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Credit Investigations

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Topics covered are how to conform to the legal and ethical requirements of credit investigations, the difference between direct and indirect credit investigations, how to gather information, etc.

Topics covered are how to conform to the legal and ethical requirements of credit investigations, the difference between direct and indirect credit investigations, how to gather information, etc.

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  • Discuss Learning Objectives with the class – found on page 251
  • Legal Aspects of the Exchange of Credit Information The exchange of factual credit information is legal and proper, but the information exchanged must be restricted to factual , historical data. The courts of the U.S. have recognized in numerous decisions the legitimate business interest in the exchange of factual credit information among businesses with legitimate interests. Such cases are the foundation for conducting all business and trade credit investigations and exchanging business credit information on specific customers among competitors. See page 253 for an example of a document regarded as the foundation for the exchange of credit information during industry credit group meetings. Federal Law Legal ramifications of a poorly managed credit information process can lead to costly problems. A detailed explanation of many legal issues for the credit professional handling credit information exchange is found on pages 252-257 . Review these with the class. Antitrust in Credit Investigation Primary objective is to avoid violating various antitrust laws. Regulations attempt to allow for free-flow of credit information so creditor and competitors can avoid fraud, including non-payment of an outstanding debt. Conspiracy, Restraint of Trade, Joint Action Any agreement, express or implied, between competitors on any action concerning a common customer or class of customers is illegal. Exchange of factual information about the credit experience with customers is proper, care should be taken that no agreements are made for any common action, nor should there be any effort made to influence the credit decision of another company. Defamation in Credit Investigation: In regards to owners, partners, or principals of the business credit customer, libelous statements must be carefully avoided. Libel and Slander: Defamation is a false statement made to others that injures the name or reputation of a third party. The two types of defamation are libel and slander . Libel is defamation in some permanent form, such as printed media or writing in any form. Slander is defamation in a temporary form, such as speech. See page 257 of the text (Figure 10-1) for a list of things ruled as Libelous Per Se. Defenses to Charges of Libel Truth is a complete defense to an action in libel and must be so pleaded. Some defamatory statements are not actionable as libel because they are privileged information (statements made by one person in pursuance of a duty to another person having a corresponding duty or interest).
  • Confidential Nature of Credit Information: Two cardinal principals in exchange of credit information: confidentiality and accuracy of inquiries and replies. All parties involved trust that the information has been requested for a legitimate purpose and will not be used indiscriminately. When conducting a credit investigation, the identity of the inquirer should not be divulged without its authorization. The law protects the free interchange of credit information among business credit grantors. Without these laws the flow of information could not survive. Summing Up Ethical Considerations Key factors to consider: Personal Behavior – obligation to behave professionally and guard against violating laws against restraint of trade. Honesty - always present company’s experience honestly to any party requesting credit information. Objectivity – Phrase questions and requests objectively to foster clear communications and to avoid relying on someone else’s opinion. Topics to Avoid – avoid discussing future prices, future terms or future discounts. Avoid any conversations touching on discriminatory trade practices or anything that might be construed as restraint of trade or in violation of antitrust legislation. Company Policy A company policy should be established as to who is permitted to access credit files in order to keep information confidential within the organization and should only be released with great care to companies, agencies and others. An untrained person could seriously jeopardize the relationship between the customer and the company, and even subject the company to a lawsuit, by unwarranted or unguarded revelations of information that the customer might consider detrimental to its reputation or character.
