be asked to be paid on demand.
Its silent feature is, the entire amount of the sanctioned loan is paid to the debtor at one time.
Interest is charged on the debit balance.
4. Term loans:
Term loan is an advance for a fixed period to a person engaged in industry, business
or trade for meeting his requirement like acquisition of fixed assets etc. the maturity period
depends upon the borrower’s future earnings. Next to cash credit, term loans are assumed of
great importance in an advance portfolio of the banking system of country.
5. Bill purchased:
Bankers may sometimes purchase bills instead of discounting them. But this is
generally done in the case of documentary bills and that too from approved customers only.
Documentary bills are accompanied by documents of title to goods such as bills of loading or
lorry and railway receipts. In some cases, banker advances money in the form of overdraft or
cash credit against the security of such bills.
6. Bill discounted:
Banker loans the funds by receiving a promissory note or bill payable at a future date
and deducting that from the interest on the amount of the instrument. The main feature of this
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lending is that the interest is received by the banker in advance. This form of lending is more
or less a clean advance and banks rely mainly on the creditworthiness of the parties.
Credit Instruments:
Credit instruments prove very helpful in encouragement and the development of
credit and help in the promotion and development of trade and commerce. Some of the credit
instruments are,
1. Cheque:
Cheque is the most popular instrument. It is an order drawn by a depositor on the
bank to pay a certain amount of money which is deposited with the bank.
2. Bank draft:
Bank draft is another important instrument of credit used by banks on either its branch
or the head office to send money from one place to other. Money sent through a bank draft is
cheaper, convenient and has less risk.
3. Bill of exchange:
It enables a seller of commodity to issue an order to a buyer to make the payment
either to him or to a person whose name and address is mentioned therein either on the site of
the bill or within a period of time specified therein.
4. Promissory note:
According to the Indian negotiable instrument act, „a promissory note‟ is an
instrument in writing containing an unconditional undertaking signed by the maker to pay a
certain sum of money only to or the order of certain person or the bearer of the instrument.
5. Government bonds:
Government issues a sort of certificate to the person who subscribes to these loans. Such
certificates are called government bonds. Some of them are income tax free.
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6. Treasury bills:
These bills are also issued by the government. They are issued in anticipation of the public
revenues.
7. Traveler’s cheque:
This is the facility given by bank to the people. It was most useful when recent
technological instrument like ATMs were not available. A customer was used to deposit
money with the banks and banks give traveler’s cheque in turn. It was used to avoid risk of
having cash while travelling.
Advantages of Credit:
Credit plays an important role in the gross earnings and net profit of commercial
banks and promotes the economic development of the country. The basic function of credit
provided by banks is to enable an individual and business enterprise to purchase goods or
services ahead of their ability. Today, people use a bank loan for personal reasons of every
kind and business venture too. The great benefit of credit with a bank is probably very low
interest rates. Majority people feel comfortable lending with bank because of familiarity.
1. Exchange of ownership:
Credit system enables a debtor to use something which does not own completely. This
way, debtor is provided with control as distinct from ownership of certain goods and services.
2. Employment encouragement:
With the help of bank credit, people can be encouraged to do some creative business
work which helps increasing the volume of employment.
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3. Increase consumption:
Credit increases the consumption of all types of goods. By that, large scale production
may stimulate which leads to decrease cost of production which in turn also lowers the price
of product which in result rising standard of living.
4. Saving encouragement:
Credit gives encouragement to the saving habit of the people because of the attraction
of interest and dividend.
5. Capital formation:
Credit helps in capital formation by way that it makes available huge funds from able
people to unable people to use some things. Credit makes possible the balanced development
of different regions.
6. Development of entrepreneurs:
Credit helps in developing large scale enterprises and corporate business. It has also
helped the different entrepreneurs to fight with difficult periods of financial crisis. Credit also
helps the ordinary consumers to meet requirements even in the inability of payment. One can
borrow money and grow business at a greater return on investment than the interest rates of
loan.
7. Easy payment:
With the help of various credit instruments people can pay without much difficulty
and botheration. Even the international payments have been facilitated very much.
8. Elasticity of monetary system:
Credit system provides elasticity to the monetary system of a country because it can
be expanded without much difficulty. More currency can be issued providing for
proportionate metallic reserves.
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9. Priority sector development:
Credit helps in developing many priority sectors including agriculture. This has
greatly helped in rising agriculture productivity and income of the farmers. Banks in
developing countries are providing credit for development of SSI in rural areas and other
priority sectors too.
Disadvantages of Credit:
Credit is a mixed consent. It involves certain advantages and some dangers also at the
same time. Credit is useful as well as harmful to the user even. So it should be used very
cautiously otherwise it may spoil all industries and enterprises. Credit, if not properly
regulated and controlled it has its inherent dangers.
1. Encouragement of expenditure:
Credit encourages wasteful expenses by the individuals as well as commercial
institutions. As people irresponsibly think that the money is not their own. Easy availability
leads to over trading over exposure that ultimately leads to bad debts.
2. Encourage weakness:
Credit encourages big entrepreneurs to continue to hide their weakness. Their own
shortcomings are met by the borrowed capital. Even the loosing concerns continue with the
help of borrowed capital in the hope to survive. In this condition, if business fails, it not only
leads the borrowers in dangers but also thousands of those people who advanced credit to
such people.
3. Economic crisis:
In several occasions credit is directly responsible for economic crisis. It leads to
recession and depression in an economy as boom of credit facilities has its own evil effect on
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the economy. Financially weak concern having credit facility takes the economy to weaker
effects.
4. Dangers beyond limit:
Credit in a country expanded beyond certain limits which results in over investment.
Over issue credit takes beyond safe limits that result in over investment, over production and
rise of prices. This danger has been emphasized by Prof. Thomas in his „Elements of
Economics‟, in his words: “There is no automatic limit to the expansion of a credit system as
there is to an expansion of a metallic circulation through the intervention of human element.
Uncertainty and variableness is the chief source of danger in a credit organization”.
5. Evil of monopoly:
Credit system has also resulted in the creation of monopolies; monopolistic
exploitation is due to money placed at the disposal of individuals or companies that leads to
monopolist exploitation. The different organizations have growth with the emergence of
credit and have worked to the damage of both the consumers and the workers.
6. Encourage inefficient:
Credit gives encouragement to certain inefficient and worthless producers. Inefficient
business concerns availing the credit and not using efficiently, accumulate money in their
hands. People come into the market with the feeling that they have nothing to do but just to
play only with other’s money. So, by this it can be said that it is clear that the government or
the central banking authorities must keep the credit within limit so that no evil is allowed to
crop up in the economy.
Role of Credit in Economy:
Commercial banks continue to remain in the forefront of Indian financial system.
Banks provide necessary finance for planned development. In developed and developing
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countries both, credit is the foundation upon which the economic structure is strengthening.
Bank credit would play a significant role by influencing the types of commodities and
quantum of their output. To achieve high rate of economic growth over a long period,
agriculture and industrial credit should be increased. At the time of sanctioning the credit, the
purpose should be investigated by the bank to ensure that the end use of funds confirms to
overall national objectives. Banks also give credit to the priority and neglected sectors by
which the sectoral development can be possible. Easy availability of credit promotes the
entrepreneurial and self employment venture in the country. Credit instruments are used as
media of exchange in place of metallic or paper currency. These instruments are more
effective and convenient in all business transactions. Bank credit provides assistance to
production and business process. Institutional credit provides a ready flow of money to the
business. Bank credit fulfills the capital requirement of an entrepreneur which increases the
production at higher level by which production cost decreases and as a result price of product
also decreases that affects the economy positively. an international market too. Credit makes
common person to change into entrepreneur. Surplus fund utilized for credit bring return that
further increase the volume of funds. Credit makes it easy and convenient for the consumers
to purchase or hire durable goods. In the period of declining market, there is greater
availability of cheaper source of funds through credit. Corporate borrowers paid greater
attention towards banks for their financial requirements. This enables the entrepreneurs to run
their business and day to day transactions very smoothly. Bank’s power to create money is of
great economic significance. This gives an elastic credit system which is necessary for steady
economic progress. This system geared to the seasonal demands of business. Bank lending
operation acts as a governor controlling the economic activity in the country. Bank lending is
very important to the economy, for it makes possible the financing of the agricultural,
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industrial and commercial activities of the country. According to an economist, “Credit has
done more to enrich nations than all the gold mines in the world put together.”
Concept of Credit Management:
Banks and financial institutions mobilize deposits and utilize them for lending.
Generally lending business is encouraged as it has the effect of funds being transferred from
the system to productive purposes which results into economic growth. The borrower takes
fund from bank in a form of loan and pays back the principal amount along with the interest.
Sometimes in the non – performance of the loan assets, the fund of the banks gets blocked
and the profit margin goes down. To avoid this situation, bank should manage its overall
credit process. Bank should deploy its credit in such a way that every sectors of economy can
develop. Credit management comprises two aspects; from one angle it is that how to
distribute credit among all sectors of economy so that every sector can develop and banks
also get profit and from the other angle, how to grant credit to various sectors, individuals and
businesses to avoid credit risk.
Credit management is concerned mainly with using the bank’s resource both productively
and profitably to achieve a preferable economic growth. At the same time, it also seeks a fair
distribution among the various segments of the economy so that the economic fabric grows
without any hindrance as stipulated in the national objectives, in general and the banking
objectives, in particular.Credit provides financial ability to use advanced technology in the
production. So the quality of production and product may increase.
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Administration of Credit:
1. Appraisal:
The norms for appraisal should be spelled out in the loan policy. The format, credit
information, financial observation, method of lending etc., should be included.
2. Pricing:
Fixing of loan pricing should be based on the cost of funds and nature of the risks.
The cost of fund should be spelled out by bank depending on credit rating of the borrower
and probability of default.
3. Expiry Terms:
The terms of expiry of the loan should be based on maturity pattern of resources and
movement in interest rates and life of collateral.
4. Sanctioning:
Sanctioning power of the authority should be clearly mentioned in loan policy. The
sanction should be in written form and within the delegated authority. Time schedule for
reporting sanctions and exceptions for confirmation of the higher authorities should also be
spelled out.
5. Documentation:
Documentation starts with a written loan application by the borrower followed by
signed loan covenants like, right of set off, right to enforce collateral / securities on default,
right to debit account for charges, right to freeze operation on misuse of facilities, right to
receive statements of business etc. The borrower should be given a sanction letter in standard
format and borrower’s written acknowledgment in terms of sanction should also be obtained.
6. Disbursement:
Proper authorization for disbursement of loan should be there. Adequate drawing
power and security cover within stipulated margin should be taken carefully while disbursing.
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This should be made after proper documentation. It should be ensured also that the use of
credit is for the purpose for which it was granted.
7. Recoveries and Rehabilitation:
In the loan policy, procedures for prompt follow up on due dates should be spelled
out. To avoid such ambiguity, time schedule may also be highlighted.
8. Income Recognition and Provisioning:
Some information and norms regarding NPA should also be spelled out in loan policy.
9. Internal Controls:
The internal control system regarding policy, the procedure to be followed in this
regard should be stated.
10. Loan Review:
Loan should be reviewed by an independent middle office. The job of this department
is to make analysis of portfolio risk. This is an emerging concept. The basic fundamental of
the overall loan policy should be to ensure safety of funds with returns.
Trade Credit (Accounts Receivables)

