Professional Documents
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#9 Credit Management
#9 Credit Management
SESSION
#9
Credit Management
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Chapter Outline
1. 2. 3. 4. 5. 6. Terms of the Sale The Decision to Grant Credit: Risk and Information Optimal Credit Policy Credit Analysis Collection Policy How to Finance Trade Credit
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Example:
2/10, net 30 Net 60 Seasonal Sales.3/10,net 60,May 01 dating
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Credit Period
Credit periods vary across industries. Generally a firm must consider three factors in setting a credit period:
The probability that the customer will not pay The size of the account The extent to which goods are perishable
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Cash Discounts
Often part of the terms of saleto speed up the collection of receivables. There is a tradeoff between the size of the discount and the increased speed and rate of collection of receivables. An example would be 3/10, net 30
The customer can take a 3% discount if s/he pays within 10 days. In any event, s/he must pay within 30 days.
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Some customers will pay on day 10 and take the discount. $970 0 10 30
Other customers will pay on day 30 and forgo the discount. $1,000 0 10 30
PROF. KULBIR SINGH (IMT-NAGPUR)
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(1 + R)
20 365
$1,000 = $970
1 = 0.7435 = 74.35%
PROF. KULBIR SINGH (IMT-NAGPUR)
Credit Instruments
Most credit is offered on open accountthe invoice is the only credit instrument. Promissory notes are IOUs that are signed after the delivery of goods. Commercial drafts call for a customer to pay a specific amount by a specific date. The draft is sent to the customers bank. When the customer signs the draft, the goods are sent. Bankers acceptances allow a bank to substitute its creditworthiness for that of the customer, for a fee. Conditional sales contracts let the seller retain legal ownership of the goods until the customer has completed payment.
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The only cash flow of the first strategy is: Q0 (P0 C0)
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h Q0 P0
1 and get paid in 1 period by h% of our customers.
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Net 30
1,300 $500 $425 95% 30 10%
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At the optimal amount of credit, the incremental cash flows from increased sales are exactly equal to the carrying costs from the increase in accounts receivable.
PROF. KULBIR SINGH (IMT-NAGPUR)
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1. The selling firm has a cost advantage over other lenders. 2. The selling firm can engage in price discrimination. 3. The selling firm can obtain favorable tax treatment. 4. The selling firm has no established reputation for quality products or services. 5. The selling firm perceives a long-term strategic relationship.
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4. Credit Analysis
Credit Information Financial Statements Credit Reports on Customers Payment History with Other Firms Banks Customers Payment History with the Firm
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Credit Analysis
Credit Scoring: The traditional 5 Cs of credit
Character Capacity Capital Collateral Conditions
5. Collection Policy
Collection refers to obtaining payment on past-due accounts. Collection Policy is composed of:
The firms willingness to extend credit as reflected in the firms investment in receivables Collection effort
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For example, a firm with average daily sales of $20,000 and an investment in accounts receivable of $150,000 has an average collection period of
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Collection Effort
Most firms follow a protocol for customers that are past due:
1. 2. 3. 4. Send a delinquency letter Make a telephone call to the customer Employ a collection agency Take legal action against the customer
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Collection Effort
There is a potential for a conflict of interest between the collections department and the sales department. You need to strike a balance between antagonizing a customer and being taken advantage of by a deadbeat.
Factoring
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The sale of a firms accounts receivable to a financial institution (known as a factor) The firm and the factor agree on the basic credit terms for each customer.
The factor pays an agreedupon percentage of the accounts receivable to the firm. The factor bears the risk of nonpaying Factor customers.
Customer
Goods
Firm
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3. Securitization
Occurs when the selling firm sells its accounts receivable to a financial institution, which then pools the receivables and sells securities backed by these assets.
PROF. KULBIR SINGH (IMT-NAGPUR)
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Quick Quiz
Explain a credit term quoted 2/10, net 30. Discuss the process used for evaluating the creditworthiness of potential customers. Identify the optimal credit policy.