  • The credit application is the cornerstone of a customer’s credit file, and should provide at the minimum, the most basic information about the customer. (The credit professional should be aware of record retention requirements for declined applications.) The Credit File The credit department should have a credit file for every customer and every credit applicant. This is particularly important to ensure compliance with regulatory record retention requirements found in Reg B for declined applications. The file should contain relevant pieces information pertaining to credit investigation-documents, reports, correspondence, notes, and summaries of telephone conversations. The Sales Department gathers a wealth of information about prospective customers discovered during sales visits and interviews with the company’s management. They provide the credit department with an approximate amount of credit required and give an estimate of annual purchases or initial purchases for a new or prospective customer. As the “eyes and ears” for the credit department the sales department can effectively observe details about a potential customer’s premises, organization, etc. All information is relevant when opening a new account. Financial Statement information is an integral component of the credit decision making process. Review the Sample Financial Statement Form on page 263 in the text book, Figure 10-4. Customer-Supplied Information The most readily available source of information about a business and its financial condition is the business customer itself. Through direct contact the credit professional can establish a close working relationship with the applicant. Third-Party Information holds a distinct advantage in being objective and impartial. The speed at which and volume of information is greater through third-party information. Industry credit groups , also known as trade credit groups, are also a kind of third-party reporting resource which can yield information for credit grantors before they set up accounts or continue to sell to existing customers on open account credit terms.
  • Credit investigations have been traditionally divided into two types: direct and indirect. See slides for each type, following. Direct Investigations occurs when the creditor collects credit information either through direct contact with the customer or through direct contact with noncommercial sources of information such as competitors, banks and other trade references that may have relevant details to share. Indirect Investigations usually refers to acquiring information from third-party sources that are in the business of preparing information on businesses/companies.
  • Direct investigation occurs when the creditor collects credit information either through direct contact with the customer or through direct contact with non-commercial sources. Sources of Direct Investigation Customer supplied trade references, bank references and financial statements; information obtained from the Secretary of State’s Office; information found in public records; details collected through personal interviews; material found through internet search engines or on customer websites. Trade Information describes how customer actually pays. Should be examined for specifics, including payment trends. Should be reconciled with customer’s financial statements. See page 267 of the text for sample questions in a trade inquiry. Bank Information Banks are extremely cautious about releasing information about customers. Creditors may have to have written authorization from the customer. Creditor can also have customer list bank officer who handles the business account and directly correspond with that individual. See page 368 of the text for list of questions to ask in a bank inquiry. Other Sources of Direct Investigation see pages 269-271 of text.
  • Indirect investigation usually refers to acquiring information from third party sources that are in the business of preparing information on businesses as opposed to individuals. Note : Much information can be found electronically. See page 272 , Figure 10-7. Commercial (Business) Credit Reporting Agencies Provide reports on proprietorships, partnerships, corporations, LLC’s, joint ventures, and limited partnerships. These reports reveal payment history, business background, public record, collection activity, banking relationships, UCC filings, credit score. Each reporting agency provides basic business and trade credit reports that reveal payment history, business background, public record, collection activity, banking relationships, UCC filings, credit score. See pages 274-277 for details on NACM, Equifax, Experian, Dun & Bradstreet. With millions of data lines on businesses, the largest general reporting agency is Dun & Bradstreet (D&B). Experian , formally TRW, differs from other reporting services by including very small businesses and sole proprietorships in its data base as well as larger companies. NACM p rovides business credit reports and industry credit group meetings through its affiliate network. Industry credit groups provide credit professionals, with mutual interest in the same class of customers, an opportunity to participate regularly in informative round table discussions of accounts and to evaluate credit management procedures and techniques.
  • Every credit policy should include procedures for updating customer credit files on a periodic basis. Of course, sometimes specific events will trigger an immediate reevaluation. When to Investigate an Existing Account Credit applications should be updated whenever there is a change in the credit grantor’s policies or credit terms or at certain timeframes (annually, every 3 years, etc.) An update should begin whenever any of the following events occur: an account usually purchases small amounts suddenly starts to place large orders a prompt payer suddenly begins to pay slowly a lot of inquiries suddenly come in about an account there is a change in ownership or legal business structure of an account Methods of Contact Methods of contact include: written communications, requests for financial statements, offer of advice, revision of credit availability, and the sales representatives. Sources of Information The sources of information for updating a credit file are the same ones used for opening a new account. It may be useful to utilize the Internet to check a company’s Web site and see what they are saying about their business.
