This document discusses credit management. It covers terms of payment like cash terms, open account, consignment, and letters of credit. It also discusses credit policy variables like credit standards, credit periods, cash discounts, and collection efforts. The document outlines methods for credit evaluation like traditional credit analysis, numerical credit scoring, and discriminant analysis. It then discusses making credit granting decisions using formulas that consider revenue, costs, and default probabilities. Finally, it covers controlling accounts receivable using days' sales outstanding and aging schedules.

1. CREDIT
MANAGEMENT
Prepared By:
Ketan Vagh
Saurabh Raval
Nidhi Shah
Kushal Shah
Chirag Parekh

2. TABLE OF CONTENTS
 Terms of payment
 Credit policy variables
 Credit evaluation
 Credit granting decision
 Control of accounts receivable
 Credit management in India

3. TERMS OF PAYMENTS
 Cash Terms
 Open Account
 Credit Period
 Cash Discount
 Billing

4. TERMS OF PAYMENTS
 Consignment
 Bill of Exchange
 Letter of Credit

5. CREDIT POLICY
VARIABLES
 Credit Standards
 Credit Period
 Cash Discount
 Collection Effort

6. 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.

7. 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

8. 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

9. 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

10. 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.

11. 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

12. 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 Rating Factor
r Score
Past Payment Weigh 4
0.30 1.20
Net Profit
t
0.20 4 0.80
Margin
Rating 2.00
Index

13. 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 + + + +
+ +
O O+ +
O O
O + O
O
O
Return on Equity

14. 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

15.  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

16. 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

17. CONTROL OF ACCOUNTS RECEIVABLES
 Two methods for that
 Days’ sales outstanding
 Ageing schedule

18. Days’ sales Outstanding
Month Sales Receivables
January 150 400
February 156 360
March 158 320
April 190 310
May 170 300
June 180 320

19.  DSO= Account receivable
Average daily sales
Quarter
First 320 = 62 days
(150+156+158)/90
Second 320 = 54 days
(190+170+180)/91

20. Ageing Schedule
In days Receivables
0-30 35%
31-60 40%
61-90 20%
>90 5%

21. Collection of Matrix
 Whether the Collection is improving stable or reduced .
January February March
Collection 13 20 24
Of
payment

22. CREDIT MANAGEMENT IN
INDIA
 Credit Policy
 Credit Analysis
 Control of Receivables
 Room for Improvement