Definition of Credit and Collections
In general finance, collections also
Generally, credit is defined as the process of
providing a loan, in which one party transfers
wealth to another with the expectation that it will
be paid back in full plus interest. The definition of
collections is connected to the term credit.
Collections generally refers to the current period’s
sales and the credit sales of the last period
combined. However, you can also define both terms
in several other ways.
CREDIT IN FINANCE
A credit contract is a legal agreement whereby one
party loans funds to another. The terms of the
contract specify the amount lent, the payback date
and the interest rate on the loan. In other words, a
credit is a contract of a loan or delayed payments of
funds or goods. Credit can also refer to the
borrowing capacity of an enterprise or individual.
The term is often used to mention the terms and
conditions of a postponed payment option, while
the word credit also denotes the period that is
offered for deferred payment.
CREDIT IN ACCOUNTANCY
According to the book "Financial Accounting: An
Introduction to Concepts, Methods, and Uses," in
accounting theories credit stands for a journal entry
that registers an increase in assets. Credit is also
known as the part where payments of debtors are
registered, which is typically the right side of a
ledger account. As a consequence, you can mean
the aggregate of all the entries or just a single entry
with this term. Moreover, sometimes a credit line is
understood as credit.
COLLECTIONS IN FINANCE
Collections is the receipt of a check, draft or other
negotiable instrument to for the purposes of
restituting a loan. The book "Principles of Finance"
claims that you can use this term not only for check
clearing and payment, but also for other banking
services such as the collection of returned items or
bad checks, coupon collection and foreign
collections.
refers to the conversion of accounts to cash.
COLLECTIONS IN ACCOUNTANCY
In accountancy and banking the term collections is
understood in two ways. First, it is the presentation
of a draft or check and the new credit entry or the
receipt of the obtained amount in cash. Second,
collections refers to the shift of past-due or
delinquent accounts to a collection agency or
department, which has the task to partially or fully
recover the lent funds.
Letter of Credit: Pros & Cons
Before credit cards and traveler's checks came into
common use, many merchants and individuals used
letters of credit as financial backing for their sales
and service transactions when dealing with
unknown customers or merchants. Letters of credit
are still in use, and provide a number of
advantages. However, letters of credit also have
drawbacks, some of which are significant.
DEFINITION
A bank issues a letter of credit to guarantee
payment made on the behalf of a named
beneficiary, often a business or merchant customer
of the bank. When used for commercial
transactions, letters of credit serve a similar function
as a line of credit or an account with a specified
payment date, such as net -15--payment within 15
days--or net -30--payment within 30 days. Banks
may also issue letters of credit to prominent citizens
whom they trust to make good on their financial
obligations. Letters of credit allow individuals to
travel without carrying large sums of cash.
TYPES
Letters of credit take several forms, which differ in
some functions depending on the specific type. A
letter of credit may be primary--that is, it serves as
the main method of payment--or secondary, which
means that the letter of credit serves as a backup in
case the beneficiary fails to pay. A confirmed letter
of credit is issued by a foreign bank and guaranteed
as valid by a domestic bank. A commercial letter of
credit guarantees payment for goods to a seller
delivered to the bearer of the letter upon
presentation of satisfactory documentation by the
seller. An irrevocable letter of credit guarantees
payment by the issuing bank as long as the
beneficiary meets the terms specified in the
document, as opposed to a revocable letter of
credit, for which a bank may modify or cancel
payment.
SPECIAL LETTERS OF CREDIT
Letters of credit also cover special circumstances.
Transferable letters of credit allow the original
beneficiary to transfer the letter of credit and its
guarantee of payment to a third party, who then
becomes the beneficiary. Deferred payment letters
of credit specify payment after a specific time has
passed. A back-to-back letter of credit uses the first
letter of credit as collateral for a second letter of
credit, which the beneficiary issues to the actual
supplier of merchandise or service. A red-clause
letter of credit advances cash to the seller in
advance of actual delivery of merchandise or
services. A revolving line of credit allows the
beneficiary to draw on the specified amount of
credit for a specified number of times; the issuing
bank restores the credit to the original amount after
each transaction.