  • Credit information is available on international customers and their countries, but financial statements are not easy to obtain and are difficult to evaluate. Customer Supplied Information The best starting point for international credit information is the customer. The buyer may volunteer valuable data, including financial reports, a detailed biography of the principals, and a detailed history of the business. Bank Information An excellent source of credit information is the exporter’s bank. Bank information generally includes a history of the foreign firm, antecedents of the principals, and some financial data. Domestic banks usually have extensive credit information on many foreign firms. Foreign banks vary widely in their cooperation with requests for information and, like information received from the customer, the credit information secured directly from the foreign bank varies. Exporter’s Foreign Sales Representative The exporter’s sales representative abroad can also be a valuable source of information. Reporting Agencies A number of agencies provide business information reports on companies located outside the United States: D&B, Experian, Equifax, Graydon America, Creditel, FCIB-NACM and Veritas Business Information. FCIB-NACM Corporation The purpose of the association is to raise the level of expertise of members and to provide enhanced job enrichment through relevant discussion and exchange of experiences. The services FCIB provides: Conferences, Industry Export Credit Groups, International Bulletins and Newsletters, Country Reports and International Credit Reports. OECD The OECD is a Paris-based intergovernmental organization whose purpose is to provide its 29 member countries with a forum in which governments can compare their experiences, discuss problems they share and seek solutions which can be applied within their own national contexts.
  • Review the Learning Objectives with the class
  • Chapter Outline The character and experience of principal owners, officers, members and/or management of a customer entity have always been recognized as important factors in evaluating creditworthiness. Knowing as many details about a business entity will help the credit professional understand the customer’s needs and help uncover problems that could arise as the relationship develops. These are certainly contributing factors in determining a potential debtor’s creditworthiness. It is important that a full picture of the credit applicant be obtained. This means that, in addition to extensive financial analysis, there must be analysis that is non financial. Much of this non financial analysis focuses on the applicant’s management, their experience, background, knowledge, honesty, and ingenuity.
  • The factors examined in a credit analysis are generally known as the five “C”s of credit-character, capacity, capital, conditions, and collateral. These factors provide the credit manager with a framework for evaluating credit applications. Character Willingness of the debtor to pay Capacity Ability of debtor to pay Capital Signifies financial strength Conditions How environmental changes impact customer Collateral Availability of different resources to support credit
  • Importance of the Principals Even stable businesses can encounter financial difficulties. A company that has a good business record is not as likely to encounter difficulties. Credit professionals follow a prescribed method of investigation in order to gather details about the company in order to develop an understanding of the personal and business background of an account. Names of the Principals It is important to find out who the people are who have invested money in the business in question. It is important to find out what their experience, training and qualifications are. Often companies are managed by a group of private investors. Business Experience and Ability of Principals Credit risk increases if principals do not have knowledge of and business experience relating to the industry in which the business operates. The business ability of principals is largely determined by their past records. Distribution Functions It is preferable that managerial functions of a business are divided among principals. This spreads the danger of serious business loss.
  • Business Name Some proprietor or partnerships use an assumed name or trade style and should register that name, while using the legal name to place orders or make payments. If the business principal is unaware of the legal name or does not notify the creditor of changes, the creditor will have to search for information on the legal name. Resources are a city or county licensing bureau or the customer’s bank. Age and Reputation of the Business Some businesses are known for their pricing, others stress quality and service, while still others develop a reputation for effective performance on schedule. Seasons Frequency of seasonal activity also influences a firm’s earning power and ability to recover from a poor season. Changes in Operation A business may find it necessary to adopt its method of operation to meet changing conditions. The credit professional can review what changes have taken place and why. Consideration: has the change/adaptation succeeded? Location Factors The location of a business affects the cost of operation and nearness to buying and selling markets. Physical facilities should be large enough for efficient operations. Lease or Own The credit professional should know whether assets like buildings, fixtures, and machinery are owned or leased. The difference will affect a potential security agreement or court action to lien or claim a right to the asset for payment of a subsequent debt.
