Credit management

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Credit management

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  4. 4. TABLE OF CONTENTS Terms of payment Credit policy variables Credit evaluation Credit granting decision Control of accounts receivable Credit management in India
  5. 5. TERMS OF PAYMENTS Cash Terms Open Account Credit Period Cash Discount Billing
  6. 6. TERMS OF PAYMENTS Consignment Bill of Exchange Letter of Credit
  7. 7. Credit Policy Variables Credit Standards Credit Period Cash Discount Collection Effort
  8. 8. Credit Standards ∆RI = [∆S (1 – V) - ∆S bn] (1 – t) -k ∆I Where ∆RI = Change in residual income ∆S = increase in sales V = ratio of variables costs to sales bn = bad debt loss ratio on new sales t = corporate tax rate k = post tax cost of capital ∆t = increase in receivables investment.
  9. 9. Credit Period ∆S *ACP * V 360 ∆S/360 = average daily change (increase) in sales. The divisor here can with equal justification be 365, rather than 360 ACP = average collection perid
  10. 10. Cash Discount ∆RI = [∆S (1 – V) - ∆DIS] (1 – t) + k∆I Where ∆S = Increase in sales V = ratio of variable cost to sales k = cost of capital ∆I = savings in receivables investment ∆DIS = increase in discount cost
  11. 11. Collection Effort ∆RI = [∆S (1 – V) - ∆BD] (1 – t) + k∆I Where ∆RI = Change in residual income ∆S = Increase in sales V = ratio of variable cost to sales ∆BD = increase in bad debt cost t = tax rate k = cost of capital ∆I = savings in investment in receivables
  12. 12. Credit Evaluation Type I Error : A good customer misclassified as a poor credit risk. Type II Error: A bad customer misclassified as a good credit risk.
  13. 13. TRADITIONAL CREDIT ANALYSIS “Five C’s of credit” Charcter Capacity Capital Collateral Condition Sources of informations about five c Financial statement Bank references Experiences of firm
  14. 14. Numerical Credit Scoring  Identify factors relevant for credit evaluation  Assign weights to these factors  Rate the customer on various factors using suitable rating scale.  Multiply weights with the rating scale.  Add all score to get consumer rating index  Based rating index classify customer Factor Facto r Weigh t Rating Factor Score Past Payment 0.30 4 1.20 Net Profit Margin 0.20 4 0.80 Rating Index 2.00
  15. 15. Discriminant Analysis This technique is employed to construct better risk index. e.g. ABC company manufacture some product for industrial customer, they take two financial ratio into consideration, namely return on Equity and Current ratio. Current Ratio Return on Equity + + + + + + + + O OO O O O O O +
  16. 16. CREDIT GRANTING DECISIONP=Probability that customer pays his dues 1-P=The Probability that Customer can not Pays his dues. Revenue=Revenue from sale Cost =Cost of good sold
  17. 17. Formula P(Rev-cost)-(1-P)Cost Example ABC company is considering offering credit to a customer.the probability that customer would pay is 0.8 and the probability that customer would default is 0.2.The revenue from sale would be Rs 1200 and cost would be Rs.800 Sol:- 0.8(1200-800)-0.2(800) = 160
  18. 18. REPEAT ORDER FORMULA { P1(Rev1-cost1)-(1-P1)Cost1 } + P1{ P2(Rev2-cost2)-(1-P2)Cost2 } SOLUTION {0.9(2000-1500)-0.1(1500)} + 0.9{0.95(2000-1500)-0.05(1500)= 660
  19. 19. CONTROL OF ACCOUNTS RECEIVABLES Two methods for that  Days’ sales outstanding  Ageing schedule
  20. 20. Days’ sales OutstandingMonth Sales Receivables January 150 400 February 156 360 March 158 320 April 190 310 May 170 300 June 180 320
  21. 21. DSO= Account receivable Average daily sales Quarter First 320 = 62 days (150+156+158)/90 Second 320 = 54 days (190+170+180)/91
  22. 22. Ageing ScheduleIn days Receivables 0-30 35% 31-60 40% 61-90 20% >90 5%
  23. 23. Collection of Matrix January February March Collection Of payment 13 20 24 Whether the Collection is improving stable or reduced .
  24. 24. CREDIT MANAGEMENT IN INDIA Credit Policy Credit Analysis Control of Receivables Room for Improvement

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