Definition and Meaning:
Trade credit is a kind of business credit which is extended by the seller of goods to the
buyer of the same at all levels of production and distribution process down to the retailer.
Before the goods and services have reached the ultimate users or consumers, they pass
through many hands starting from the producers down to the retailer. Trade credit is used by
various agencies operating in the trade channel between the producer and the retailer. For
example, the producer may extend credit to the wholesaler, who may also facilitate the
retailer’s trade by extending credit to him. Such credits extended by the wholesaler to the
retailer or producer to the wholesaler are known as trade credit.
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Trade credit has been defined as the short-term credit by a supplier to a buyer in
connection with purchase of goods for ultimate resale. Trade credit is a credit extended for
the purchase of goods with the ultimate purpose of resale. The credit accepted for the
purchase of goods which are consumed by the purchaser is not trade credit, it becomes
consumer credit. So a credit, in order to be designated as trade credit, must be extended in
connection with the purchase of goods which must be resold.
Terms of Trade Credit:
Terms of credit vary considerably from industry to industry. Theoretically, four main
factors determine the length of credit allowed.
 The economic nature of the product: products with a high sales turnover are sold on short
credit terms. If the seller is relying on a low profit margin and a high sales turnover, he
cannot afford to offer customers a long time to pay.
 The financial circumstances of the seller: if the seller’s liquidity position is weak he will
find it difficult to allow very much credit and will prefer an early cash settlement. If the
credit term is used as part of sales promotion then, he may allow more credit days and use
other means for improving liquidity position.
 The financial position of the buyer: If the buyer is in weak liquidity position he may take
long time to settle the balance. The seller may not be willing to trade with such customers,
but where competition is stiff there is no choice other than accepting such risk and improve
on sales levels.
 Cash discounts: when cash discounts are taken into account, the cost of capital can be
surprisingly high. The higher the cash discount being offered the smaller is the period of
trade discount likely to be taken.
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Components of Trade Credit

Free Trade Credit: Credit received during the discount period. When a company
buys something from a supplier they typically will not pay for it immediately. They will be
given an invoice and it will have terms that look like " 2/7 n/30". This means that you can
receive a 2% discount if the bill is paid within 7 days, or the payment of the bill in full is due
in 30 days.
It provides a very short term financing arrangement for the purchaser because instead
of having to pay cash upfront they can use that cash elsewhere for 30 days at no cost. Of
course, there is an opportunity cost involved if the purchaser wants to wait the whole 30 days
before paying bill that is the 2% discount.
Costly Trade Credit: Credit taken in excess of free trade credit, whose cost is equal
to the discount lost.
Advantages /Reasons for use of Trade Credit:
Low Cost: One of the most important reasons for the use of trade credit is its
cheapness. Trade credit, in most cases, is cheaper than other sources of credit, obtaining
funds form finance companies or banks gives rise to many complications. The lender may
impose restrictions on the action of the management. The rate of interest to be paid on the
funds is also determined in advance. In trade credit no specific rate of interest is to be paid.
Convenience of Informality: Trade credit is also used as a matter of convenience. It
is convenient to obtain, because the purchaser receives the goods from the seller when the
latter sends the goods on receipt of the order form the former. The purchaser is to make
payment on a stipulated date. But obtaining finance from the financial institutions is not so
easy. Many formalities are to be performed to obtain funds from such institutions.
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Less Risk: Trade credit has also got widespread use because of the fact that it is less
risky than other sources of funds. If the credit cannot be repaid by the end of the credit
period, the trade creditors usually don’t proceed to liquidate the firm. If the default is only for
a few weeks or a month and does not occur frequently, the creditor may not even be heard
from.
Availability: When other sources of obtaining funds are closed to a business
organization trade credit may be obtained easily. This is especially true of small concerns.
Such enterprises do not usually possess a good credit standing and that’s why, they cannot
approach big lending intuitions for loans. The banks, insurance companies and other finance
companies hesitate to lend funds to the business enterprises that are small in size and
financially weak. They fear that these enterprises would not be able to repay the debt on
maturity. As such, the small business concerns rely mostly on trade credit.
Disadvantages of Trade Credit:
1. Cost of Trade Credit: Trade credit may cause the purchase price to be higher than the list
price of the merchandise because the supplier may demand compensation for the risk
transferred to him through accounts receivables.
2. Frequent Maturity: Usually goods are sold on credit for short term for which a cash
discount may be provided if amount returned before the due date of payment but keeping
all this aside, the downside is that this source of finance can’t be used for longer term and
it give a headache to the business to take care of its accounts payable to prevent from bad
credit reputation.
3. Insolvency: When an individual or organization can no longer meet its financial
obligations with its lender or lenders as debts become due, it is considered insolvent.
Insolvency can lead to insolvency proceedings, in which legal action will be taken against
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the insolvent entity, and assets may be liquidated to pay off outstanding debts. Businesses
with deficit cash budgets for longer periods are more likely to taste these conditions.
Who Bears the Cost of Funds for Trade Credit?
1. Suppliers -- when trade costs cannot be passed on to buyers because of price competition
and demand.
2. Buyers -- when costs can be fully passed on through higher prices to the buyer by the
seller.
3. Both -- when costs can partially be passed on to buyers by sellers.
Credit Functions:
The following points highlight the nine main functions of credit. The functions are:
1. Economy in the use of money
2. Easy exchange and remittance
3. Helpful to production
4. Promotion of trade especially foreign trade
5. Expansion of bank credit
6. Financial accommodation to industries
7. Benefits to consumers
8. Credit to the government sector 9. Stability.
Function # 1. Economy in the use of money:
The credit system economises the use of metallic money and paper notes. The credit
instruments like promissory notes, bills of exchange, cheques, credit cards, etc. are used in
the modern society as money-substitutes, and so they have reduced the cost of issuing
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metallic money and paper notes. Likewise they have minimized or eliminated the risks and
inconveniences involved in cash transactions.
Function # 2. Easy exchange and remittance:
The credit instruments minimize the cash transactions and thereby make the scope of
exchange wider and the remittance of funds easier. They permit wealth to be transferred to
places where more economic use can be made of it.
Function # 3. Helpful to production:
The credit system facilitates large-scale production. It stimulates and finances
production in anticipation of demand. Producers nowadays very often obtain credit from
banks to begin and expand their operations. Even the farmers and the small artisans depend
on bank credit for production. The wholesale and retail traders conduct their trading with
bank credit.
It is rightly said that the credit system lubricates the production processes and keeps
the wheels of production constantly moving. There is a steady flow of goods from the
wholesaler to the retailer and from the latter to the consumer with the help of credit.
Function # 4. Promotion of trade especially foreign trade:
The bills of exchange have increased the scope of both internal and external trade as
the trade- payments can now be made without the transfer of funds or gold. The commercial
credit enables the buyers to make payments for the value received at convenient times. So,
the credit system enables the traders to tide over periods of difficulty.
Function # 5. Expansion of bank credit:
The credit system enables the banks to create a large amount of credit out of a small
amount of deposit. This has resulted in the vast expansion of bank deposits.
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Function # 6. Financial accommodation to industries:
Function # 7. Benefits to consumers:
Bank credit to the consumers enables them to buy durable consumer goods, especially
household goods on installment basis.
Function # 8. Credit to the government sector:
The credit to the government also helps them to meet both temporary necessities and
growth requirements.
Function # 9. Stability:
If the issue of credit is properly regulated, it tends to stabilise trade and reduce
fluctuations in prices.
Worthiness of an Applicant:
An individual or firm is requesting credit. What sources of information are available
to judge the credit worthiness of the applicant? Sources that can be utilised are financing
statements, bank references, and credit bureaus.
Financial Statements: A vital source of information is the applicant’s financial
statements. An applicant who is in a financially sound position would have no hesitation in
making available his or her financial statements. Interim reports, if available, are more
desirable than annual reports. Audited and CPA certified reports are preferred to unaudited
reports. The financial statements are useful for calculating various liquidity, leverage,
efficiency, and profitability ratios that may be used in evaluating credit risk. If the firm is
using a credit scoring model or if the applicant is requesting a large amount of credit,
financial statements are essential.
23
Bank references – these may not give a lot of information but they tend to use a series
of standardised replies, and experience of these will indicate the relative credit grading.
Credit Bureaus: Credit bureaus specialise in consolidating the experiences of other firms with
the applicant. Credit bureaus compile a history of the applicant’s credit payment performance
as reported by the credit-granted firms. Financial information on a credit applicant may be
obtained by credit bureau member firms who agree to provide credit bureaus with
information on their clients.
In addition to these information sources, a firm may try to compile its own
information. It may have its sales personnel prepare a report on the credit applicant.
Alternatively, if the credit request is large enough, it may send a credit department employee
to visit personally with the credit applicant and garner as much financial information as
possible. Reports published in trade journals or the financial press dealing either with the
customer company or with the type of business in which it is engaged.
Collection Management:
The accounts receivable are usually around 25% of total assets, although this ratio
depends strongly on the business sector (trade, industry, services…).
It is therefore very significant for many businesses and very consumer of financial
resources without being remunerated. It can be considered as a permanent financial weight
for companies.
Accounts receivable are an amount of money at risk. This risk has to be managed so that
financial resources of your company scattered among your customers (bills issued but not
paid yet) do not create bad debts with negative consequences for your business.
24
We can identify four main risks associated with receivables:
 risk of losses and provisions for bad debts,
 risk about working capital requirement and cash flow,
 risk of depreciation of value due to inflation,
 risk of excessive consumption of financial resources with result an incapacity to make
investments for your business.
It is more difficult to determine the opportunities of receivables:
 it is often a business requirement to grant a payment to your customers. By this way you
finance the activity of your client. This is precisely what he is requesting even if he does
not formulate this need in these terms,
 ability to discount your receivables to get cash faster compare to the due date of your
invoices.
It depends mainly on your business' financial structure and profitability, the weight of
your receivables and your business overall strategy.
A Credit Policy is not

something that is only
operated by the Credit and
risk Department. All
25
workers included with

clients, in any capacity,
should be mindful of the
credit strategy and
guarantee that it is worked
reliably
(http://www.bwaresolutions.co
m/).
Keeping in mind the end goal
to be successful, credit
strategies must be conveyed all
through the
association, executed through
proper techniques, observed
and intermittently overhauled
to
26
consider changing inward and

outer circumstances.
They ought to be connected,
where suitable, on a
solidified bank premise and
at the level of
individual subsidiaries.
Furthermore, the strategies
ought to address just as the
essential elements
of evaluating.
Monetary conditions and the
association's credit strategies
are the boss impacts on the
level of a
27
company's record receivable.