  • Review Learning Objectives with class
  • Review Learning Objectives with class
  • Introduction All orders should be processed quickly, particularly first orders from new customers. Prompt handling of initial orders often means continuing sales. It is difficult to replace past experience with a customer, so many credit granters take a conservative approach with initial orders, unless the customer’s credit rating and size is such that credit risk is not a major concern. ECOA requires the business credit grantor to notify the applicant of adverse action in connection with an application for credit. For issues to consider when processing first orders, see page 302 of the text. Approval of Small Initial Orders If initial orders are so small that the time and expense of a credit investigation is unwarranted, programmed credit approval may be given for all orders lower than a specified amount. Criteria based automated credit approval should be guided by the credit grantor’s credit policy. Approval Based on Agency Ratings Another method of handling initial and future orders without extensive investigation is to use agency ratings and/or credit scores as the basis for the amount to be approved. Many companies have developed a credit limit and an initial order limit key based on reports from Dun & Bradstreet or other agencies. For a list of advantages to this method, see page 303 of the text. Non-routine First Orders If a first order fails to meet the requisites for streamlined approval, the decision to investigate may be determined by the following questions: Is the order large enough to warrant the cost of investigation? Is the potential for future sales large enough so as to merit a full credit analysis? Is the treatment of non-routine orders covered by the company policy? Terms Other Than Open Account If the circumstances do not warrant open-account credit, the sale may be made on some other basis, such as cash in advance, cash on delivery, sight draft, certified check, cashiers or bank check, or standby letter of credit. Of these methods of payment, only a cashier’s or bank check and standby letter of credit can guarantee payment.
  • Purpose As soon as possible after first-order approval, controls should be established to ensure prompt and appropriate disposition of further orders. The basic means of control is the credit limit, or maximum amount of risk to be taken on any customer. Credit line is sometimes used when credit limit is meant. The two terms are not the same because a credit line implies that credit will be or has been granted up to a specific amount usually for a given period of time, as in the case of a bank line of credit. A credit limit indicates that a credit grantor retains discretion over credit granting Underlying Factors The customer’s credit limit is usually based on the requirements for the supplier’s products and the ability of the customer to pay its debts. The ability of the customer to pay its debts must be evaluated by an analysis of: Financial information Agency ratings, reports and credit scores Bank checks Trade clearances and other data as warranted Influences on Credit Decisions For the credit grantor, net profit margins on the products or services sold are a significant factor in the decisions about how much and when to grant credit to its customer base. Financial exposure is greater when credit terms are longer. See Figure 12-1 on page 306 of the text for additional details about profit margins. Methods for Establishing Credit Limits Credit granting companies establish their credit limits based on factors that represent their own set of unique circumstances. Such factors may include: Payment record Competition Secured or unsecured Payment performance Period of time Agency rating See Figure 12-2 on page 308 of the text) By formula Expectation of use Collection These are outlined on pages 306-307 of the text.
  • Credit Scoring Computer technology has made it possible to use statistical and probability analysis for assigning credit limits, using credit scoring techniques. Companies identify the factors they consider most meaningful and input the data into a computer system that creates a scoring matrix. Review Appendix 12A for a detailed example of a scoring model. Implementing Credit Limit Decisions Credit limits serve as guides for order approval, minimize upward referral of orders, and call immediate attention to any change in a customer's purchasing or paying habits. An order limit specifies the dollar amount that may be released without delay on any single order. Communicating Credit Limit Decisions Many companies advise their sales department of the credit limits assigned to customers, often expressing the limits in terms of units or dollars allowed during a given period of time. Informing Customers of Credit Limits There is no law or regulation that requires creditors to inform customers of their credit limits. Credit limits vary from company to company which is based on the creditor’s policy regarding credit extension. The advantages and disadvantages of informing customers of their credit limits is outlined on page 310 of the text.