ADVANTAGES AND DISADVANTAGES
The main advantage of a letter of credit is that it
eliminates the need for up-front cash payments.
However, sellers may encounter problems with
letters of credit, such as impossible delivery
schedules or unacceptable costs. Attempts to
modify the terms of a letter of credit may also
cause disruptions in the transaction. Discrepancies
in the documents presented by the seller may also
cause the issuing bank to void the letter of credit,
according to the Credit Research Foundation.
Do You Debit or Credit Accrued Interest?
Accrued interest is the amount of interest that has
accumulated on a loan since the last interest
payment and that has yet to be paid. When your
small business borrows or lends money, you must
record accrued interest at the end of an accounting
period to apply it to the proper period. In
accounting, a debit or credit can either increase or
decrease an account, depending on the type of
account. The accounting entry to record accrued
interest requires a debit and a credit to different
accounts.
CALCULATING ACCRUED INTEREST
The daily interest rate at which interest accrues
equals the annual interest rate divided by 365. The
accrued interest at the end of a period equals the
daily rate times the number of days since interest
was last paid times the loan amount. For example,
assume your small business has a $5,000 loan with
a 6 percent annual interest rate. Assume you last
paid interest 30 days ago. The daily interest rate is
0.00016, or 0.06 divided by 365. The accrued
interest equals $24, or 0.00016 times 30 times
$5,000.
BORROWER’S INTEREST EXPENSE
When you record accrued interest as a borrower at
the end of the period, you must adjust two separate
accounts. First, record a debit for the amount of
accrued interest to the interest expense account in
a journal entry. A debit increases this expense
account on your income statement and applies the
expense to the current period. Using the accrued
interest from the previous example, debit $24 to
the interest expense account.
BORROWER’S INTEREST LIABILITY
The second affected account is the interest payable
account, which is a liability on the balance sheet
showing the amount you owe. Record a credit to
this account in the same journal entry for the same
amount of accrued interest. A credit increases the
interest payable account. To finish the journal entry
from the above example, credit $24 to interest
payable.
LENDER’S INTEREST RECEIVABLE
When you lend money, you also record accrued
interest in two separate accounts at the end of the
period. First, debit the amount of accrued interest
to the interest receivable account in a journal entry.
A debit increases this account, which is an asset on
the balance sheet that shows the amount someone
owes you. For example, assume a customer owes
your small business $35 in accrued interest at the
end of the period. Debit $35 to the interest
receivable account.
LENDER’S INTEREST INCOME
The interest income account is the other account
affected by accrued interest when you lend money.
Record a credit to this account for the same
amount of accrued interest in the same journal
entry. A credit increases interest income on the
income statement, which applies the income to the
current period. To complete the entry from the
previous example, credit $35 to the interest income
account.
CONTENTS
An evergreen letter of credit includes information
regarding a specific shipment of goods or delivery
of services. A maximum amount of credit is written
in the letter, and the money provided by the bank
cannot exceed this amount. The letter of credit also
contains a list of shipping documents required in
order for the credit to be paid. For instance, the
letter may require a signed shipping invoice and
signed bill of lading. These documents must be
presented as proof that shipment has occurred
before money will be transferred.

What Is an Evergreen Letter of Credit?

International trade is increasingly common in

business. Not all foreign businesses use the
same banking systems as the United States,
however. In order to increase trust among
companies in different countries, letters of
credit are often used. A letter of credit is one
way of guaranteeing that funds are available,
and provides reassurance that money will be
sent after a shipment occurs. While some
letters of credit expire after a short time,
evergreen letters of credit are long term
documents that stay active unless cancelled.

PURPOSE
An evergreen letter of credit is a legally binding
document issued by a bank or other financial
institution. It provides a guarantee the funds for a
purchase are available, and promises money will be
transferred after a shipment is complete. A letter of
credit is typically provided by the bank of a buyer
and given to the seller of a good or service, and is
often used to decrease the transaction risks during
international trade. Unlike a standard letter of
credit, an evergreen letter does not have a preset
expiration date.