Monetary conditions,
obviously, are to a great
extent outside the
ability to control of the money
related chief. Similarly, as
with other current resources,
be that as
it may, the administrator can
fluctuate the level of
receivables in keeping with the
trade-off in the
middle of benefit and danger.
Settling for the easiest option
may invigorate request, which,
thusly,
28
ought to prompt higher

beneficial receivables, and in
addition a more serious
danger of awful
obligation.
The credit and accumulation
strategy of one firm are not
free of those of different firms.
On the off chance that item
and capital markets are
sensibly focused, the credit
and accumulation
practices of one organization
will be impacted by what
different organizations are
doing.
29
Such practice identified with

the valuing of the item or
administration and must be
seen as a major
aspect of the general
aggressive procedure.
The examination of certain
approach variables infers that
the focused procedure is
represented in
the determination of the
interest capacity and in the
open-door expense connected
with tackling
extra receivables. The
approach variables
30
incorporate the nature of the

exchange records
acknowledged; the length of
the credit period, the money
rebate, any uncommon
terms, for
example, occasional dating
and the gathering project of the
firm.
A Credit Policy is not
something that is only
operated by the Credit and
risk Department. All
workers included with
clients, in any capacity,
31
should be mindful of the

credit strategy and
guarantee that it is worked
reliably
(http://www.bwaresolutions.co
m/).
Keeping in mind the end goal
to be successful, credit
strategies must be conveyed all
through the
association, executed through
proper techniques, observed
and intermittently overhauled
to
consider changing inward and
outer circumstances.
32
They ought to be connected,

where suitable, on a
solidified bank premise and
at the level of
individual subsidiaries.
Furthermore, the strategies
ought to address just as the
essential elements
of evaluating.
Monetary conditions and the
association's credit strategies
are the boss impacts on the
level of a
company's record receivable.
Monetary conditions,
33
obviously, are to a great

extent outside the
ability to control of the money
related chief. Similarly, as
with other current resources,
be that as
it may, the administrator can
fluctuate the level of
receivables in keeping with the
trade-off in the
middle of benefit and danger.
Settling for the easiest option
may invigorate request, which,
thusly,
ought to prompt higher
beneficial receivables, and in
34
addition a more serious

danger of awful
obligation.
The credit and accumulation
strategy of one firm are not
free of those of different firms.
On the off chance that item
and capital markets are
sensibly focused, the credit
and accumulation
practices of one organization
will be impacted by what
different organizations are
doing.
Such practice identified with
the valuing of the item or
35
administration and must be

seen as a major
aspect of the general
aggressive procedure.
The examination of certain
approach variables infers that
the focused procedure is
represented in
the determination of the
interest capacity and in the
open-door expense connected
with tackling
extra receivables. The
approach variables
incorporate the nature of the
exchange records
36
acknowledged; the length of

the credit period, the money
rebate, any uncommon
terms, for
example, occasional dating
and the gathering project of the
firm.
Credit Procedure:
A credit review process is needed to ensure that a business does not
grant credit to customers who are unable to pay. The credit department handles all credit
reviews. The department may receive paper copies of sales orders from the order entry
department, documenting each order requested by a customer. In this manual
environment, the receipt of a sales order triggers a manual review process where the
credit staff can block sales orders from reaching the shipping department unless it
forwards an approved copy of the sales order to the shipping manager. The order entry
procedure for a manual system is outlined below.
1. Receive sales order. The order entry department sends a copy of each sales order to the
credit department. If the customer is a new one, the credit manager assigns it to a credit
staff person. A sales order from an existing customer will likely be given to the credit
person already assigned to that customer.

37
2. Issue credit application. If the customer is a new one or has not done business with the
company for a considerable period of time, send them a credit application and request
that it be completed and returned directly to the credit department. This may be done by
e-mail to speed the application process.
3. Collect and review credit application. Upon receipt of a completed sales order, examine
it to ensure that all fields have been completed, and contact the customer for more
information if some fields are incomplete. Then collect a credit report,
customer financial statements, bank references, and credit references.
4. Assign credit level. Based on the collected information and the company’s algorithm for
granting credit, determine a credit amount that the company is willing to grant to the
customer. It may also be possible to adjust the credit level if a customer is willing to sign
a personal guarantee.
5. Hold order (optional). If the sales order is from an existing customer and there is an
existing unpaid and unresolved invoice from the customer for more than $___, place a
hold on the sales order. Contact the customer and inform them that the order will be kept
on hold until such time as the outstanding invoice has been paid.
6. Obtain credit insurance (optional). If the company uses credit insurance, forward the
relevant customer information to the insurer to see if it will insure the credit risk.
7. Verify remaining credit (optional). A sales order may have been forwarded from the
order entry department for an existing customer who already has been granted credit. In
this situation, the credit staff compares the remaining amount of available credit to the
amount of the sales order, and approves the order if there is sufficient credit for the
order. If not, the credit staff considers a one-time increase in the credit level in order to
accept the order, or contacts the customer to arrange for an alternative payment
arrangement.
38
8. Approve sales order. If the credit staff approves the credit level needed for a sales order,
it stamps the sales order as approved, signs the form, and forwards a copy to the shipping
department for fulfillment. It also retains a copy.
9. File credit documentation. Create a file for the customer and store all information in it
that was collected as part of the credit examination process.
39
Unit-II
Meaning of credit Management:
Credit management is the process of granting credit, setting the terms it's granted on,
recovering this credit when it's due, and ensuring compliance with company credit policy,
among other credit related functions. The goal within a bank or company in controlling credit
is to improve revenues and profit by facilitating sales and reducing financial risks.
A credit manager is a person employed by an organization to manage the credit
department and make decisions concerning credit limits, acceptable levels of risk, terms of
payment and enforcement actions with their customers. This function is often combined with
Accounts Receivable and Collections into one department of a company. The role of credit
manager is variable in its scope and Credit managers are responsible.
Nature of Credit Management:
 Controlling bad debt exposure and expenses, through the direct management of credit
terms on the company's ledgers.
 Maintaining strong cash flows through efficient collections. The efficiency of cash flow
is measured using various methods, most common of which is Days Sales
Outstanding (DSO).
 Ensuring an adequate Allowance for Doubtful Accounts is kept by the company.
 Monitoring the Accounts Receivable portfolio for trends and warning signs.
 Hiring and firing of credit analysts, accounts receivable and collections personnel.
 Enforcing the "stop list" of supply of goods and services to customers.
40
 Removing bad debts from the ledger (Bad Debt Write-Offs).
 Setting credit limits.
 Setting credit terms beyond those within credit analysts' authority.
 Setting credit rating criteria.
 Setting and ensuring compliance with a corporate credit policy.
 Pursuing legal remedies for non-payers.
 Obtaining security interests where necessary. Common examples of this could be PPSA's,
letters of credit or personal guarantees.
 Initiating legal or other recovery actions against customers who are delinquent.
Scope of Credit Management:
The Scope of credit management touches very key aspects of any organization which
include:
a) Customer attraction- many organizations use credit as a way of attracting new
customers by giving those attractive terms for repayment of purchases. In that case the credit
decision is actually a marketing decision.
b) Liquidity decision- Credit policy directly affects the liquidity of an organization
since it means the goods advanced on credit represent a financing gap which the organization
has to fill. If an organization has a lot of its working capital tied in accounts receivable is
likely to face liquidity challenges hence the credit decision is a financing decision.
c) Competitive strategy–The credit decision is also used by organizations to compete
in the market place with organizations positioning themselves in the market by formulating
attractive credit policies.
d)Effect on the balance sheet–Credit management affects the quality of the accounts
receivable as relates to their collectability and since they are presented as part of the working
41
capital the credit decision affects the value of the accounts receivable depending on how
sound the credit policy are.
e) Exposure to credit risk–This refers to the risk that accounts receivable will not be
collected as expected or that the clients with contractual obligations with the company will
not be able to settle their accounts as they become due. This is a risk to the organization.
Since the credit management decision keeps on changing (Rises and falls), the function of
credit management should be examined by all the departments concerned, especially the sales
and finance departments as it affects them in a big way. The credit management department
should hold a compromise position between the optimism of the sales department and the
rigidity of the finance department so as to have credit policies that enable the organization to
compete in the market while at the same time avoiding the risks of bad debts.
Effective Credit Management:
Some companies do their utmost to bring in new business, but may falter at the last
hurdle of ensuring that deals turn in to ‘paid deals’. Over half of all bankruptcies are
attributed to poor credit management – signifying its importance. Credit management
involves much more than reminding customers to pay. Rather, it involves gaining a thorough
examination and process of detecting possible reasons of non-payment, perhaps even whether
a solution or product was not delivered and even as far as the invoicing containing
discrepancies. Effective credit management is a comprehensive process consisting of:
 Determining the customer’s credit rating in advance
 Frequently scanning and monitoring customers for credit risks
 Maintaining customer relations
 Detecting late payments in advance
42
 Detecting complaints in due time
 Improving the DSO
 Preventing any bad debt from arising
Objectives of Credit management:
Banks and financial institutions mobilize deposits and utilize them for lending.
Generally lending business is encouraged as it has the effect of funds being transferred from
the system to productive purposes which results into economic growth. The borrower takes
fund from bank in a form of loan and pays back the principal amount along with the interest.
Sometimes in the non – performance of the loan assets, the fund of the banks gets blocked
and the profit margin goes down. To avoid this situation, bank should manage its overall
credit process. Bank should deploy its credit in such a way that every sectors of economy can
develop. Credit management comprises two aspects; from one angle it is that how to
distribute credit among all sectors of economy so that every sector can develop and banks
also get profit and from the other angle, how to grant credit to various sectors, individuals and
businesses to avoid credit risk. Credit management is concerned mainly with using the bank’s
resource both productively and profitably to achieve a preferable economic growth. At the
same time, it also seeks a fair distribution among the various segments of the economy so that
the economic fabric grows without any hindrance as stipulated in the national objectives, in
general and the banking objectives, in particular
Importance of Credit Management:
We have heard that many business start and get closed in a very short span of their
operations saying that they have gone bankrupt or having high cash crunches. Have you ever
43
what why did it happened? That it’s because of improper management of credit or poor credit
policy. Thus it is important for every business to maintain optimal credit policy to overcome
problem related to cash or cash management.
Credit Monitoring:
A good lending is that the amount lent, should be repaid along with interest within the
stipulated time. To ensure that safety and repayment of the funds, banker is necessary to
follow-up the credit, supervise and monitor it. Credit monitoring is an important integral part
of a sound credit management. The bank should always be careful for that fund properly
utilized for what it has been granted. Banker keeps in touch with the borrower during the life
of the loan. There are some steps from the banker’s point of view, to ensure the safety of
advance.
1. Documentation: Once the loan is sanctioned by the bank, the borrower must
provide certain documents. The properly executed and stamped documents are essential
which should be dully filled and authenticated by the borrower.
2. Disbursement of advance: The advance should be disbursed only after obtaining the
documents. Loan account should be scrutinized to ascertain that the funds are utilized for the
business purpose only.
3. Inspection: The unit and the securities charged to the bank should be inspected
periodically. The banker stipulates different terms and conditions at the time of granting the
advance. And the banker should continue to keep a watch that all these are observed. In this,
the team of financial and technical officers visits the borrower’s firm to get view about
customer’s affairs.
44
4. Submission of various statements: All the statements required by a banker should
be regularly obtained and thoroughly scrutinized. The health of the borrower’s accounts are
indicated by control formats, so, should be reviewed properly. Borrower’s accounts show
movement of accounting and operation stage. Financial statements and balance sheets should
be examined along with credit risk rating at least once in a year. The positive and the negative
progress of the loan assets are indicated by these verifications.
5. Annual review: Every loan account should be revised annually. A borrower makes
lending decision on certain assumptions. So, it is necessary to hold those as good throughout
the continuance of the advances. Annual review provides an insight view of the borrower’s
general and financial conditions. 6. Market information: The banker should keep in touch
with the market environment. Market reports are an important source to get the present
information regarding trade and industry. The banker should have resource for such
information. Hence, bank must take all the precautions before sanctioning loans and after in
follow-up also. The post sanctioning period is also most important to avoid the risk of NPA.
It is helpful to banker to prevent the debt to be converted into bad debt
Advantages of Credit Management:

 Increase in cash conversion or cash inflow.
 Low bad debts.
 Increase in profitability.
 Increase in liquidity
Evaluation of Credit:
45
To make prudent credit decision, bank essentially should know the borrower well.
Without these information bank cannot judge the loan application. Credit worthiness of the
applicants is evaluated to ensure that the borrower conform to the standards prescribed by the
bank. It can be said that a loan properly made is half-collected. So, a bank should make
proper analysis before making any credit decision. With increasing credit risks, banks have to
ensure that loans are sanctioned to „safe‟ and „profitable‟ projects. For this they need to fine
tune their appraisal criteria. A mix of both formal and non-formal credit appraisal techniques
will go a long way to ensure perfection in credit appraisal. The credit evaluation process
involves three steps:
1. Gathering Credit information
2. Credit Analysis (credit worthiness of applicants)
3. Credit Decision 1. Gathering credit information:
The credit department of a bank collects various important information regarding
borrower from different sources to evaluate the customer. A number of sources would
available for gathering information which depends upon the nature of the business, form of
loan, amount of loan etc. these sources are,
Interview: Interview with the borrower enables the banks to secure the detail
information about the borrower’s business which can help in credit decision process. If the
applicant does not satisfy the credit norms, the lending officer may stop further procedure. In
case of the success of preliminary investigation, as up to the standards, borrower may be
asked to submit various financial reports.
Financial statements: Financial statements include the balance sheet and the profit
and loss account. The financial statements of the last few years should be obtained. This
46
analysis would provide an insight into the borrower’s financial position, funds management
capacity, liquidity, profitability and repaying capacity of the borrower.
Report of credit rating agencies: Credit Information Companies (Regulation) Act
2005, (CICRA) provided for the creation of credit information agencies or companies, which
enable the banks to readily access the full credit history of the borrower. This is an institution
that is set up by the lenders like bankers, credit card companies etc. Banks can gather
information on the creditworthiness of the applicant. These companies maintain the credit
histories on individuals and business entities. The CICRA became a piece of legislation with
effect from June 23, 2005. Credit information in this context only includes past track record
in loans availed and future repayment ability.
Bank’s own records: If the applicant is the existing customer of the bank, the banker
can study the previous records, which provides an insight into the past dealings with the
bank. Every bank maintains a record of all depositors and borrowers. The transactions of
borrower can give depth idea to banker.
Bazaar report: Report regarding applicant can also be obtained from various markets.
The strengths and weaknesses of the borrowers are monitored by the markets continuously.
Market opinion can also predict the future of the business. Market intelligence can also be
gathered through borrower’s competitors. It should be a continuous process on existing
current account holders and other prominent businessmen.
Report from other banks: Bank credit department may ask to other banks in which
the applicant has dealings.
Other non-formal methods: There are other ways also which can give many clues and
make the judgment more accurate. The most popular non-traditional method is to understand
47
the personality, motive and the capabilities of the borrowers, based on non-verbal clues as
trying to predict the results of a human mind.
Credit analysis (credit worthiness of applicants):
After gathering the credit information, banker analyses it to evaluate the
creditworthiness of the borrower. This is known as Credit Analysis. It involves the credit
investigation of a potential customer to determine the degree of risk in the loan. The
creditworthiness of the applicant calls for a detailed investigation of the 5 „C‟ of credit –
Character, Capacity, Capital, Collateral and Conditions.
Character: The „character‟ means the reputation of the prospective borrower. This
includes certain moral and mental qualities of integrity, fairness, responsibility, trust
worthiness, industry, etc. The honesty and integrity of the borrowers is of primary
importance. So, credit character should be judged on the basis of applicant’s performance in
bad times
Capacity: It is the management ability factor. It indicates the ability of the potential
borrower to repay the debt. It also shows the borrower’s ability to utilize the loan effectively
and profitably.
Capital: Capital refers to the general financial position of the potential borrower’s
firm. It indicates the ability to generate funds continuously over time. Capital means
investment represents the faith in the concern, its product and nature. Bank should also
determine the amount of immediate liabilities that are due. For the true estimate, market value
of assets should be considered rather than book value.
48
Collateral: Collateral means assets offered as a pledge against the loan. It serves as
cushion at the time of insufficiency of giving a reasonable assurance of repayment of the
loan.
Conditions: It refers to the economic and business conditions of the country and
position of particular business cycle, which affect the borrower’s ability to earn and repay the
debt. This is beyond the control of the borrower. Sometimes borrower may have a high credit
character, potential ability to produce income but the condition may not be in favor. For the
proper evaluation, bank should have eyesight on the economic condition too. For this, they
have to rate the borrowers in different categories like excellent, well and poor. Both the
formal and non-formal tools combined would lead to perfection in credit appraisal and ward
of increasing default tendency in credit. There are number of tools and techniques developed
to evaluate the creditworthiness of the borrower like, ratio analysis, cash flow projections,
fund flow statement, credit scoring etc.
49
Unit-III
Credit and Collection Policy:
A credit collections policy is a document that includes “clear, written guidelines that
set the terms and conditions for supplying goods on credit, customer qualification criteria,
procedure for making collections, and steps to be taken in case of customer delinquency”.
In fewer words, it is a guide offering an organized and repeatable philosophy on selling on
the rules, regulations and procedures to manage daily operations. The goal for a credit
collections plan is to clearly define these elements so that sales and collections employees
conform to documented steps and procedures designed to optimize your resources, reduce
credit risk, and improve overall cash flow.
Importance of having Credit Collection policy:
Along with cash and inventory, accounts receivable is one of the most important
short-term assets a company has. The more predictably and effectively you can convert your
A/R, the healthier your cash flow will be. One of the most important factors in effectively
collecting the money owed to you is through consistency. By having a formalized plan that
your employees follow and by documenting all steps and communications along the way,
you’re team will be much more consistent, effective, and efficient in collecting outstanding
A/R.
A well written and comprehensive credit collection policy will:
o Ensure continuity in the department in the event that key personnel leave the credit
department.
o Help make sure all customers are treated fairly.
50
o Ensure consistent credit decisions are being made.
o Be used as a training tool for new sales associates and the credit and collections team.
o Be used to ensure consistency of procedure and execution between the credit department,
sales, and management.
Your policy can be as general or as specific as you would like, just keep in mind that
in order to protect your cash flow, arming your employees with knowledge and predefined
best practices and procedures is best so they always know what to do in certain situations and
can react quickly and confidently to resolve any problems or answer any questions.
Keeping Your Credit Collections Policy Up To Date:

