Chapter Outline A policy is a general course of action developed for recurring situations, designed to achieve established objectives. In business concerns, complementary policies exist at several levels: some apply to the activities of the company as a whole, others to the activities of a major division, and still others to a single department. With regard to the credit function, credit policies apply to the credit department’s activities for the company as a whole. They establish a framework or guide for consistent credit decisions directed toward attaining the goal established by the company for the credit function.
Importance of Credit Policy to distinguish among a credit policy, procedure, and rule. A policy is a general course of action developed for recurring situations and designed to achieve established objectives . It is a general statement that serves as a guide for the credit manager’s decision making. A credit procedure describes the actual working steps that should be followed in the appropriate order to accomplish the desired credit result or decision . A credit rule is a statement that defines and/or restricts the actions that a credit manager can take (or not take) in a specific situation or decision . Objective of Policy typically, a company has written and defined objectives over stated periods of time. To help the company achieve these overall objectives, each functional department, including the credit department, must reach certain specific goals. The policy is established to meet the objectives of the company, which are determined before any other actions can be taken. Policy and Procedures Credit policy serves as a guide in determining how to handle given kinds of problems, but it does not offer a definitive solution - it presents a range of solutions with which the credit executive is free to exercise judgment. In the process of decision-making, credit policy is constantly interpreted and applied to actual situations with the help of specific guidelines or procedures. Policy and Practice In practice, the range of possible decisions provided under a firm’s credit policy is narrowed for particular personnel, kinds of situations, or time periods. Changes is practice within a given policy provide flexibility in meeting changing conditions. Handling Exceptions A company’s credit policy is intended to be applicable to the majority of credit situations. Like the credit policy itself, the exceptions must be handled consistently within the overall company policy and objectives.
Because credit policy concerns the company as a whole, it is usually established officially by top management. Credit policy is probably most effectively implemented when all who are directly affected have some voice is its development. A credit policy assures that there will be consistency across departmental functions. Credit Policy Focal Points When a company is developing a new credit policy or is reviewing an existing one, a number of factors should be considered. Review the list on pages 103-104 of the text. Other Influences on Credit Policy Credit practices within the industry also bear upon the credit policy of an individual company. Other influences include: competition, market share, type of customer, number of classes of customers, length of terms offered, type of merchandise, merchandise policy, large extension of credit, markup, price, inventory, geographical distribution and economic conditions. Formulating the Policy The actual formulation of credit policy begins with the establishment of objectives. What does the company want to accomplish during the period for which policy is to be established? There are four essential components of credit policy: Reasons for a Written Policy A written policy is more useful because it can be a source of stability and continuity in the operation, not only of the credit department but of the company as a whole. A clearly stated credit policy is a valuable aid in training credit and sales personnel. Checklist for a Well-Defined Credit Policy, Review list on page 109 Review Figure 5-2 on page 110 for an Example of Credit Policy
To be effective, policy must be directly and explicitly related to action. Credit management should take the steps necessary to translate broad, flexible policy statements into guides that can be used by credit personnel in the daily operation of the department. Communication of Policy A basic requirement is effective communication of policy, both inside and outside the credit department. Understanding how credit decisions are made improves the sales representatives’ knowledge of the business. The ideal time to describe credit policy to a customer is when the first order is placed. Assignment of Responsibility While the organization of a credit department is not determined by credit policy, it plays an important part in putting policy into action through specific assignment of responsibility and delegation of authority. Establishing Procedures Closely allied to assignment of responsibility is the development of detailed procedures for day-to-day operations. Typical credit activities that can require written procedures: Review Figure 5-3 on page 112 of the text. Applying Policy Under Varying Conditions Because credit policy is intended to apply to the great majority of the company’s credit activities over a long period of time, it is often necessary to provide for varying interpretations within the one policy. Factors Influencing Short-Term Policy Application The short-term application of policy should be flexible, consistent, fair, and allow for the credit manager’s judgment. Conditions that Can Cause Credit Policy To Change Increases or decreases in critical factors, such as profit margins, monthly cash flows, aged accounts receivable, bad debt, competition, and market share can cause credit policy to change. Review of Credit Policy Both the credit policy and its application should be reviewed at definite stated intervals. One means of reviewing credit policy is by conducting a credit department audit. The result of the audit should be an objective evaluation of the department’s effectiveness as well as the identification of any areas that need improvement.