  • General Considerations Marginal customers fall short of expectations in one or more ways, so a sale to one presents an abnormal risk even when full information is available. Many companies define marginal risks as having one or more typical characteristics. Review a list of these on page 310 in the text book. Profit Issues Profit on incremental sales to marginal customers may materially improve the earnings of the business, even allowing for increased credit losses. A number of factors related to profit margins may influence the decision to sell to marginal accounts. As a rule, a seller with a wider profit margin can afford to take greater credit risks. Other Decision Factors Product distribution affects the credit decision on marginal business. Obsolete or slow moving inventory may be better sold to a marginal risk than disposed of or written off. Marginal accounts are better risks during prosperous times than they are during recessions.
  • Reasons Based on Limited Information Credit information is readily available from many sources, and normal investigation usually produces adequate data for sound credit appraisals. Despite this, a credit department is sometimes obligated to act upon limited information. A customer refuses to supply customary banking and trade references or financial details. When customers refuse to supply information, the reasons for such refusal should be ascertained. Unless the business is new, a payment record is almost always available. What action to take and how to go about it should be decided after a factual, realistic review of the situation. Other Factors Other factors include the general economy, competition, and supply and demand.
  • Regular Reviews Credit limits are based on information, assumptions, experiences, estimates, forecasts, and economic conditions . Since all of these factors are subject to change, it is important for a well-organized credit system to provide for review or credit limits, and to identify the criteria that trigger such reviews. A well-organized credit procedure should provide for a periodic review of all active files. See page 313 for a list of steps for a thorough and complete review. Improved Credit Situations The most desirable reason for an off-schedule review of a customer’s credit limit is a marked improvement in its credit position. A compliment to the customer on such improvement can reinforce goodwill. Changes in Business Conditions Changing conditions in business, in a particular industry, or in a geographic area generally may warrant review of accounts. Improving conditions in the country, market area, or industry of the customer should trigger a review for the purpose of raising its credit limit. Exceeded Credit Limit Orders that exceed the customer’s credit limit require a review to determine whether the customer will pay and when it will do so. The credit executive will need financial and background material that justifies additional credit. Questions to ask, see page 314 in text.
  • Extraordinary Credit Needs Requests for credit not warranted by the customer’s financial condition may lead to sales and profits which otherwise would not materialize or, on the other hand, to increased credit losses or expanded slow receivables. Thorough investigation and current information should support a decision to extend unusually high credit limits. A list of reasons for unusual needs can be found on page 314-315 of the text. Extended Terms While the element of risk is common to all credit transactions, the degree of the risk varies with the credit period: the longer the credit period, the greater the risk. The condition in which a need for extended terms exist typically include expanding sales, seasonal financing of accounts receivable and inventory, and special contracts. Overdue Accounts Slow payment is probably the factor that most frequently leads to account review. Credit information should be reviewed and brought up to date. Other Reasons for Reviews A credit file should be reviewed upon receipt of information that is deemed unusual or significant: Receipt of new financial statement Change in accounting method for reporting sales and income New auditors Death of one of the principals Admission of a new partner or other change in management Change of banks Change in legal structure of the entity Merger or acquisition


  • 1. Credit Investigations Chapter Ten NACM
  • 2. Learning Objectives
    • How to conform to the legal and ethical requirements of credit investigations
    • What to do to open a new credit account
    • The difference between direct and indirect credit investigations
    • How to gather information in a direct and indirect credit investigations