Once you’ve developed your collections policy, it is important to update it regularly
and make sure it is still relevant and effective. It is recommended that this be done once every
year, but a recent survey from Credit Today revealed that nearly 50% of companies are
reviewing their policy far less frequently. Some of the major points from the study include:
o 19% said they review and adjust their policy every 2 years.
o 13% said they review and adjust their policy every 3 years.
o 15% reported they only review and adjust their policy when they need to.
o 12% said “other” which really makes you wonder the last update took place.
o SMB businesses are by far the worst offenders of neglect when it comes to their
collections policy, and these are the companies who should be the most invested in
formulating an A/R strategy that brings in the cash flow they need to grow their
businesses.
51
Formulation of Loan Policy:
A bank has the social obligation to meet the credit needs of different sectors of the
community. But it cannot afford to incur losses. Bank has to manage lending business in safe
manner by that the loan portfolio of bank remains balanced from the point of view of size,
type, maturity and security that promises for reasonable and steady earnings. This is called
clear cut and definite credit policy. A credit policy includes detailed guidelines for the size of
the loan portfolio, the maturity periods of the loan, security against loan, the credit worthiness
of the borrower, the liquidation of loans, the limits of lending authority, the loan territory etc.
Credit policy provides some directions for the use of funds, to control the size of loans and
influences the credit decision of the bank. So, the loan policy is a necessity for a bank.
Formulating and implementing loan policies is the most important responsibilities of bank
directors and management. In this activity, the Board of Directors take the services and co-
operation of the bank’s credit officers, who are well experienced and expert in the techniques
of lending and are also familiar with external and internal factors that affect to the lending
activities of the bank. In formulating the loan policies, the policy formulators must be very
cautious because the lending activity of the bank affects both the bank and the public at large.
All the influencing factors should be considered. 
Contents of Loan Policy:
1. Size of loan account: The total amount of the total advances that a bank would
sanction should be clearly mentioned in loan policy. There is no iron-clad formula for fixing
the size of the loan. The only rule is that bank should continue to lend till the bank has funds
for lending. The basic social and business excuse for the bank is the ability to supply credit to
the community. A bank should determine the optimum size of loan portfolio. In this decision,
52
management must foresee the economic situation of the economy and region also. The size of
the loan account may be fixed at a higher limit in case of good capital position in relation to
its total deposit liabilities.
2. Credit for infrastructure: The operational guidelines on financing infrastructural
projects have been issued to commercial banks in April, 1999. According to that, banks
would be free to sanction term loans for technically feasible, financially viable and bankable
projects undertaken by both public and private sector.
3. Types of loan portfolio: Decision on the type of loan must also be taken. Different
types of loans carry different degrees of risks which are depended upon the adequacy of its
capital fund and the structure and stability of bank deposits. In the loan policy, various forms
of loans and the proportion of each form should be clearly spelled out. Policy statement
should also mention the maximum amount of the loan that might be granted to a particular
borrower.
4. Acceptable security: The Government policy and credit policy of the RBI should
also be kept in view while granting any credit. Bank should observe the rules and regulation
time to time for maintaining liquidity and profitability. Otherwise if security aspect is not
considered, bank will have to suffer from any loss which may occur from any unsecure loan.
5. Maturity: A loan may be called back in times of need to satisfy the liquidity needs
of the bank. Short term loans are more liquid and less risky. The minimum period of loans
and spread over various maturities subject to roll-over would now be decided by banks and
banks could invest short-term / temporary surplus of borrowers in money market instruments.
6. Compensating balance: Compensating balance is a protective device to save the
bank from the risk of default. The compensating requirement may not be common for all the
53
customers. The way in which the compensating requirement is applied seems to vary from
bank to bank.
7. Lending criteria: To minimize the risks in lending, a bank should grant loans only
to deserving parties whose credit character, capacity and integrity are good. The criteria of
evaluating credit character and capacity to generate income should be set forth in the policy
statement.
8. Loan territory: The loan policy statement of the bank must include the regions to
be served by the banks. This will save the time and efforts of the credit department in respect
to receive a loan application.
9. Limitations of lending authority: Large-scale commercial banks consists a
number of loan officers. The loan authority of different officers should determine to avoid
overlapping and duplication of efforts and wastage. The management must set forth the
lending limits of each officer in the policy statement.
Factors Influencing Credit Policy:
Competition:
Credit practices within an industry influence the formal credit policy of any individual
company. Competitive conditions place a high degree of importance on credit availability.
The credit policy of a company is important for maintaining or improving its competitive
position. Even where credit is not generally a competitive tool, an individual company can
use it in this manner if it is willing to do so.
Customer Type:
The type of customer has a direct limiting influence on the credit policies of all
companies in an industry. Where the buyers’ line of business is characteristically short of
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capital, it is unrealistic for credit policy to be unduly restrictive. A company that operates on
that basis will not maintain its market.
Merchandise:
The type of merchandise affects the credit policy of the seller in a number of ways.
There is a tendency to sell on a more liberal basis if the merchandise has a relatively high
profit margin or high price. Also, terms may be somewhat more liberal if the merchandise
can be repossessed or returned inward in the same condition as it was sold. On the other hand
if the shelf life is shorter of the merchandise then most probably the credit terms will provide
shorter credit period. For example, those that can spoil will require shorter terms, so terms are
usually net 10 in the food industry.
Profit Margin:
Markup is important. When profit margins are slim, the credit department may be
more careful in the selection of its accounts. High-markup goods should, at least in theory,
encourage credit professionals to approve sales to marginal credit risk accounts. In other
words, the higher the gross profit margin, the more tolerant of credit risk the credit manager
should be. This is a general statement and not always true.
Unit Price:
It is easier to establish a uniform liberal policy that applies to all customers when the
unit price of merchandise is relatively low. Even on a wrong decision, the dollar amount of
risk is low credit exposure is greater. A more detailed analysis is usually conducted before a
customer order is approved.
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Geographical Distributions:
The geographical distribution of customers determines credit policy to some degree.
Widely separated markets require particular modifications in credit analysis and in collection
efforts. A highly concentrated selling and buying area, on the other hand, involves a special
type of price competition and service requirements.
Government Regulations:
In the case of particular commodities, such as spirits and liquors, government
regulations specify credit policies or procedures which must be followed by the seller. There,
the overall policy must take the regulations into consideration. In a very general way,
expected long-range trends in the economy also influence credit policy.
Economic Conditions:
Economic or business conditions are of much greater significance, however, in
determining how policy is to be applied over a shorter period of time. When times are
prosperous, ability of debtors to pay their bills is somewhat improved; however, there is a
danger that they may tend to overbuy. During slack business periods, debtors tend to delay
payment of their bills and credit requirements may tend to be stricter. Concurrently, as sales
drop, the company is faced with the problem of maintaining volume in the face of decreasing
sales and more demanding selection of credit customers.
Analysis of credit information:
A Credit Information Report or CIR plays a key role in the lender’s decision when
you apply for credit. It is therefore important to monitor it on a regular basis to ensure that the
credit information report is up-to-date and to check for any inaccuracies in your CIR.
Your credit score and Credit Information Report is a measure of your credit worthiness.
Your Credit Information Report contains details of your credit history and track
record in taking and repaying loans from banks and NBFC’s. Credit Bureaus like CIBIL™,
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Equifax and Experian consolidate every individual’s borrowings, credit history sourced from
different member credit institutions such as banks and other NBFC’s into a single report
called as CIR.
A Credit Information Report (CIR) is a report on past repayment performance as
reported by various member banks and financial institutions about an individual. It is
important that you monitor your CIR from time to time. There are a number of things you can
do to improve your credit profile: It provides information on prompt payment, as well as
defaulted payments. The Credit Information Report (CIR) additionally has a list of enquiries
made on your account by various member banks / financial institutions/NBFCs for the
purpose of approving a credit facility.
As your credit history plays a key role in your ability to obtain credit, it is important
to understand the information that is shared by the lenders with a credit information company
also known as credit bureaus. Understanding your credit history enables you to take control
of your financial situation. So it is a good idea to keep your CIR updated and correct, as it
makes it easier for banks to approve your loans.
Make sure that you repay on time: If you have a good repayment history, this helps boost
your credit score, with which you are likely to get the most competitive terms from loan
providers.
CIBIL (Credit Information Bureau (India) Limited) is a Credit Bureau or Credit
Information Company. This company is engaged in maintaining the records of all the credit-
related activities of companies as well as individuals including credit cards and loans. The
registered member banks and several other financial institutions periodically submit their
information to CIBIL. Based on the information and record provided by these institutions,
CIBIL issues a CIR (Credit Information Report) as well as a credit score.
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CIBIL is a credit information database and does partake in any kind of lending
decisions. It provides data to the banks and such other lenders for quickly and efficiently
filter the loan applications which they receive in the course of their business.
Product offerings by CIBIL
CIBIL offers three products viz. credit score, a credit report for individuals and credit
report for companies:
 Credit score:
Credit score refers to a 3 digit numeric value which represents the creditworthiness of
an individual. The creditworthiness ranges between 300 to 900 with 900 being the highest
and 300 being the least. This score is computed with the help of the credit history of an
individual. Banks and most of the financial institutions prefer extending credit to an
individual whose score is 750 and more. Individuals with good credit scores are less likely to
default on their loan payments.
 Credit report:
Credit report contains the credit information that CIBIL fetches from various financial
institutions. This detailed report contains information about an individual’s history of
borrowing and repayment routine, including defaults and delays. The important parts of this
report are credit Score, individual’s personal information, employment details, contact
information and account details.
 Credit report for companies:
Credit report for companies constitutes details about a company’s credit history. The
several segments in a company credit report speak about potential lenders, existing credit
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which the company has, any pending lawsuits and outstanding amount. A good credit report
is essential for approval of any loans, whereas a bad report could damage/reduce the chances
of the loan being granted to the company.
Factors which can influence CIBIL score:
 Repayment History
Your CIBIL score would tell the loan providers if you are capable of dealing with the
debt burden and whether you can repay the loan obligation. A repayment history with EMI
defaults or late payments could negatively affect your credit score.
 Credit Utilization Ratio
This is another key factor which could impact your CIBIL score. Credit utilization
ratio refers to the total amount of credit that you use against the total amount of credit that
you’ve been authorized. Financial experts suggest that individuals should try and keep the
credit utilization ratio in the range of 25-30 % for maintaining a good CIBIL score report.
 Excess Personal Loans/ Credit Cards
Credit cards and personal loans both are unsecured loans. Too many credit cards and
high amount of personal loans with no secured loans such as an auto loan or home loan could
have a negative impact on your CIBIL score. So, if you have a balance of both the secured as
well an unsecured loan, it might lead to a positive impact on the CIBIL score.
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 New Accounts
Increase in the number of credit cards and loans sanctioned to you imply a rise in your
debt burden. In case numerous credit cards and loans are sanctioned over a short time period,
your credit score would be negatively affected.
Role of credit agency:
Credit rating has gained wide significance among investors and in Indian financial
market in the last two decades. Credit rating is simply an opinion on the credit quality of a
firm i.e. the ability of debt issuing firm to service the instrument.
Assessment of credit quality calls for expertise which credit rating agencies should
possess. The rating issued by a rating agency serves as summary information about credit
quality for economic decision makers. As long as the agency assigning the rating is perceived
as being credible, economic decision-makers would not evaluate the inputs that go into the
rating process.
Credit rating originated in the U.S.A. in 1909 when Moody’s began rating corporate and
railroad bonds. Since then the practice of credit rating has been adopted in several countries
around the world.
In India, the practice of credit rating began in 1988 with the setting up of the Credit
Rating and Investor Services of India Ltd (CRISIL)
A credit rating agency is a company which rates the debtors on the basis of their
ability to pay back the debt in a timely manner. They rate large-scale borrowers, whether
companies or governments.
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A credit rating agency is an organization which assigns credit ratings to the debtors
predicting their capability to pay back debt timely and simultaneously making the forecast on
the chances of the debtor being default. These rating agencies rate large borrowers (both
governments and companies).
Key functions of Credit Rating Agencies:
Some of the key functions of credit rating agencies are discussed below:
 Low-cost information:- The credit rating agency collects, analyses, interprets and
makes a proper conclusion of any complex data and transforms it into a very lucid and
easily understandable manner.
 Provides a basis for suitable risk and return:- The instruments rated by rating
agency gets greater confidence amongst investor community. It also gives an idea
regarding the risk associated with the instrument.
 Helps in the formulation of Public policy:- If debt instruments are professionally
rated, it becomes very easy to judge the eligibility of various securities for inclusion
in the institutional portfolio with greater confidence.
 Provides superior information:- Credit rating agency being an independent rating
agency, due to highly trained and professional staffs and with the access to
information which is not publicly available information, these agencies are able to
deliver superior information.
 Enhances corporate image:- Better credit rating for any credit investment enhances
visibility and corporate image in the industry.
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Corporate credit ratings:

