The document details a potential credit policy that emphasizes credit analysis, focusing on customer creditworthiness evaluation and structured credit terms to minimize risk while promoting business growth. Key components include defining eligibility criteria, payment terms, and limits, conducting thorough credit analysis, and implementing risk mitigation strategies. It also discusses factors affecting credit policy, such as competition, financial position, and economic climate, guiding organizations in optimizing their credit practices.

1. Potential Credit Policy
including
CREDIT ANALYSIS
BY
N ILANGO
Assistant Professor, Department of MBA
Sri Ramakrishna College of Arts & Science, CBE

2. Potential Credit Policy including Credit Analysis
Involves:
= ‘evaluating’ creditworthiness of customers &
= ‘defining’ structured terms
: for extending credit
Ensures that company minimizes credit risk while fostering
business growth
1. Assess Business Objectives
Define purpose of offering credit
Eg: to increase sales, enter new markets or build customer
loyalty
Balance sales growth with need to maintain a healthy cash flow
& minimize bad debts

3. Potential Credit Policy including Credit Analysis
2. Establish Credit Policy Guidelines
A potential credit policy typically includes:
Eligibility Criteria:
Define types of customers eligible for credit
Credit Limits:
Set maximum amounts based on customer risk profiles
Payment Terms:
Specify terms like net 30, net 60, or customized terms for
key customers
Discounts & Penalties:
Offer early payment discounts &
Impose late payment fees
: to encourage timely payments
Approval Process:
Outline who approves credit applications & required
documentation

4. Potential Credit Policy including Credit Analysis
3. Conduct Credit Analysis
Credit analysis is process of evaluating a customer's ability &
willingness to pay
Involves:
A. Gathering Customer Information
Financial Statements:
Analyze income statements, balance sheets & cash flow
statements
Credit Reports:
Obtain credit scores & histories from credit rating agencies
Eg: Dun & Bradstreet, Experian
Trade References:
Contact other vendors or suppliers who have extended credit to
customer
Bank References:
Verify customer’s banking relationships & account status

5. Potential Credit Policy including Credit Analysis
B. Assessing Key Factors (The 5 Cs of Credit)
Character: Evaluate customer's reliability & reputation for
repaying debts
Capacity: Assess customer's ability to repay based on financial
stability & cash flow
Capital: Review customer’s financial strength, including equity
& reserves
Conditions: Consider industry trends, economic conditions &
market risks that may affect repayment
Collateral: Determine if customer can provide security or
assets to back credit
C. Analyzing Financial Ratios
Liquidity Ratios: Current ratio & quick ratio to measure
short-term financial health
Profitability Ratios: Gross margin & net profit margin to
assess earning potential
Debt Ratios: To evaluate financial leverage

6. Potential Credit Policy including Credit Analysis
4. Define Credit Limits
Use results of credit analysis to set appropriate credit limits
For high-risk customers, set lower limits or require additional
guarantees.
For low-risk customers, consider higher limits to encourage
business growth
5. Monitor & Review Credit Performance
AR Aging Reports:
Track overdue accounts & payment patterns
Customer Reviews:
Periodically reassess customer creditworthiness based on
updated financial data
Policy Adjustments:
Revise credit limits, terms or eligibility criteria as needed

7. Potential Credit Policy including Credit Analysis
6. Implement Risk Mitigation Strategies
Credit Insurance:
Protect against potential losses from non-payment
Factoring:
Sell receivables to a third party to improve cash flow
Advance Payments:
Request partial payments upfront for high-risk customers
7. Communicate & Enforce Policy
Clearly communicate credit terms to customers during on-
boarding
Ensure sales & AR teams understand & consistently enforce
credit policy

8. FACTORS Affecting CREDIT POLICY
The size of accounts receivables is determined by various factors,
such as:
The effect of granting credit to customers on the volume of
company’s sales
Details of credit terms
Details of cash discount
Policies & practices adopted for selecting appropriate credit
customers
Paying practices, trends & habits of customers
Policies & practices in collection of debts
Degree of operating efficiency of billing & record keeping
Costs associated with: interest, collection, bad debts, etc.,

9. Evaluation of CREDIT POLICIES
 A significant task is done by the Finance Manager
 Optimum amount shall be fixed for spending on the
collection from debtors
 A trade-off shall be found between:
levels of expenditure &
decrease in bad debt losses/ increase in sales revenue

10. Monitoring & Controlling of Accounts Receivables
Re-engineering Receivable Process and Centralisation
Alternative Payment Strategies
Customer Orientation
Evaluation of Risk
Automated Accounts Receivables Management System
Accounts Receivable Collection Practices
Credit Analysis & Credit Rating
Ageing Schedule
Collection Policies & Collection Programme

11. FACTORS AFFECTING THE CREDIT POLICY
a) COMPETITION:
Consideration should be given to the terms of credit your
competitors are offering
b) FINANCIAL POSITION:
The cost of granting credit is an important factor in determining
the degree to which you are prepared to extend payment terms
Credit terms and period should always be compared with the cost
of running an overdraft or any other loans obtained to finance
credit
c) ATTITUDE TO RISK & BAD DEBTS:
Each and every organization should be able to measure the risk
involved in comparison to the profits made
A number of organizations tend to ignore this area in the name of
business and each year you get the company’s profits declining due
to the provision of bad debts

12. FACTORS AFFECTING THE CREDIT POLICY
d) THE NATURE OF THE PRODUCT:
The nature of the business dictates the credit periods offered
Eg: In the food industry the credit period is shorter while in
heavy industries the credit period is longer
Eg: Supermarkets and plant industries
e) SIZE OF THE ORDER:
The bigger the order the more the profits and this would warrant
a longer credit as the cost of credit is supported by the profits
f) ECONOMIC CLIMATE:
Credit periods are also dictated by the position of the underlying
domestic economy
Eg: Is the country in a boom or suffering a recession
Eg: The level of the interest rates
NB This is an area that need to be reviewed regularly to enable
the company make appropriate changes to the credit policy