Analysis of Risk One type of policy deals with the analysis of risk. Risk classifications should be assigned for each customer. Risk criteria include the likelihood that the customer will pay on terms; the success of the customer in staying within the maximum account of credit made available; the customer’s overall creditworthiness and general financial stability; and the likelihood that the customer will not have sufficient liquid reserves, over the medium term, to be able to pay on terms. Degree of Collection Effort Another type of policy deals with the degree of collection effort a company will consider. This means answering several questions. The answers to these questions will determine the strictness of collection effort. How much money and effort is the company willing to spend in collecting amounts owed to it? How will it treat past-due accounts? Will unearned discounts be permitted? A number of different credit and collection policies can be set when these questions are answered. Four such policies are show in Figure 5-4 on page 115
Importance A credit manual is important as a ready reference. Large companies need it as a standard guide for their many department personnel, and even small companies find it useful. The manual should cover rules, regulations, and procedures necessary for consistent department operations. It is also a useful tool in job training programs. Format & Maintenance The credit manual may be issued as a separate book or as part of the manual of general company instructions. The credit manual must be kept current. Recommended Contents The table of contents is a ready reference of the topics in the credit manual. It should emphasize that the manual only outlines the framework that credit department personnel should follow and does not attempt to provide a specific blueprint for handling each and every credit decision. Review recommended table of contents in pages 116-119. See Figure 5-5 on page 116 of the text.
See pages 116-1 19 of text for list of recommended contents for procedures manuals.
Purpose of a Credit Application Credit applications serve several purposes for the credit professional. A well-planned credit application can assist the seller during the four stages of the creditor-debtor relationship; it should be used before a decision to extend credit is made (pre-credit), during the credit relationship with the debtor (during the credit cycle), during problems in a credit relationship (problem credit) and during judgment (after credit). In addition to using the credit application as an investigative tool, the credit application should create a contract between the seller/creditor and the customer, the applicant/debtor. Most credit investigations start with the information supplied by the applicant on the credit application. Keep in mind that the key goal of a credit application is to assist the seller in learning as much as possible about the applicant/debtor before making a decision to extend credit. The credit application is often considered to be the cornerstone of the customer’s file. See pages 119-120 of text Credit Application as a Source of Information The credit application must contain sufficient factual information to permit an intelligent decision to be made with respect to the extension of credit. Key points to consider in a credit application are: Review section on pages 121-127 of the text. Credit Application as a Contract The properly executed credit application is a binding contract when there is agreement to terms and conditions. Review items on pages 127-134 of text. Below the Signature Line If an applicant is questionable, the credit professional may obtain a consumer credit report but there must be a permissible purpose and written authorization must be obtained. See pages 134-135 of the text. Supplemental Information When circumstances dictate, a credit professional may consider adding additional items to a credit application. These items could also be used as amendments or to replace language for items that apply to a specific industry or business. See pages 136-140
Review Learning Objectives with the class
Chapter Outline Arrangements between seller and buyer that specify the conditions of payment for goods and services are known as terms of sale. They indicate if credit is to be part of the sales transaction, the length of time for which credit is to be granted, and other features such as discounts. Terms of sale are made up of many factors. They represent a commitment of operating funds by the seller and should therefore be carefully understood.