S&P, Moody’s, Fitch and DBRS are the only four rating agencies that are recognized
by the European Central Bank (ECB) for determining collateral requirements for banks to
borrow from central bank. These rating agencies assign a rating to the company and to its
financial instruments like bonds.
Credit rating system:
A credit rating is an evaluation of the credit risk of a prospective debtor (an
individual, a business, company or a government), predicting their ability to pay back the
debt, and an implicit forecast of the likelihood of the debtor defaulting. The credit rating
represents an evaluation of a credit rating agency of the qualitative and quantitative
information for the prospective debtor, including information provided by the prospective
debtor and other non-public information obtained by the credit rating agency's analysts.
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Unit-IV
Documents required at the time of getting Credits:
Credit cards have revolutionized the way people in India look at debt. Those who
were afraid to take loans earlier are now considering credit cards as an effective line of credit.
Since their inception, credit cards have been one of the most popular credit instruments for all
categories of people including salaried, self-employed, NRIs and even for students. With the
demand for the cards increasing at rapid pace, banks and financial institutions are introducing
credit cards with attractive features and benefits. Individuals can take the same opportunity to
get the best credit card they could ever imagine. Well, the documents and the eligibility
criteria to apply for a credit card would vary from bank to bank and from card to card.
However, there are certain common documents that most of the banks including the top
banks such as SBI, HDFC, ICICI, Axis Bank, Citibank and others require the applicant to
submit along with the credit card application.
We compiled a list of documents required to apply for a credit card for most
categories of individuals or credit cards possible. You can consider it as a checklist to know
whether or not you have the minimum documents ready to apply for a credit card. However,
when applying for a specific credit card, we recommend you to check with the respective
bank for the list of documents required to apply for that card.
Documents Required For Resident Salaried Individuals to Apply Credit
Please note that a photocopy of the documents mentioned below need to be submitted but not
the originals. The bank may ask you for originals to verify the photocopies.
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Identity Proof (Any one of the Below)

 Aadhaar card
 PAN card
 Driving license
 Voter ID card
 Passport
 Address Proof (Any One Of The Below)
 Electricity bill
 Ration card
 Passport
 Driving license
 Telephone bill
 Last two months’ bank statement
 Voter ID
Make sure the address in the submitted proof matches with the one you entered in the
application.
 Income Proof (Any One Of The Below)
 Latest pay-slip
 Form 16
 Income tax (IT) return
 Age Proof (Any One Of The Below)
 Tenth standard school certificate
 Birth certificate
 Passport
 Voter ID card
 Other Documents
 PAN card photocopy
 Form 60
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Documents Required For Resident Self-employed Businessmen / Professionals to Apply

For Credit Card
1. Identity Proof (Any One Of The Below)
2. Aadhaar card
3. PAN card
4. Driving license
5. Voter ID card
application.
Income Proof (Any one of the below)
1. Income tax returns with computation of income or
2. Certified financial documents and
3. Proof of business continuity
4. PAN card
5. Age Proof (Any One Of The Below)
6. Tenth standard school certificate
7. Birth certificate
8. Passport
9. Voter ID card
Documents Required For Students to Apply For Credit Card
Identity Proof (Any One Of The Below)
1. Aadhaar card
2. PAN card
3. Driving license
4. Voter ID card
5. Passport
6. Address Proof (Any One Of The Below)
7. Ration card
8. Passport
9. Driving license
10. Telephone bill
11. Voter ID
application.
1. Age Proof (Any One Of The Below)
2. Tenth standard school certificate
3. Birth certificate
4. Passport
5. Voter ID card
6. Enrolment Proof
7. College identity card or
8. Admission slip or
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Study certificate from the college or university

