CHAPTER 1

The nature and meaning of credit

Learning objectives:
• fully define the concept of credit
• define the concept of credit worthiness
• briefly explain the elements of credit
• explain the credit transaction
• distinguish between the various forms of credit
• discuss the advantages/disadvantages of credit for
enterprise and the individual
• discuss the costs that credit involves
 Question Time
1. How would you define the concept of credit?
2. What does creditworthiness mean?
3. What are the three main elements of credit?
4. What are the different forms that credit may take?
5. What are the advantages and disadvantages of
credit for a business undertaking?
6. What are the advantages and disadvantages of
credit for an individual?
7. What are the costs of credit that accrue to a
business that provides credit?
 Introduction
• In olden days human specialisation (hunter versus
bow maker) led to the existence of the barter
system and ultimately the first system of credit
• Credit can be defined as a medium of exchange
that makes it possible to get goods, services or
money in the present on the basis of a promise to
pay for it at some time in the future (hence an
element of risk involved)
• The word credit comes from the Latin word
‘creditum’ literally meaning ‘trust.’
• Credit stimulates an economy through growth
How?
 Introduction
• Advantage of credit for buyers is the immediate
use of goods, even though not paid for (e.g.,
clothing)
• Buyers include any person (natural or juristic) that
buys on credit (e.g., factories who buy raw
materials)
• We usually say that a business gives credit or that a
bank gives a loan (In fact, it is the buyers who give
their ‘credit’ to the business to get a product or
service). The business will decide if it will accept
the ‘credit risk’ of buyers or not
 Introduction
• Before a buyer can use credit as a medium of
exchange, he must meet the requirements of
creditworthiness
• Creditworthiness is a summary of all the
characteristics that make the buyer`s promise of
future payment acceptable to the seller
• Characteristics include the buyer`s integrity and
willingness, as well as his ability to pay
 Elements of credit
1. Risk
Never certain of payment

2. Time
Wait for payment

3.Cost
Involves cost, e.g., administration of credit
accounts
 Credit transactions have the
following implications:
1. The seller has the right to be paid. The seller is
called the creditor. The creditor must receive
payment from the buyer.

2. The buyer has a duty to pay. The buyer is called

the debtor. The debtor (borrower) owes the
enterprise (lender) the money.
 The different forms of credit
1. Consumer credit
(Selling to final consumers)
2. Trade credit
(Selling between enterprises)
3. Financial credit
(Credit granted by financial institutions)
4. International or export credit
(Credit transactions across borders)
 Advantages of credit for a business

1. It may increase sales

2. It is an aid to sales promotion
3. It promotes multiple sales
4. It increases profits
5. It helps the enterprise to maintain its
competitive position in the market
6. It can increase the enterprise`s market share
 Advantages of credit for a business

7. It is an aid to advertising
8. It can help the enterprise to compile a
mailing list
9. It improves customer relations
10. It helps the enterprise to obtain supplies
11. It finances the capital requirement
 Disadvantages of credit for a business

1. The enterprise has to wait for its money

2. Late payments
3. Bad debts
4. Negative image
5. Lack of working capital
 Disadvantages of credit for a business

Cost of credit

6.1 The cost of the credit investigation and

assessment of the buyer`s creditworthiness
6.2 The cost of financing the debtors
6.3 The cost of administering the debtors
6.4 The cost of collecting debtors
6.5 The cost of bad debts
 Advantages of credit for individuals

1. It finances purchases
2. It is convenient
3. It gives a person use of product or service
before it paid for
4. It help people to cope with financial
emergencies
5. It raises living standards
 Advantages of credit for individuals

6. It helps people to buy quality products

7. It keeps credit buyers informed
8. It gives a person a credit record
 Disadvantages of credit for individuals

1. It ties up a person’s future income

2. It can lead to overspending
3. The buyer has to pay for credit (e.g.,
interest charges at the applicable rate)
4. It may lead to a poor credit record
5. It may cause people to buy more expensive
products
 Benefits of credit
• For businesses and individuals to benefit
from credit (and to limit the disadvantages
of credit) the enterprise must teach its
customers how to use credit
• Customers should be informed about the
terms and conditions for buying on credit
 Benefits of credit
• Businesses should inform customers how
and when they should pay and what
consequences the customer would incur for
non payment
• Therefore it is essential that the enterprise
has a clear credit granting and collection
policy
 Chapter 1- Recap

• Fully define and understand the concept of credit

• Define the concept of creditworthiness
• Briefly explain the elements of credit
• Explain what a credit transaction is
• Distinguish between the different forms of credit
• List and discuss the advantages of credit for the
enterprise and the individual
• List and discuss the disadvantages of credit for the
enterprise and the individual
• Discuss the cost of credit for the enterprise