Credit Policy Credit policy must provide the framework for all terms offered by the business. There are many different terms of sales, ranging from prepayment of cash to permitting the customer considerable time within which to pay for the goods after received. There is a direct correlation between the terms of sale and the seller’s perception of the buyer’s ability to pay. To be enforceable, it is important that terms of sale be contractual; agreed to by both the seller and buyer. Contractual Considerations A term stated in a contract is a contractual condition. Thus, terms, when set forth in a contract, include the kind of goods, the time of delivery, the words, terms of sale are actually the terms of payment. Terms of sale are an integral part of each sales contract and, like the price, require agreement by both buyer and seller. The seller sets terms for its products based on credit policy and the creditworthiness of the buyer. Antitrust Implications Terms of sale, also referred to as credit terms, selling terms, or payment terms, must be set independently by each seller, without collusion or conspiracy with other sellers, to avoid violation of the antitrust laws. The courts have ruled that credit terms are part of price, and the seller should be fully aware of the provisions of the Robinson-Patman Act regarding discrimination in terms of sale if any departure from regular terms is contemplated. The key is to apply the same standards to determine creditworthiness for all customers. To avoid misunderstanding, companies should include their credit terms on important documents relating to the transaction, such as credit applications, price lists, purchase orders, sales contracts, and the invoice itself. See Chapter 4 for more detail on antitrust implications.
General Considerations Once terms of sale are established, they are quite difficult to change. Since they have both marketing and financial aspects, it is important that decisions related to establishing or changing terms be made jointly by the company’s sales and financial management. Competition and market and product characteristics are two important factors that influence terms of sale. Competition Credit is extended in response to either direct or indirect customer demand for the firm's products or services. This implies that sales might not occur without the extension of credit. Basically, terms are an element much like prices in the overall competitive scene. Any competitive advantage may only be temporary, since it can lead competitors to offer other inducements to the same customers. Market and Product Characteristics Market and product characteristics range widely in impact and complexity, from production time to physical characteristics of raw materials. There is a direct relationship between the time it takes to convert goods or materials into cash and the time allowed to repay the debt created by the purchase of the materials. It is commonly believed that terms of sale should cover a customer’s operating cycle which is the length of time it takes to process the material, sell it, and collect the funds. Review section on pages 146-147 of the text. Type of Customer Companies often employ different terms for different types or classes of customers. Customers can be classified in many ways, for example by size of order or type of buyer. Retailers may receive one set of terms, wholesalers another, and institutional buyers still another. Profitability Products with higher profit margins can support longer terms than those with lower margins, and selling terms should take this factor into consideration. In the real world, however, competition may nullify this by forcing a seller to offer longer terms in lines where depressed prices yield little or no profit.
Terms of sale can be separated into different categories: cash , open , and special . Regardless of the kind of terms used by a seller, they should be clearly communicated in writing and agreed to by the buyer. Prepayment Terms or Cash Terms Cash terms , also referred to as prepayment or closed terms , include payment before the transaction or at the time of the transaction. Examples of prepayment terms are: (see page 148 of the text) Cash in Advance (CIA) Cash before delivery (CBD) Cash on delivery (COD) Cash with order (CWO) There are several kinds of cash; cash can mean a buyer’s check, a certified check, or a cashier’s check. “ Short” Terms Extremely truncated duration; usually offered as matter of industry practice. Bill-to Bill terms Receipt of Invoice (ROI) Credit Card Payment Purchasing Debit Card See pages 149-150 for examples. Go over: (see page 150 of text) Kinds of cash Cashier’s check Wire transfer Electronic funds transfer (EFT) Open account terms , Include as many as three elements: the net credit period, the cash discount and the cash discount period. The net credit period is the length of time allowed for payment of the face amount of the invoice. Go over: (See pages 151-152 of text) Net credit period Terms Based on Invoice Date Single Payment Term End-of-Month Terms Middle of the Month (MOM) Terms Proximo Terms Discount Terms Net terms with a cash discount offer an inducement for the purchaser to pay ahead of maturity. A cash discount is offered off the invoice amount if the customer pays with a specified period of time called the discount period. It is usually expressed as a percentage but can be stated as a dollar amount. Anticipation is a form of early payment allowance wherein a discount is allowed base don the number of days an invoice is paid early, using a pre-established annual rate converted to a daily rate. Trade Discounts are allowances offered to purchasers because of industry custom or the volume of purchases. Chain Discounts represent a manner in which a trade discount and a payment discount can be combined in a single set of terms. Review pages 152-155 of the text . Analyzing the Cost of Offering Cash Discounts from the Seller’s Perspective Review pages 156-162 of the text on this topic. Late Charges Financing of credit after the due date becomes an additional cost to a business. Late charges are a way for a business to recover these lost costs. Late charges should be distinguished from interest payments which are charges made by financial institutions for loans.
See pages 163-166 of the text Receipt of Goods (ROG) permits the buyer to compute the cash discount period or net credit period from the date the merchandise is received rather than from the invoice date. Bill and Hold (B&H) are used in some industries, such as textiles, to permit sellers to invoice buyers under normal payment terms on the agreed upon completion date, whether or not shipment has actually occurred. Consignment Consignment terms offer an alternative to an open-account sale. Consignment is not a true sale until the buyer, called the consignee, actually sells the goods; until then, title remains with the owner, usually the manufacturer, called the consignor. Floor-plan Financing Floor-plan financing involves an inventory financing company called the floor-plan creditor, that has contractual arrangements with both the supplier/seller and the buyer. The supplier ships the product to the buyer, but sends the invoice to a third party. The third party pays the supplier and the buyer pays the third party over a longer period of time, with interest. Contra Accounts Some companies find that they are reciprocal suppliers with their customers, so only the net amount needs to be paid regularly.
See pages 165-166 of the text Extra Dating Terms Extra dating arrangements, found primarily in the farming and textile industry, extend the discount period. Seasonal Dating Terms Seasonal dating terms are used when there is a high seasonal demand for a product and sellers wish to encourage off-season purchases by granting terms that postpone payments to coincide with the buyers’ selling seasons, such as in the agricultural industry. [email_address] Security Interest Creditors may enhance their position by taking a security interest in assets such as inventory, bank accounts or real estate. Advances Occasionally when work is done to a customer’s specification it is customary to ask for a partial payment with the order to provide the seller with some working funds for the job and to offer some protection in case the customer cancels the custom order. Progress Payments Partial payments are sometimes made on a contract as it progresses, especially when manufacturing or construction time is long and the creditor cannot afford to finance production, such as in the construction industry.
The terms of sale in an export transaction are a matter of prior arrangement between the buyer and the seller. The choice of payment method or financial instrument will depend on such factors as the credit standing of the foreign buyer, possible foreign exchange restrictions, geographic location of the buyer, and competition locally and internationally. Pro forma invoice is an abbreviated invoice sent in advance of a shipment, usually to enable he buyer to obtain an import permit, an exchange permit or both. Barter Arrangements This form of payment allows a buyer to pay with merchandise or work performance instead of currency and is often used with a third party clearinghouse as an intermediary. Barter is often used when a country does not have a fully convertible currency or is in an early stage of development and the country risk is significant. Incoterms Because of additional risks encountered with export and import business, standard terms related to freight, insurance, clearance of goods through customs, and other such costs have been standardized by the International Chamber of Commerce. These terms are known as Incoterms which is short for International Commercial Terms.
Credit Policy and Procedures
Credit Policy and Procedures Chapter Five NACM
Learning Objectives <ul><li>Components of a credit policy </li></ul><ul><li>Steps used in establishing a credit policy </li></ul><ul><li>How a credit policy is implemented </li></ul><ul><li>Types of credit policies </li></ul><ul><li>Components of a credit manual </li></ul><ul><li>Create a credit application </li></ul><ul><li>Trade laws </li></ul>
Defining Credit Policy <ul><li>Importance of Credit Policy </li></ul><ul><li>Objectives of a Credit Department </li></ul><ul><li>Policy and Procedures </li></ul><ul><li>Policy and Practice </li></ul><ul><li>Handling Exception </li></ul>
Establishing Credit Policy <ul><li>General Considerations </li></ul><ul><li>Credit Policy Focal Points </li></ul><ul><li>Other Influences on Credit Policy </li></ul><ul><li>Formulating the Policy </li></ul><ul><li>Reasons for a Written Policy </li></ul><ul><li>Checklist for a Well Defined Credit Policy </li></ul><ul><li>Example of a Credit Policy </li></ul>
Implementing Credit Policy <ul><li>Communication of Policy </li></ul><ul><li>Assignment of Responsibility </li></ul><ul><li>Establishing Procedures </li></ul><ul><li>Applying Under Varying Conditions </li></ul><ul><li>Factors Influencing Short-Term Policy Application </li></ul><ul><li>Conditions that Can Cause Credit Policy to Change </li></ul><ul><li>Review of Credit Policy </li></ul>
Types of Credit Policy <ul><li>Analysis of Risk </li></ul><ul><li>Risk Criteria </li></ul><ul><li>Degree of Collection Effort </li></ul>
Credit Procedures Manual <ul><li>Importance </li></ul><ul><li>Format </li></ul><ul><li>Maintenance – must be kept current </li></ul><ul><li>Recommended Contents </li></ul>
Credit Procedures Manual Recommended Contents <ul><li>Table of Contents </li></ul><ul><li>Investigation </li></ul><ul><li>Security Devices </li></ul><ul><li>Credit Approval and Administration </li></ul><ul><li>Collections </li></ul><ul><li>Reports </li></ul>
Credit Application <ul><li>Purpose of a Credit Application </li></ul><ul><li>Credit Application as a Source of Information </li></ul><ul><li>Credit Application as a Contract </li></ul><ul><li>Below the Signature Line </li></ul><ul><li>Supplemental Information </li></ul>
Learning Objectives <ul><li>The role played by terms in day-to-day business transactions </li></ul><ul><li>Major factors that influence terms </li></ul><ul><li>Key elements of terms </li></ul><ul><li>Types of terms and how they differ </li></ul><ul><li>Impacts of payment timing and discounts on profitability </li></ul>
Terms and Conditions of Sale <ul><li>Important Considerations </li></ul><ul><li>Influencing Factors </li></ul><ul><li>Categories of Terms of Sale </li></ul><ul><li>Special Terms </li></ul><ul><li>Export Terms </li></ul>
Important Considerations <ul><li>Applying Credit Policy to Terms </li></ul><ul><li>Contractual Considerations </li></ul><ul><li>Antitrust Implications </li></ul>
Influencing Factors <ul><li>General Considerations </li></ul><ul><li>Competition </li></ul><ul><li>Market and Product Characteristics </li></ul><ul><li>Type of Customer </li></ul><ul><li>Profitability </li></ul>
Categories of Terms of Payment <ul><li>Cash/Prepayment Terms </li></ul><ul><li>“ Short” Terms </li></ul><ul><li>Open Account Terms </li></ul><ul><li>Discount Terms </li></ul><ul><li>Analyzing the Cost of Offering Cash Discounts </li></ul><ul><li>Late Charges </li></ul>
Special Terms <ul><li>Receipt of Goods </li></ul><ul><li>Bill and Hold </li></ul><ul><li>Consignment </li></ul><ul><li>Floor-Plan Financing </li></ul><ul><li>Contra Account </li></ul>
Special Terms (continued) <ul><li>Extra Dating </li></ul><ul><li>Seasonal Dating </li></ul><ul><li>Security Interest </li></ul><ul><li>Advances </li></ul><ul><li>Progress Payments </li></ul>
Export Terms <ul><li>Pro Forma Invoice </li></ul><ul><li>Barter Arrangements </li></ul><ul><li>Incoterms </li></ul>