Documents Required For Non-resident Indians (NRIs) to Apply For Credit Card
1. Identity Proof
2. Passport or
3. Driving License
4. Address Proofs
For Mailing Address In India (Any one of the below)
1. Driving license
2. Passport
3. Original electricity bill
4. Original telephone/post-paid mobile invoice
5. Original bank account statement
6. Voter ID
7. Rental agreement
8. Lease deed
9. Title deeds of property
For Mailing Address In Overseas (Any one of the below)
1. Driving license
2. Overseas bank statement
3. Government-issued ID card
4. Utility bill
5. Credit card statement
6. Lease agreement
7. Rent receipt
8. Company appointment letter
9. Company ID card
10. Passport
application.
Documents Required To Apply For Travel Credit Cards or Forex Cards
1. For Salaried / Self-employed Travelers
2. Passport
3. Visa
4. Travel ticket
5. PAN card
6. Form A2
7. For Student Travelers
8. Form A2
9. Passport
10. Appointment letter or admission letter or University identity card
11. Passport size photograph
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Credit Monitoring:
Credit Monitoring is the tacking of an individual’s credit history, for any changes or
suspicious activities. A credit monitoring service is will show an individual's credit report
provide them with new information regarding new credit inquiries, accounts etc. The
individual also can ensure if this information is actually genuine. Credit Monitoring can also
be used by individuals to keep a check on their credit score, as well as keep track of them,
giving them the option to be well of their credit history before applying for loans and
mortgages. The process of monitoring takes many steps to ensure negligent loans in
parameters of the credit policy followed when it comes to delinquency. The credit
management section will ensure the collection of the loans.
Credit Monitoring helps you understand the your credit history, and protects your
credit identity as well. It helps you get your credit scores and reports which benefit you when
trying to get loans or various kinds from mortgages to auto loans. As soon as an individual
applies for a loan and repays the same, a credit report is formed. And will be available with
the credit monitoring agency. In India the credit monitoring agency is Credit Information
Bureau India Limited or CIBIL. CIBIL monitors you payments towards any loan and
advances taken on your name, over the tenure of your loan they will keep a check on your
payment trends and set a score for the same. An individual should aim for a score of 750 and
above to be considered a good score and to get good credit limit and great rates as well. It
provides individuals with reports if any changes occur on their history, with also provides
your score and report.
 With credit monitoring, the possibility of credit fraud and identity theft is curtailed due to
monitoring.
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 Alerts provided to the individuals on their important activities, such as credit history, credit
inquires, delinquency, records of public nature, and even any other negative information.
Sales Ledger:
A sales ledger is a detailed itemization of sales made, presented in date sequence.
It may also contain credits issued that reduce the amount of sales, perhaps for products
returned by customers. The information in a sales ledger can be quite detailed, including
such items as the sale date, invoice number, customer name, items sold, sale amounts,
freight charged, sales taxes, value-added tax, and more.
The information in a sales ledger is summarized periodically and the aggregated
amounts are then posted to the sales accounts in the general ledger. This posting can be
as infrequent as the end of each month (as part of the month-end closing process) or even
every day. The detail level information in the sales ledger is kept separate from the
general ledger, in order to keep the general ledger from being overwhelmed with too
much information.
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The following are examples of how a sales ledger can be used:
 Financial statements. The sales ledger is the ultimate source document for the sales
figure that appears at the top of the income statement.
 Research. If someone wants to research a sales issue, they typically begin with a high-
level analysis in the general ledger, such as a trend line analysis, and then switch to the
sales ledger to determine the details of exactly what happened.
 Auditing. An auditor will likely want to ensure that the total sales amount reported in a
company's financial statements is correct, and will investigate by examining a selection
of the invoices listed in the sales ledger, which comprise that sales figure.
Originally, the sales ledger was manually maintained, with postings to the general
ledger also being completed by hand. With the advent of computerized accounting
systems, it is not always apparent that a sales ledger exists, since a user simply searches
for a specific invoice number, date range, or amount, and never realizes that he or she is
accessing what used to be called the sales ledger. Thus, the term is less commonly used
than had previously been the case.
Importance of sales Ledger:
Sales ledger is gaining traction as a financing option for mid-sized companies that are
in good financial shape and are growing quickly. This solution is offered to companies that
have outgrown conventional invoice factoring but are not able to meet the qualification
requirements of a line of credit.
Sales ledger financing offers a number of advantages to businesses, including:
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1. Improved cash flow and increased sales
The most important benefit of a sales ledger financing line is that it improves your
cash flow – often very quickly. This benefit allows you meet your obligations, enabling you
to manage the company more strategically.
Additionally, sales ledger financing lines can be used as a platform for growth. Your
company can now offer payment terms to clients without having to worry about the impact
that slow payment have on your cash flow. When used correctly, this solution enables you to
pursue strategic clients and increase your revenues.
2. A simple application process
Applying for a sales ledger financing line is relatively simple and does not require all the
formalities of applying for a line of credit.
Aside from submitting an application for funding, the company must include up-to-date
financial statements, such as:
 Profit and loss statements
 Balance sheet
 Accounts payable aging
 Accounts receivable aging
 Sales ledger (also called an open invoices report)
3. It’s easier to get than a line of credit
Lines of credit are great – if you can get them. The problem is that meeting
the qualification requirements of a line of credit is very difficult. The company must have
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impeccable financial statements and plenty of assets. It must also meet strict lending
covenants and have owners whose personal assets can be pledged as collateral.
Getting a sales ledger financing line is much easier. The company must be profitable
or have a short path to profitability. Its financial statements must be reasonably good, and the
company must have credit-worthy commercial clients in its ledger.
4. An easy funding process
The funding process is straightforward. To get funded, the client submits a copy of the
current ledger to the financial institution. Funds are usually deposited to the company’s bank
account within a business day.
5. Competitive rates
The all-in financing rates for a sales ledger financing line are extremely competitive.
Rates fall somewhere between the rates for a line of credit and the rates for a factoring line of
comparable size.
The financing cost of the line is based on the WSJ prime rate plus a small incremental
cost. This structure is commonly referred to as “prime + x%.” Additionally, some lines have a
monthly maintenance fee based on the face value of the receivables being financed.
6. A facility that grows with your sales
Sales ledger financing lines are flexible and designed to grow with your business. The
main requirement to get a line increase is to have clients in your ledger with good commercial
credit. Most line increase requests can be processed in a couple of days.
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7. Minimal redundant controls
An important advantage of sales ledger financing, especially compared to invoice
factoring, is that the facility does not have all the redundant controls that are built into
factoring lines. This advantage makes the line more user friendly for both you and your
customers.
Note that lenders do check their collateral regularly; however, they also use controls
similar to those offered by lines of credit.
8. It’s designed for mid-sized companies
The facility is designed with mid-sized companies in mind. When used strategically,
sales ledger financing can serve as a stepping stone to better and more flexible financing
solutions, such as commercial lines of credit or asset-based loans.
Computerized Credit management:
Credit management is one of the most intimate, sensitive and critical functions in any
business. Because it is repetitive and most effective when following clearly defined
methodologies, it is also probably one of the most suitable areas for computerisation.
Credit control disciplines have been transformed in recent years by the advent of credit
management software, online factoring and full business process outsourcing, yet many
finance managers are still reluctant to let credit management out of their direct control.
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With commerce being driven at internet speeds, companies can process credit and
financing applications in seconds rather than days he notes. Yet why are most credit decisions
still manual?
Ron Wells, author of the book 'Global Credit Management' comments that internal
credit departments are viewed as "a burden to the enterprise, constantly harangued from all
sides" and are usually given minimal resources to tidy up transactions for what are seen as
more important value adding parts of the business. Finding and applying the right credit
management techniques and technologies can help you turn this perception on its head.
This Accounting WEB Expert Guide sets out to describe the how and whys of
computer-aided credit control. Once you know and understand the beast better, its attractions
may become more apparent.
As Wells notes, global credit management is going through major changes as a result
of the banking industry's new risk-based rating methodology imposed by the Basel II rules.
Predictive statistics, based primarily on a company's financial statements going back three
years, are fed into the banks' risk models to establish credit worthiness.
Right from the outset, the credit equation is being determined by computer software.
Wells argues, however, that suppliers are much more important providers of capital to your
business than banks and that managers themselves should be willing to use technologies and
information of their own to protect their cash flows.
In the future, Wells predicts the credit management process will revolve around payment
risk trading and look something like this:
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 Salesperson with a new prospect asks credit manager for a credit limit on the new
account
 Credit manager checks website for quoted price for credit default protection on the
new buyer.
 Based on the information, credit manager grants credit line with an internal credit
charge, for example 0.1% per shipment.
 This internal charge is added into the sales quotation.
 When goods are shipped, the credit manager buys credit default protection based to
hedge the company's exposure, effectively transferring the customer's credit risk to
the credit derivative marketplace.
It's a breathtakingly efficient, market-driven process. But the systems and information
infrastructure may not be there yet for typical UK companies to apply it to their credit
processes. Here are some other approaches, ranging in graduated steps from simple efficiency
tips to those demanding more profound structural and cultural shifts:
e-Invoicing
First and foremost, are you using electronic communications to expedite invoicing
and payments? With more than 90% of UK businesses now connected to the internet, email
and other delivery methods can take days out of your collection processes - and save money
on paper, envelopes and postage.
Sending an invoice to someone's inbox makes it much harder for them to claim a bill
has been lost in the post, and you can fire a reminder to them and get confirmation of recepit
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while you're on the phone. Many accounting and sales order processing programs will now
automatically dispatch invoices for you.
Suppliers including Accounts, Open Business Exchange and Isabel invoice would
argue that email is a passive and inefficient approach to the problem. These online sites
provide more sophisticated invoice management services to deliver process transactions.
Accounts, for example, can translate invoice data into appropriate nominal codes for each
line item that can be imported to your accounts package. The customer receives an email
taking them to a secure online area where they can view, authorize, pay and download the
invoice.
Electronic payments, In just the same way that email and e-Invoicing websites reduce
postal time lags, electronic funds transfers via the BACS system make sure money is
deposited into your account more quickly. Direct credit payments are easy to arrange - as
long as your customer agrees to it as part of your terms of business.
Online information and credit scoring: The internet's biggest effect on credit
management has been to expand the amount of relevant information and credit ratings
available to you on the World Wide Web. Ratings agencies such as Experian, Dun &
Bradstreet and Standard & Poor use the Net to speed up their services and reduce costs.
Accounting WEB's company data partner ICC provides its own credit score based on the
information filed at Companies House.
Also available via Accounting WEB is the Mastering Credit Control, a toolkit to help
businesses and their advisers ensure credit control systems are as efficient as possible. The
online service provides guidance on credit terms and conditions and techniques for collecting
debt and managing the overall credit operation. Credit management software tools
Good credit controllers are like the Mounties - they're organised, methodical and always get
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their man. Fortunately, there are numerous solutions available for those people who are not
brilliant at compiling and following procedural call lists.
In a small company, it would be a simple matter to email customers invoices and set
time alerts against them in Microsoft Outlook..
There are several applications tailored for Sage Line 50, Line 100 and MMS users,
including Credit Hound from Draycir and Credit Collector from Microstyle. Both
applications provide on-screen summaries of the relevant account and transaction details
when you're chasing a debt and generate call lists and follow-up reports and emails. Credit
Hound deserves a mention for basing its corporate logo (and online assistant) on a cartoon
beagle, but also comes with an attractive portal interface with alerts, charts and other visual
aids to guide the user.
For a full-on treatment, take a look at the Enterprise Edition from US developer e-
Credit. The software can plug into multiple systems in different departments and divisions
and is governed by a rules-based software engine that automates most accounts receivable
processes. Rather than just automating the tasks, the better credit management emphasise the
importance of identifying high risk accounts early and communicating with them in a
structured, well documented way.
Unit-V
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Introduction:
In the current economic and business environment, liquidity and accounts receivable
has emerged as a topic of concern. Making sales is important, but collecting on those sales is
critical.
A recent survey by the Credit Research Foundation showed that 93% of respondents
believed that their customers were relying on suppliers for working capital.
Other key findings of the survey:
 81% felt that their customers experienced a tightening of available bank financing
 66% stated they were experiencing more customer bankruptcies than a year ago
 76% stated that the Federal Economic Stimulus Package had no impact on their
business
A collections policy is the set of procedures a company uses to ensure payment of
overdue accounts receivable. This is a very broad definition, so I like to narrow the focus as
“the set of procedures a company uses to ensure payment of overdue accounts receivable,
after securing the debt, and before litigation”. Generally, a collections policy systemizes the
steps taken to recover amounts due prior to the initiation of litigation, if that step is required.
These processes include when a customer should be contacted, how they should be contacted,
how disputes are resolved, when internal or external “collectors” are used to step-up
collection efforts, and ultimately when and whether to turn the account over to litigation or
write-off the debt.
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Alternative Policies for financing Current Assets / Working Capital:
To understand the financing policies of current assets it is essential to understand the
two levels of current assets/working capital and the sources of finance available to them.
Permanent current assets
Permanent current assets are often the minimum current assets held by companies at
any given time. Example of which may include minimum inventory held by a company at
any given time for precautionary purpose, others may include the minimum trade receivable
that are almost always outstanding, another permanent current asset could be the minimum
cash balance that company always wish to hold for precautionary and speculative purpose.
Even though these minimum current assets a still recorded as current assets, it exhibits
characteristics similar to that of non-current assets.
Fluctuating current assets
Fluctuating current assets are therefore the current assets that are used continuously
by the company in its operating activities, such that before it reaches the minimum it takes
action to replenish such current assets, such as inventory, cash etc. with fluctuating current
assets, just as it is being used, it is always replenished by the company anytime such assets
reaches re-order levels, or return points etc, to avoid such assets going out of stocks.
Source of Finance for Current Assets:
Company may use short-term sources of finance to finance the fluctuating levels of
current assets and long-term source of finance for its capital investments in permanent current
assets as well as non-current assets. The choice of which source of finance a company uses to
finance its working capital and other activities depend on several factors such as: availability
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of fund, the length of time such funds may be required for, the purpose for which the funds is
required, the size of the company, the rate of interest but for the discussion of the financing of
the working capital, the two main factors that needs to be considered are the risk of the
finance used and the cost of finance; either by financing working capital using short or long-
term source of finance. The risk and cost factors are inversely related, in that if a company
goes for a low risk source of finance, it is related to a high cost source of finance and vice
versa.
Assuming a normal yield curve where the interest rate curve is upward sloping, a short-term
loan will be cheaper than a long-term source of finance. This means that based on cost, a
company may rather choose to use short-term source of finance than a long-term source of
finance.
Based on risk, short-term source of finance (e.g. bank overdraft) is assumed to be more risky
than a long-term source of finance (e.g. long-term bank loans).
In Summary:
Source of finance Cost Risk
Short-term Low High
Long-term High Low
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Three Approaches to financing Working Capital:
1. Aggressive approach to financing working capital
The aggressive method is where a company predominantly finances all its fluctuating
current assets and most of its permanent current assets using short-term source of finance and
it is only a small proportion of its permanent current assets that is financed using long-term
source of finance.
A company that uses more short-term source of finance and less long-term source of
finance will incur less cost but with a corresponding high risk. This has the effect of
increasing its profitability but with a potential risk of facing liquidity problem should such
short-term source of finance be withdrawn or renewed on unfavorable terms.
2. Conservative approach to financing working capital
The other extreme method of financing working capital is where a company decides
to use mainly long-term source of finance and very little short-term source of finance to
finance its working capital. This option means that the company’s finance is going to be
relatively high cost (that is sacrificing low cost finance) but low risk; this will make the
company’s profit to be low but does not run the risk of being faced with liquidity problem as
a result of withdrawal of its source of finance.
The conservative method is where a company predominantly finances all its
permanent current assets and most of its fluctuation current assets using long-term source of
finance and it is only a small proportion of its fluctuating current assets that is financed using
short-term source of finance.
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3. Moderate approach to financing working capital
Between the two extreme approaches to financing working capital is the moderate (or
the matching or balancing) approach. This approach makes distinction between fluctuating
current assets and permanent current assets with the suggestion that to finance working
capital; short-term source of finance should be used to finance fluctuating current assets,
whiles long-term source of finance should be used to finance permanent current assets. This
matches the source of finance with the character of the current assets.
Aggressive More short-term source of Low cost, high risk leading to
approach finance, less long-term source of high profitability but low
finance liquidity
Matching approach Uses short-term source of Balance between cost and risk,
finance for fluctuating current leading to a balance between
assets and long-term source of profitability and liquidity
finance for permanent current
assets
Conservative More long-term source of High cost, low risk leading to
approach finance, less less-term source of low profitability but high
finance liquidity
In short, the financing of working capital approach adopted by a company is very important
since it will have an impact on its profitability and liquidity. It is also important for
companies to consider other factors apart from cost and risk in making such financing
decisions with regards to its working capital financing.
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Short Term Finance:
Meaning and Definition:
“It is the activity of providing fund to the business for the period of one year or less”.
Short Term financing is that from of financing which embraces borrowing or lending of funds
for a short period of time. It refers to the finance obtained on short term basis, usually one
year or less in duration. Short term finance is secured for financing the current assets, for
example, inventories.
Sources of Short Term Finance:
Following are the sources of short funds available to all business.
1. Trade Creditors: Trade creditors are probably the most important single source of short
term credit. Trade creditors are those business organizations which sell good to others on
credit. That is, they do not require payment on the spot; rather they are to be paid after
some days from the date of sale.
2. Customers Advances: Customers often finance the seller through advance payment for
the goods. The prices of the goods to be purchased are paid in advance, i.e. before the
receipt of the goods. This practice is prevalent where the seller does not wish to sell
goods without prepayment and the buyer also cannot purchase goods from other sources.
The seller might require advance payment if the quantity of goods ordered is so large that
he cannot afford to tie up more fund in raw materials or in good-in-process. Special type
machine manufactures often demand advance payment in order to protect them from the
loss caused by cancellation of contract at a time when the machine has been built up or is
in work in process.
3. Commercial Banks: The commercial banks of a country generally supply funds to the
business concerns on a short-term basis, either with security or without security if the
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customer is financially established. The banks, collecting scattered savings of the people,
invest a portion of the deposits in the business for a short period of time.
4. Finance Companies: Finance companies usually lend money to business. They are
specialized financial institutions and their primary function is to advance funds to the
business
5. Commercial Paper House: They are specialized financial agencies and they are created
to purchase promissory notes and to sell them, in turn, to other investors who desire to
have some sort of short-term liquid assets. The firm having high credit standing can use
this source for obtaining short-term funds.
6. Personal Loan Companies: These companies make small loans to individual generally
for consumption purposes. The small business undertakings can procure fund form such
companies.
7. Governmental Institutions: There are some governmental and semi-governmental
corporations which are authorized to advance short term funds to business concerns.
Their importance is of course not so much less than other sources.
8. Factors or Brokers: Factoring is a financial transaction whereby a business sells its
accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. In one
basic respect, factoring is different from other forms of financing. In other forms funds
are granted to one individual largely on the basis of his property. Factoring is based on a
different philosophy. In considering a company’s request for funds we are more interested
in the men behind the company their ability.
9. Miscellaneous Sources: There are many more sources from which can secure funds for
short period. They are friend and relatives, public deposits, loan from officer and the
company directors and foreign exchange banks.
83
Advantages of Short Term Financing:
1. Easier to Obtain: Short –term credit can be more easily obtained than long term
credit. A firm which has poor credit rating may be unable to obtain long term funds but it
can get, at least some trade credit from sellers who are anxious to increase their sales. The
short-term creditors, by granting loans, assume less risk than long term creditors because
there is less chance of substantial change in the financial soundness of the creditor within a
few week’s or month’s time.
2. Lower cost: Short term credit may be obtained with lower cost than the long term
finance because of priority of creditors in general. Because of the prior position given
creditors in the matter of claim to income and to assets in dissolution they generally will
accept a relatively low interest.
3. Flexibility: Due to seasonal nature of business many firms have a temporary demand
for short-term funds to carry heavier inventories. Most enterprises are in constant need of
short term funds. Short-term financing is flexible in the sense that the firm is able to secure
funds as they are needed and repay then as soon as the need vanishes. Funds may be needed
to meet the daily, weekly or monthly requirements. Such funds can be advantageously
supplied by short term credit. It long term credit is secured to finance the daily or weekly or
seasonal variations, it would become inflexible because long term funds cannot be repaid as
soon as the need for funds vanishes.
4. No Sharing of control: Obtaining funds form short term creditors prevents the
inclusion of more owners through the procurement of owner’s funds. This results in
maintaining the position of control by the existing owners. Because the creditors have no
voice in the operations of the business.
5. Availability: In many cases, particularly for small enterprises short term credit is the
only source available. It may not be possible for a small firm to obtain long term funds
84
because of poor credit standing. Long-term credit is not generally granted without adequate
margin of protection which the small firms may not be able to provide with. The small
business has then recourse to short term funds.
6. Tax Savings: The cost of short term funds are deductible for income tax purposes
while the dividend paid to the owners is not deductible. Thus a substantial tax-savings may
result from the use of short-term funds.
7. Convenience: Short Term credit can be more conveniently secured than the other
types of funds. It is more convenient to pay labour weekly or employees monthly than
every day.
8. Extension of credit: Many enterprises purchase equipments, supplies and good by
ordering from a supplier with the intent of paying after delivery has been made. If
subsequently the bills are met promptly, the firm acquires a good credit standing. Then, if
any emergency arises for the purchase of any goods the firm.
Disadvantages of Short-Term Financing:
1. Frequent Maturity: Short-Term credit is disadvantageous in the sense that it matures
frequently. The principal must be repaid when due, otherwise the creditors may close the
business. The use of such credit is also a risk to the owners’ investment from the inability
to meet the creditor’s claims when due. There may be danger of either meeting the
principal payment at maturity of the loan or meeting the principal payment at maturity of
the loan or meeting any periodic interest payment or both. The shorter the credits the
greater the potential risk to the owners because of the problem of prompter repayment.
2. High Cost: The rate of interest paid on short-term financing is usually subject to change
with changing interest rates. The rate of interest usually depends on the risk involved, size
of loan, collateral protection, etc. The lenders may demand a high interest if the credit
85
involves large amount and the potential credit risk is also high or the debtor may not give
suitable security. A high interest may also be demanded when the firm cannot procure
funds from other sources on suitable terms and conditions.
Influence of Working Capital on Collecting Policy:
Working Capital Requirement is the amount of money needed to finance the gap
between disbursements (payments to suppliers) and receipts (payments from customers).
Almost every company must incur expenses before obtaining the fruits of his labor
(the payment of customer invoices). The nature of these costs depends on the activity.
For example, if the business activity consists to buy and resell goods, it will require to
purchase a stock of goods before selling. If it's an industry, it is necessary to buy the raw
material before transforming it and then sell the finished product.
This operating cycle must be financed because it is necessary in most cases to pay
suppliers before being paid. The working capital requirement represents the amount
necessary to finance this delay.
*****
86

