CREDIT MANAGEMENT

Prepared By:Ketan VaghSaurabh RavalNidhi ShahKushal ShahChirag Parekh

TABLE OF CONTENTS

Terms of payment

Credit policy variables

Credit evaluation

Credit granting decision

Control of accounts receivable

Credit management in India

TERMS OF PAYMENTS

Cash Terms

Open Account

Credit Period

Cash Discount

Billing

Consignment

Bill of Exchange

Letter of Credit

TERMS OF PAYMENTS

CREDIT POLICY VARIABLES

Credit Standards

Credit Period

Cash Discount

Collection Effort

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.

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

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

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

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.

“Five C’s of credit” CharcterCapacityCapitalCollateralCondition Sources of informations about five c Financial statement Bank referencesExperiences of firm

TRADITIONAL CREDIT ANALYSIS

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 FactorWeight

Rating FactorScore

Past Payment 0.30 4 1.20

Net Profit Margin

0.20 4 0.80

Rating Index

2.00

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

OO

O

O+

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

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

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

CONTROL OF ACCOUNTS RECEIVABLES

Two methods for that

Days’ sales outstanding

Ageing schedule

Days’ sales Outstanding

Month Sales Receivables

January 150 400

February 156 360

March 158 320

April 190 310

May 170 300

June 180 320

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

Ageing Schedule

In days Receivables

0-30 35%

31-60 40%

61-90 20%

>90 5%

Collection of Matrix Whether the Collection is improving stable or reduced .

January February March

Collection

Of payment

13 20 24

CREDIT MANAGEMENT IN INDIA Credit Policy

Credit Analysis

Control of Receivables

Room for Improvement