    • How to gather foreign credit information
    • The importance of conducting credit investigations on existing accounts
    • How to use the internet as a source for credit information
  • 3. Legal and Ethical Aspects of Credit Investigation
    • Exchange of Credit Information – The Legal Perspective
      • Antitrust in Credit Investigation
      • Conspiracy, Restraint of Trade, Joint Actions
      • Defamation in Credit Investigation
      • Libel and Slander
      • Defenses to Charge of Libel
  • 4. Legal and Ethical Aspects of Credit Investigation
    • Exchange of Credit Information – The Ethical Perspective
      • Confidential Nature of Credit Information
      • Summing Up Ethical Considerations
      • Company Policy
  • 5. Opening a New Credit Account
    • The Credit Application
    • The Credit File
    • The Sales Department
    • The Financial Statement
    • Customer-Supplied Information
    • Third-Party Information
  • 6. Credit Investigations Direct and Indirect
    • Direct Investigations
      • Creditor collects information through direct contact with customer
    • Indirect Investigations
      • Creditor collects information through a third-party
  • 7. Direct Investigation
    • Sources of Direct Investigation
    • Trade References
    • Bank Information
    • Other Sources
      • Voluntary Trade Group, Bankruptcy Court, Internet, Customer Website, Specialized Information
  • 8. Indirect Investigation
    • Commercial Credit Reporting Agencies
    • NACM Affiliate System
    • Equifax Commercial Report
    • Experian
    • Dun & Bradstreet
      • BIR
      • D & B Rating
  • 9. Investigating Existing Accounts
    • When to Investigate an Existing Account
    • Methods of Contact
    • Sources of Information
  • 10. International Credit Information
    • Customer-Supplied Information
    • Bank Information
    • Exporter’s Foreign Sales Representative
    • Reporting Agencies
      • FCIB-NACM Corporation
      • Organization for Economic Cooperation and Development (OECD)
  • 11. Know Your Customer Chapter Eleven NACM
  • 12. Learning Objectives
    • The importance of non financial analysis
    • How to apply the Five “Cs” of credit
    • The importance of the background of the principals and the business
    • How the debtor’s method of operation and industry characteristics affect creditworthiness
  • 13. Know Your Customer
    • Who is the Customer?
    • The Five “Cs” of Credit
    • Principals and the Nature of Business
  • 14. The Five Cs of Credit
    • Character
    • Capacity
    • Capital
    • Conditions
    • Collateral
  • 15. Principals and the Nature of Business
    • Importance of the Principals
    • Names of Principals
    • Business Experience and Ability Principals
    • Distribution Functions
  • 16. Nature of the Business
    • Business Name
    • Age and Reputation of the Business
    • Seasons
    • Changes in Operation
    • Location Factors
    • Lease or Own
  • 17. Making Credit Decisions Chapter 12 NACM
  • 18.
    • Approval of credit for new customers
    • Establishing credit limits
    • Implementing credit limits for existing customers
    • How credit scoring is used to help manage credit accounts
    Learning Objectives
  • 19.
    • Making credit decisions using limited customer information
    • Conducting reviews of credit limits
    Learning Objectives (continued)
  • 20. Accounts to New Customers
    • Introduction
    • Approval of Small Initial Orders
    • Approval Based on Agency Ratings
    • Non-routine First Orders
    • Terms Other Than Open Account
  • 21. Credit Availability and Limits for New/Existing/Repeat Customers
    • Purpose
    • Credit Line vs. Credit Limit Availability
    • Underlying Factors
    • Influences on Credit Decisions
    • Methods for Establishing Credit Limits
  • 22. Credit Availability and Limits for New/Existing/Repeat Customers
    • Credit Scoring
    • Implementing Credit Limit Decisions
    • Communicating Credit Limit Decisions
    • Informing Customers of Credit Limits
  • 23. Handling Marginal Business
    • General Considerations
    • Profit Issues
    • Other Decision Factors
  • 24. Decisions Based on Limited Information
    • Reasons for Limited Information
    • Other Factors
  • 25. Review of Credit Limits
    • Regular Reviews
    • Improved Credit Situations
    • Changes in Business Conditions
    • Exceeded Credit Limit
  • 26. Review of Credit Limits
    • Extraordinary Credit Need
    • Extended Terms
      • Establishing need for extended terms
    • Overdue Accounts
    • Other Reasons for Reviews
  • 27.
    • Midterm Review
  • 28. End of Session 5