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CDE, Bharathidasan University, B.Com. (B.M.

), Major Paper-V, CREDIT MANAGEMENT

CENTRE FOR DISTANCE EDUCATION

Course : B.Com. (B. M.)

Title : Credit Management (Major Paper – V)

Lesson Writer : Dr. B. Kannan, Ph.D.,

Management is a process of planning, decision making, organizing, leading,

borrowers. Credit management is a part of financial management. When credit management

decrease the profit.

Common credit Terms:

 Amortization - The reduction of debt through regular payments, or the reduction in

value of an asset through depreciation

different types of official bankruptcy under federal law.

paid, the items are forfeited.

 Compound Interest - A method by which interest is calculated on the principal

amount and on the interest that was earned earlier.

 Credit Rating - An evaluation of the credit history of an individual or firm to

determine if worthy of the extension of additional credit.

 Lien - A claim by a creditor or other party against an asset. If an obligation is not

to real estate, the term is “chattel mortgage”

both the borrower and the lender.

against the customer in terms of our documentation.

It is easy to understand the revolution of Home Theatre or mobile phone. Home

Cambium Contract with all details included.

was not induced.

The term credit means, reposing trust or confidence in somebody. In economics, it is

the borrowing capacity each lender bank provides to the individual.

an attribute of power of the borrower”.

net addition to the total amount or purchasing power”.

its equivalent will be returned”.

Important characteristics of credit are discussed below:

should have on the debtor.

should evaluate the borrower’s capacity.

possessed by the borrower.

able to obtain credit without any difficulty.

depends on above factors.

involved in its security and repayments.

credit is the most popular mode of advance for businesses.

interest on the extra withdrawal amount.

Interest is charged on the debit balance.

great importance in an advance portfolio of the banking system of country.

cash credit against the security of such bills.

Credit instruments prove very helpful in encouragement and the development of

Cheque is the most popular instrument. It is an order drawn by a depositor on the

cheaper, convenient and has less risk.

It enables a seller of commodity to issue an order to a buyer to make the payment

the bill or within a period of time specified therein.

According to the Indian negotiable instrument act, „a promissory note‟ is an

instrument in writing containing an unconditional undertaking signed by the maker to pay a

having cash while travelling.

provided by banks is to enable an individual and business enterprise to purchase goods or

work which helps increasing the volume of employment.

of product which in result rising standard of living.

of interest and dividend.

8. Elasticity of monetary system:

proportionate metallic reserves.

9. Priority sector development: