Pamantasan ng Lungsod ng Maynila

PLM Business School

A.Y. 2020 - 2021 First Semester

FIN 3104: CREDIT MANAGEMENT AND COLLECTION POLICIES

MODULE 3: CHAPTER 9
CREDIT DECISIONS, CREDIT LIMITS, AND CONTROLS

TOPICS FOR DISCUSSION:

I. Credit Decisions, Credit Limits, and Controls

A. Other Factors Affecting Credit Decisions

B. Credit Limits

C. Operating the Controls

LEARNING OBJECTIVES:

After the discussion, learners shall be able to:

• Discern the maximum amount of credit a financial institution may extend to a

debtor client.

• Monitor customers credit history before granting/re-granting of credit to ensure

future payment.

• Realize creditor’s confidence that the borrower is willing and has the capacity

to repay the funds advanced.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
RECAP/INTRODUCTION:
CREDIT ANALYSIS

• The credit analysis process refers to evaluating a borrower’s loan application to

determine the financial health of an entity and its ability to generate sufficient
cash flows to service the debt.
• In simple terms, a lender conducts credit analysis on potential borrowers
to determine their creditworthiness and the level of credit risk associated
with extending credit to them.
✓ Credit Risk: The risk of loss that may occur from the failure of any
party to abide by the terms and conditions of any financial contract,
principally, the failure to make required payments on loans due to an
entity.
• The outcome of the analysis is a determination of whether to extend credit or
loan money to the subject – Credit Decision-Making Stage; and if so, the
amount to be committed.
• During the credit analysis process, a credit analyst may use a variety of
techniques, such as cash flow analysis, risk analysis, trend analysis, ratio
analysis, and financial projections. The techniques are used to analyze a
borrower’s financial performance data to determine the level of risk associated
with the entity and the amount of losses that the lender will suffer in the event
of default.
Stages in Credit Analysis Process
The credit analysis process is a lengthy one, lasting from a few weeks to months. It starts
from the information-collection stage up to the decision-making stage when the lender decides
whether to approve the loan application and, if approved, how much credit to extend to the
borrower.
As discussed by the lecturer of Chapter 7 – Credit Evaluation, following are the key
stages in the credit analysis process:
1. Information Collection
The first stage in the credit analysis process is to collect information about the
applicant’s credit history. Specifically, the lender is interested in the past repayment
record of the customer, organizational reputation, financial solvency, as well as their
transaction records with the bank and other financial institutions. The lender may also
assess the ability of the borrower to generate additional cash flows for the entity by
looking at how effectively they utilized past credit to grow its core business activities.
The lender also collects information about the purpose of the loan and its
feasibility. The lender is interested in knowing if the project to be funded is viable and
its potential to generate sufficient cash flows. The credit analyst assigned to the
borrower is required to determine the adequacy of the loan amount to implement the
project to completion and the existence of a good plan to undertake the project
successfully.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 The bank also collects information about the collateral of the loan, which acts as
security for the loan in the event that the borrower defaults on its debt obligations.
Usually, lenders prefer getting the loan repaid from the proceeds of the project that is
being funded and only use the security as a fall back in the event that the borrower
defaults.
2. Information Analysis
The information collected in the first stage is analyzed to determine if the
information is accurate and truthful. Personal and corporate documents, such as the
passport, corporate charter, trade licenses, corporate resolutions, agreements with
customers and suppliers, and other legal documents are scrutinized to determine if they
are accurate and genuine.
The credit analyst also evaluates the financial statements, such as the income
statement, balance sheet, cash flow statement, and other related documents to assess the
financial ability of the borrower. The bank also considers the experience and
qualifications of the borrower in the project to determine their competence in
implementing the project successfully.
Another aspect that the lender considers is the effectiveness of the project. The
lender analyzes the purpose and future prospects of the project being funded. The lender
is interested in knowing if the project is viable enough to produce adequate cash flows
to service the debt and pay operating expenses of the business. A profitable project will
easily secure credit facilities from the lender.
On the downside, if a project is facing stiff competition from other entities or is
on a decline, the bank may be reluctant to extend credit due to the high probability of
incurring losses in the event of default. However, if the bank is satisfied that
the borrower’s level of risk is acceptable, it can extend credit at a high interest
rate to compensate for the high risk of default.
3. Approval (or Rejection) of the Loan Application – Credit Decision
The final stage in the credit analysis process is the decision-making stage. After
obtaining and analyzing the appropriate financial data from the borrower, the lender
makes a decision on whether the assessed level of risk is acceptable or not.
If the credit analyst assigned to the specific borrower is convinced that
the assessed level of risk is acceptable and that the lender will not face any
challenge servicing the credit, they will submit a recommendation report to the credit
committee on the findings of the review and the final decision.
However, if the credit analyst finds that the borrower’s level of risk is too high
for the lender to accommodate, they are required to write a report to the credit
committee detailing the findings on the borrower’s creditworthiness. The committee or
other appropriate approval body reserves the final decision on whether to approve or
reject the loan.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
CREDIT DECISION
A credit decision is a composite of three interlinked decisions:

• To lend or not to lend – Accept / Reject.

• Terms at which the bank should or is willing to lend – Covenants or Term Sheet
• The interest rate on loan – Loan Pricing
Accept / Reject.

There are several factors that go into the accept / reject decision. A bank's relationship
with a customer, the customer's credit history, track record, profile, future outlook, and
management team are significant factors. We will come back to these in the session on credit
decisions. The decision to approve a loan lies either with the concerned loan officer or with a
Loan Committee (varies from institution to institution). The loan committee comprises a
number of people (between three & ten). The loan officer responsible for investigating the case
presents his findings and recommendations to the loan committee. The underlying idea is that
the opinions and perceptions of people differ, and they provide a broader perspective on the
lending decision.
Most lenders have a very well-defined hierarchy that drives authority, responsibility,
and approval limits across the lending function. As loan amounts move to higher levels, the
number of people involved in making the decision also increases. Loans above a specific size
(expressed as a % of bank's capital) can only be approved by the Board of Directors.
Term Sheets
The design and structure of the term sheet are dependent on how strongly the bank feels
about the overall credit profile of its customer. Term sheets are a function of the risk
management, loan monitoring, and diversification policies of a bank. These are stipulations that
the borrower promises to abide by those that are designed to protect the rights and interests of
a lender.

Covenants can be of three types:

Negative – where the borrower is asked not to do certain things, i.e., restrictions are
placed on the borrower. The lender may prevent the borrower from taking on the additional
debt until the term of this loan expires. Alternatively, the borrower may be asked to refrain from
selling certain assets. Limitations may also be placed on the payment of dividends or stock
repurchases by the firm. These limitations, however, must be realistic and should be designed
to work with the interests of both parties.

Affirmative – where the borrower agrees to fulfil specific duties and perform certain
actions. For example, the borrower has to agree to make interest and principal payments, give
periodic and timely financial information (e.g., when a borrower pledges inventory at the time
of taking the loan, the lender may ask for periodic inventory reports to assess its value)

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 Financial – where the borrower agrees to meet specific financial requirements over the
term of the loan. For example, the lender may ask the business to maintain certain profitability,
leverage, and liquidity levels.

Loan Pricing
The interest rate charged on loan is a function of competitive pressures, market factors,
customer's credit ranking, relationships & the bank's strategic positioning (conservative,
moderate, aggressive). A well-defined & objective loan pricing process ensures that a lender
stays within the risk & earnings profile approved by the board of directors. However, more
often than not, competitive pressures will drive rates below targeted yields and risk profile.

Compliance & Documentation

In litigations, it is the side with the best documentation that wins. Documentation is the
most essential and crucial part of the lending process. This is where a bank establishes a claim
on the customer's assets in the event of default. It also establishes if the bank's loan is senior or
subordinate to other loans. Subordination and seniority define when a creditor is repaid in case
the business goes bankrupt. If the lending documentation is inaccurate or non-compliant, the
claim can be invalidated. An invalidated claim leaves a bank with no recourse to collateral
securing the loan.

However, documenting or establishing a claim is not enough. There are a number of

internal, external, industry, and regulatory agencies that regulate & review the lending process.
A lender also has to document compliance with the best practices, checklists & guidelines
established by these organizations.

The terms and conditions of the loan remain negotiable throughout the life of the loan.
Six months later, a borrower may find that certain covenants are affecting the operations of the
firm negatively. Lenders do allow relaxations in the terms, primarily if the borrower provides
strong and realistic reasons. Documentation, therefore, needs to remain current with changes in
the loan structure, business environment, market conditions, and relationships.
When do documentation and compliance start? In well-managed banks, it starts with the
point of contact between a customer and a lending officer. It goes on throughout the one- to-
eight-week duration of the credit process. It peaks when additional documentation is
prepared and filed after the term sheet is presented and approved by the loan committee and the
customer.
Making Credit Decisions
The basic objective in making credit decisions is to find ways to approve an order with
reasonable expectation that the customer will pay in accordance with established credit terms.
A decision to grant or not to grant credit affects sales revenue, profit, production and
procurement. If the customer is a good credit risk, the order may be approved as submitted.
Otherwise, alternatives should be developed that are acceptable to the credit department and the
sales department — and still meet the customer’s needs.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 It is desirable to establish routine procedures for making most credit decisions. Credit
approval, through the use of order limits or overall credit limits, can streamline the workload in
the credit department. The goal is to approve credit with minimum delay, provide customers
with prompt service and control administrative costs. If routine orders can be processed quickly
and efficiently, the credit professional has additional time to devote to more demanding credit
matters. This chapter discusses approaches and decision factors associated with making credit
decisions with speed, accuracy and efficiency.
Ideal Situation

The ideal situation in making a credit decision would be to take the following steps:

1. Ask the prospective customer to fill up a “Credit Application Form” This can
be done either through the salesman or through the credit people.
2. Interview the prospect personally, or through one of the more experienced credit
staff. This step is one of the more important procedure that must be followed as
rigidly as possible.
3. Send out a credit investigator for the proper credit investigation.
4. If there is still doubt, ask one of the reliable credit agencies to do supplementary
credit reports.
5. Collate all the credit information thus gathered.
6. Evaluate the credit risk through your time- tested credit rating or evaluation
formula.
7. Finally, make your credit decision.

“Hurried” Credit Decisions

Of course, this is the ideal situation. But the people who are in the front line of credit
work, all know that this is not the usual case. The eager salesman, through some means,
legitimate or not, often get a go-signal from “up-there” “to hurry up the credit decision,” for
we are reliable “to lose the sale or to lose the interest of the client.”

In such a case, what do they do? If they do not hurry up, they are in trouble. If they do,
they are also in trouble. Of course, the best course of action would be to make the best of the
situation. How? Take the following shortcut steps:

1. At least get to interview the prospect. As we have said previously, credit interview
is one of the more important procedures in knowing and evaluating the credit risk.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 2. With the information thus acquired from the interview, discreetly call by phone the
references given, especially on credit dealings. A good credit history will at least tell
you that the prospect has one of the most important factors of a reasonable risk:
credit character. If negative pieces of information gathered, then the credit man has
a good ground for either rejecting the sale outright or, at least informing top
management about it and the need to have more time for a closer look.
3. Ask for copies of statement of assets and liabilities, and of real state of evaluation
which are readily available, check listing in PLDT phone and check previous cash
or credit purchase with your firm. These will give you some indication of
his capacity to pay -also one of the more important factors in credit evaluation.
4. Consider further the records of the salesman proposing the credit sales. Has
he always given good risk customers? How many bum sales has he pushed through?
Be wary of the glib-tongued salesman with records of poor risk customer. If
necessary, inform top management accordingly
5. When all of the above have been done and indications are favorable and you have
to, of necessity, make a credit decision “to save the sale,” then do, so taking into
account all external factors, like competition, inventory position, credit policies and
the like.

But be sure that this is followed by the usual credit investigation and processing.

Of course, in so making a “hurried” credit decision “to save the sale” in accordance
with instructions for “top management,” always make it a point to make it a record that such
is the situation when you made the credit decision for later reference, not so much to have a
ready “alibi” to top management if and when the accounts turn sour, but better reasons which
are:

A. As your own guide and information so that you will be better prepared to make such
pressured credit decision.
B. Collection guide – for, normally, such credit extensions should be watched closely,
especially if, later on, the usual credit investigation processing should reveal
negative information.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
Not Isolated Occurrences

Credit men would like to assure everyone that “hurried” credit decision is not isolated
occurrences. They have experienced, and are experiencing, such problems. But such is
the nature of their job, and a successful credit manager is the one who can make the best out of
such tight situations – always with that primary objective of credit management in mind: TO
MAXIMIZE PROFITS BY MINIMIZING BAD DEBT LOSSES THRU PROPER CREDIT
EVALUATION OF CREDIT RISK.

The ultimate decision in a credit situation must be one of a judgment and not a mere
computation thru the financial statements. The man must analyze, evaluate, and consider the
available credit information and based on such evaluation, make a credit decision.

Other Factors to Consider in the Credit Decision Process

As a borrower, you want to put your best foot forward when applying for a mortgage,
auto loan, or personal loan, but this can be difficult to do when you're not sure what your lender
is looking for. You may know that they usually look at your credit score, but that's not the only
factor that banks and other financial institutions consider when deciding whether to work with
you and approve your loan application.
Aside from the 5 C’s of Credit – Character, Capacity, Capital, Collateral, Condition,
which were reported by previous lecturers; judgment should be exercised by considering the
following additional factors:
• Country Risk
In many ways, international lending is similar to domestic lending. If the
potential borrower is not creditworthy or it appears that he will not be able to repay the
loan, then credit should be denied. Where these types of decisions may be difficult but
manageable from a domestic perspective, they can be next to impossible from an
international viewpoint. So many variables are missing in the international arena, which
seem vital to domestic loan decision.
A financial institution wishing to lend internationally must analyze country risk
in order to readjust loan limits according to that risk and enable the bank to avoid costly
and lengthy debt reconstructing.
Country risk is the risk associated with those factors which determine or affect
a country’s ability and willingness to pay on schedule interest and amortization on its
external debt. More specifically, it is the credit risk of borrowers in a country as a whole
viewed from a specific country perspective. It differs from sovereign risk in that the
latter is the credit risk of a sovereign government as a borrower. Thus, country risk
analysis consists mainly of the assessment of the political and economic factors of a
borrowing country which may interrupt timely repayment of principal and interest.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 Country risk needs to be treated as a separate risk – different from the credit risk of
individual borrowers – because the borrowers don’t have control over these factors.
The country risk analysis results are used as pre-lending as well as post-lending
decision tools. Prior to lending, decisions such as whether or not to lend, how much to
lend, and how much risk premium it should charge, are based on the measured risk.
After lending, periodic country risk analysis serves as a monitoring device, providing a
pre-warning system. The result of the analysis is also used to determine the need for
bank loan portfolio adjustment and the discount prices of loans when they are sold in
the secondary market.
• Appetite for Risk
The first thing to know about risk appetite is that…it’s one of the first things that
you must determine. Why? Because determining risk appetite will help you
determine the amount of risk you’re willing to “live” with, and how much risk you need
to manage.
Risk appetite is the level of risk that an organization is willing to accept while
pursuing its objectives, and before any action is determined to be necessary in order to
reduce the risk. It is defined as the “amount and type of risk that an organization is
willing to pursue or retain.” Risk appetite allows organizations to determine how much
they are willing to take risks (including financial and operational impacts) in order to
innovate in pursuit of objectives.
Risk appetite can vary based on several factors, such as:
a. Industry
b. Company culture
c. Competitors
d. The nature of the objectives pursued (e.g., how aggressive they are), and
e. The financial strength and capabilities of the organization (i.e., the more
resources a company has, the more willing it may be to accept risks and the costs
associated to them).
It is also worth noting that risk appetite can change over time. It’s always a good
idea to assess risks against risk criteria periodically or continuously (e.g., once or twice
annually, or daily in specific risk scenarios), depending on the circumstances, available
resources, skills, technologies or systems.
Pursuing opportunities that have potential high rewards forces banks to take on
high risks. When setting the risk level that could be accepted, a bank will seek to balance
its loss potential with its profit potential. In this regard, banks will concern their
business activities with the allocation of time and resources to activities that minimize
risk exposure.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 They will consider whether they need to take any immediate action concerning
their risk exposure and rely on their formal response strategies to erode the impact of
the risk event. Finally, banks will rely on the history of the bank itself or the industry in
the country and throughout the world to evaluate options for reducing effects of risk
events.
When banks have a high-risk appetite, they advance more loans to borrowers.
Therefore, the indicators of a favorable economy for lending will also work as
indicators for increased risk appetite for banks. A growing economy provides citizens
with a variety of ways to earn money and pay back loans from banks.
In return, banks find it increasingly profitable to increase their loan offerings
because there are many people capable of repaying them back. When the favorable
environment for lending changes and banks realize that the credit worthiness of
its clients is plummeting, they reduce their lending activities.
However, the transition period could be hectic, and the bank could end up with
a large amount of non-performing loans on its asset books. Writing off the loans would
then expose the bank to losses, and they could lead to collapse of the bank when they
are too much.
• Ability and Willingness to Pay
When it comes time to apply for a loan it’s good to know what the lenders are
looking for. They want to make sure that the borrowers have the ability to repay their
loan and the willingness to use their resources to do so. Both factors are important to a
lender because money the borrowers do not pay back results in a loss for them.
Large losses mean less profit for the lender and low enough profits could mean
somebody is losing their job! Plus, every loss to a lender results in higher fees and rates
for those borrowers who do pay back their loans. Thus, lenders pay a lot of attention to
both the borrower’s ability and willingness to pay the loan back.
First, lenders want to make sure borrowers have the ability to pay back their
loan. You may be the most honest person on the planet. And you have every intention
of repaying your loan. And even more important, you can demonstrate your honesty to
the lender. However, if you have no income, then you are out of luck. Even in cases
where you can find a lender to loan you money, they will not lend you as much as you
want, and they will charge you much more interest on the amounts they do lend you.
Bottom line is that lenders make sure you have the ability to pay the loan back before
they are willing to lend you their money.
Likewise, you may make lots of money and definitely have the ability to repay
the loan with no problem at all. Now the lender makes sure you are willing to pay back
the loan. Not everyone who has money is responsible with it. Again, a lender
may decide not to lend to you or to lend to you at a higher interest rate if you have a
history of making late payments or missing them altogether.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 • Age of Credit History
Credit history is a record of a consumer's ability to repay debts
and demonstrated responsibility in repaying debts.
Age of credit history refers to the length of time you’ve been using credit. In
general, credit-scoring models — such as the FICO® and VantageScore® credit
scores
— look at the age of your oldest and newest accounts and the average age of all your
accounts to determine the impact that age of credit history will have on your credit
scores.
The length of your credit history, or how long you’ve been using credit,
typically accounts for 15 percent of your total credit score.
While it isn’t the most important factor used to calculate your credit score, the
length of your credit history does matter. Generally, the longer your credit history, the
better it is for your credit score.
What Is a Good Credit History Length?
Seven years is deemed a reasonable amount of time to establish a good
credit history. After seven years, most negative items will fall off your credit
report. However, the seven-year time period doesn’t guarantee your credit score
and credit history will improve.
If you continually pay your bills on time (and in full) each month and
reduce the amount you owe, your score may get the boost you need over time.
It helps to check your credit report regularly.
There’s also no set amount of time required to achieve a certain credit
score. Everyone has a unique financial situation, so the time it takes to boost
your credit score and build credit history will vary. However, because credit
history requires longevity, it does leave younger people at a natural
disadvantage.
How Long of a Credit History Do You Need?
Credit history is important to improve your chances for loan approval.
Lenders look closely at your credit history to determine how likely you are to
repay your loan on time.
Lenders are taking a risk on any individual who requests a loan. Your
credit history is the best indicator they have to assess your overall credit health
and reliability.
A longer credit history shows you have more experience using credit,
and this helps lenders be more accurate in the level of risk they take
when lending to you. If you have a history of on-time payments, it indicates
you’re likely to make your payments on time if extended credit.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 If you have no credit history, the lender has no real basis for the decision.
The catch is that you need a credit history in order to get credit or a loan. This
can make it difficult for first-time credit applicants to get approved for credit.
• Relationship with the Bank
The older your relationship with the bank, the higher are your chances of getting
the loan approved. Banks value their old customers due to familiarity with the financial
past. A person who has been with a bank for more than 10 years is definitely preferred
over the one with no previous relationship with the bank.
• Income and employment history
Lenders want to know that borrowers will be able to pay back what they borrow,
and as such, they need to see that a borrower have sufficient and consistent income. The
income requirements vary based on the amount a person borrows, but typically, if you're
borrowing more money, lenders will need to see a higher income to feel confident that
you can keep up with the payments.
As a borrower, you'll also need to be able to demonstrate steady employment.
Those who only work part of the year or self-employed individuals just getting their
careers started may have a harder time getting a loan than those who work year-round
for an established company.
• Debt-to-income ratio
Closely related to the borrower’s income is his/her debt-to-income ratio. This
looks at your monthly debt obligations as a percentage of your monthly income.
Lenders like to see a low debt-to-income ratio, and if your ratio is greater than 43% –
so your debt payments take up no more than 43% of your income – most lenders won’t
accept you.
You may still be able to get a loan with a debt-to-income ratio that's more than
this amount if your income is reasonably high and your credit is good, but some lenders
will turn you down rather than take the risk. Work to pay down your existing debt, if
you have any, and get your debt-to-income ratio down to less than 43% before applying
for a loan.
• Size of down payment
Some loans require a down payment and the size of your down payment
determines how much money you need to borrow. If, for example, you are buying a car,
paying more up front means you won't need to borrow as much from the bank. In some
cases, you can get a loan without a down payment or with a small down payment but
understand that you'll pay more in interest over the life of the loan if you go this route.
• Liquid Assets
Lenders like to see that you have some cash in a savings or money
market account, or assets that you can easily turn into cash above and beyond the money
you're using for your down payment.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 This reassures them that even if you experience a temporary setback, like the
loss of a job, you'll still be able to keep up with your payments until you get back on
your feet. If you don't have much cash saved up, you may have to pay a higher interest
rate.
• Loan term
Your financial circumstances may not change that much over the course of a
year or two, but over the course of 10 or more years, it's possible that your situation
could change a lot. Sometimes these changes are for the better, but if they're for the
worse, they could impact your ability to pay back your loan. Lenders will usually feel
more comfortable about lending you money for a shorter period of time because you're
more likely to be able to pay back the loan in the near future.
A shorter loan term will also save you more money because you'll pay interest
for fewer years. But you'll have a higher monthly payment, and so you must weigh this
when deciding which loan term is right for you.
• Credit Insurance
Credit insurance is protection against the risk that a customer would default on
a payment obligation. Insurance indemnifies the seller against the loss.
Coverage applies whether the default is caused by insolvency/bankruptcy,
political crisis (for exports), or simple unjustified slow payment.
Credit insurance is used to:

✓ Increase sales by encouraging the use of more competitive credit terms.

Insurance reduces the risk of loss, so lenders can be more aggressive using credit
to attract and retain customers.
✓ Obtain financing by adding insured receivables to a borrowing base. Most
banks will not permit receivables to be used as loan collateral without
insurance to back them up. This is particularly true with export transactions.
✓ Reduce the risks of extending credit. Insurance protects against a variety of
perils, including bankruptcy, protracted default (unwillingness to pay),
catastrophic situations, and political upheaval.
✓ Save time and money by replacing letters of credit with open account terms.
An insured open account sale is much safer than a letter of credit with an
unresolved discrepancy, and insurance usually costs far less than a letter of credit.
✓ Enhance a customer relationship by using open account credit terms to
signify trust in a customer’s willingness and ability to pay (even if you
ensure the receivable anyway, just in case your customer turns out to be a
problem!). The customer will not know of the insurance in most cases unless there
is a default, at which point the underwriter goes after them for the loss.
✓ Provide a structure and discipline for credit decision-making. Depending
on the program and the policyholder, credit insurance can impose a rigorous
discipline. This is particularly important when a company is growing quickly,
or when a credit manager is unfamiliar with an industry or region.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 Understanding the other factors that lenders consider when evaluating loan applications
can help a borrower increase his/her odds of success. If you think any of the above factors may
hurt your chance of approval, take steps to improve them before you apply.
• Age of credit and financial data used for credit scoring.
A credit score is one number that can cost or save you much money in your
lifetime. An excellent score can land you lower interest rates, meaning you will pay less
for any line of credit you take out. Nevertheless, it is up to you, the borrower, to make
sure your credit remains strong so you can have access to more opportunities to borrow
if you need to.
• Potential of the customer
When assessing the creditworthiness of a potential customer, there is a variety
of information sources available to the decision-maker (Genriha, & Voronova, 2012).
The actual decision environment and the information available will differ from
the various users. Thus, there are different methods of assessing the creditworthiness of
borrowers that include the 5C's, CAMPARI, 5P's, and the Financial Analysis and
Previous Experience Method.

According to Apostolik, Donohue & Went (2016), the 5C's of credit is

an approach of assessing creditworthiness using different factors categorized as
Capacity, which refers to borrower’s ability to generate enough funds to repay debts as
scheduled. Capital is the company's net worth (assets minus liabilities), which provides
a cushion to absorb operating and asset losses that might affect the repayment of debt.
Conditions refer to the economic and political conditions of the country that are
beyond the company’s control and can affect the industry and thus repayment.
Character is the desire of the borrower to repay its debt. Collateral refers to the security
provided by the borrower to support the repayment of a loan. The collateral may be an
existing asset of the borrowing firm, such as equipment, real estate, accounts receivable,
or inventories.
The CAMPARI model (Apostolik, Donohue & Went, 2016), on the other hand,
comprises of seven variables that are used in the credit decision-making process and
includes Character refers to the obligation of the borrower to repay; Ability to borrow
and repay; Margin to profit, the purpose of the loan; Amount of the loan; Repayment
terms and Insurance against non-repayment such as security. Whereas the 5P’s,
developed by the Federal Reserve Centre, comprises of People (the borrower’s
commitment to repay the debt), Purpose (reasons for the loan), payment (the structure
of the repayment loans), Protection (collateral), and Prospective (loan supervision).
In addition, the Financial Analysis and Previous Experience Methods analyses
the financial records of the applicants such as balance sheets, income statement, and the
source and application of funds (Allen & Powell, 2011). The purpose is to refine and
translate the reported financial data and convert it into measures such as ratios that can
be used to construct a profile of the company, which in turn can be compared with other
companies in the same line of business to determine any trends.

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 • Competitor’s action.
• Notes to financial statements.
• News reports, periodical articles, etc.

• Weather patterns.
• Credit insurance.

CREDIT LIMITS
• The term credit limit refers to the maximum amount of credit a
financial institution extends to a client.
• Credit limit is the maximum outstanding balance a borrower can have on a
credit card or line of credit without being penalized.
✓ Line of Credit (LOC): a flexible loan or the preset amount of money
that a financial institution like a bank or credit union has agreed to
lend the borrower.
• A credit limit is a factor that affects consumers' credit scores and can impact
their ability to obtain credit in the future.
• The size of your credit limit affects the purchasing power you have with your
credit card — the larger your credit limit is, the more you can purchase.
How Does a Credit Limit Works?
After a financial institution has approved an applicant's request for a credit card
or another type of revolving credit, the lender will decide on the maximum amount of credit it's
willing to extend to that person – credit limit.
A credit limit is based on several factors that influence a borrower's ability to repay.
Generally, the applicant's credit score, income and job stability, are the main factors considered
in determining an appropriate credit limit. If you have a history of late payments or a significant
amount of debt compared to your income, you may be approved for a low credit limit to start
and vice versa.
For example, let's assume you go to Bank ABC and apply for a credit card. After being
approved, Bank ABC puts a credit limit of $10,000 on your new credit card after reviewing
your credit score, income level and the length of time you've stayed at your current job. This
means that you may potentially charge up to a $10,000 on the card.
Limits can be set for both unsecured credit and secured credit.

✓ Unsecured Loan: Unsecured loans or lines of credit (LOC) are loans where
lending happens without the backing of equal value collateral.
✓ Secured Loan: A secured credit card is a type of credit card that is backed
by a cash deposit from the cardholder.

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 Unsecured credit with limits is often in the form of credit cards and unsecured lines of
credit. If the line of credit is secured—backed by collateral—the lender takes the value of the
collateral into account. For example, if someone takes out a home equity line of credit, the credit
limit varies based on the equity in the borrower's home.
Lenders will not issue a high credit limit for someone who won't be able to pay it back.
If a consumer has a high credit limit, it means a creditor considers the borrower to be a low-
risk borrower. That borrower has greater capacity to spend with a higher credit limit.
However, it is also worth noting that high credit limits may be troublesome as
overspending may mean that the borrower cannot meet their monthly payments.
Importance of Credit Limits.
A credit limit works the same way regardless of whether the borrower has a credit card
or a line of credit. Generally, you will be granted a larger credit limit if you have a larger
income, stable job and good credit score. But if you exceed the credit limit on your card or loan,
you may be charged penalties and fees by the bank, and you may have your credit limit reduced.

✓ Penalty Rate: a higher interest rate that the card issuer can charge in specific
circumstances.
Your credit limit also impacts your credit score. Your credit limit and card balance are
reported to the credit bureaus each month. This information is used to calculate your credit
utilization, which measures the amount of your credit limit that's being used. It counts for as
much as 30% of your credit score.
The higher your credit card balance is relative to your credit limit, the higher your credit
utilization will be. This brings your credit score down, making it harder to qualify for loans and
credit. Card issuers may also deny credit limit increases if you have a high credit card balance.
It's best to keep your credit card balances less than 30% of your credit limit to achieve the best
credit score.
Imposing credit limits could be a service to buyers on credit since it could prevent them
from falling hopelessly into huge debts that they may not be able to pay regardless of the means
they employ to weed themselves out of such a precarious predicament. In other words, the
creditors may be doing them a favor which at the moment they do not realize. As one
businessman sadly remarked, it is oftentimes the liberality with which companies grant credit
that pushed them into economic difficulties if not ruin.
In a number of cases, the liberal treatment accorded them by grantors of credit have
worked against their interest because of its undue influence on over expansion of business.
Credit limits work as bars to over expansion of business. Hence, their importance and necessity.

Types of Credit Limits

In studying credit management, two types of credit limits may be noted: quantitative
credit limits and temporal credit limits. Both have their importance in granting credit.

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 By quantitative credit limits is meant the maximum amount of credit which may be
permitted to remain outstanding on account. The amount is determined by a proper analysis of
the C's of credit which cannot be exceeded.
On the other hand, instead of imposing a maximum ceiling on the amount of credit
which a debtor may be able to obtain and use, temporal credit limits impose certain
requirements which a borrower or prospective debtor must comply before he could be granted
credit. This temporal credit limits may be defined as simply "that type of credit which does not
indicate the maximum amount that an individual or business firm can obtain from the creditor-
granting company as long as the debtor is able to fully comply with conditions set."
Can Lenders Change Credit Limits?
In most cases, lenders reserve the right to change credit limits. The credit limits on your
existing credit cards and loans may change depending on the bank's circumstances or on your
actions. For example, if a borrower pays their bills on time every month and does not max out
the credit card or line of credit, a lender may increase the line of credit, which has a number of
benefits. These include increasing the borrower's overall credit score and accessing more and
cheaper credit.
In contrast, if the borrower fails to make repayments, or if there are other signs of risk,
the lender may opt to reduce the credit limit. A reduction of the borrower's credit limit increases
the balance-to-limit ratio. The bigger the ratio – which means you're using up more of your
credit limit – the worse it is for your credit score. If the borrower is using a lot of their credit,
they become a higher risk to current and future lenders.
✓ Balance-to-limit Ratio also known as credit utilization ratio, it is a comparison
of the amount of credit being used to the total credit available to a borrower.
This rate tells potential lenders how much debt someone is carrying and how
much available credit they are using.

Factors That Affect Your Credit Limit

• The Type of Credit Card
Think of credit cards as a product with predefined features. Like the interest rate
and fees, credit limits are another predefined feature. How credit limit is set depends on
the credit card.
Some credit cards have a specific credit limit, $1,000 for example, that every
approved cardholder receives, regardless of other factors. Other credit cards have
a credit limit rate and approved cardholders are assigned a credit limit within that range.
For example, possible credit limits for a particular card may fall between $5,000 and
$10,000. The well-qualified applications will be approved for a credit limit on
the higher end of the range.
It would be nice if they did, but credit card issuers don't publish the credit limits
for credit cards. If you poke around popular credit card review websites, you may find
user-submitted information about credit limits for various credit cards.

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 • Your Income
The amount of money you make generally affects the amount you can afford to
pay. While you have a better chance of getting approved for a higher credit limit if you
have a high income, there's no guarantee your income will get you a high credit limit.
Other factors, like the type of credit card, still come into play
• Your Debt-to-Income Ratio
Using the information from your credit report and credit card application, the
credit card issuer will be able to estimate your debt-to-income ratio. This ratio may
affect the credit limit you receive on your credit card. It means that a high income offset
by high debt payments could result in a lower credit limit than if you were spending less
money on monthly debt payments.
• Your Credit History
How you've handled credit limits on your other credit cards will not only affect
whether you get approved for a new credit card but also the credit limits you'll
be approved for. Late payments, high balances, and other negative information make it
less likely that you'll be approved for a high credit limit.
• Limits on Other Credit Cards
Credit card issuers may take their cues from the other credit cards you have. If
your credit report shows that you have high credit limits on your other credit cards, you
have a better chance of being approved for a high credit limit on a new credit card. On
the other hand, if you've typically had $500 and $1,000 credit limits, it's unlikely that
you'll be approved for a $10,000 credit limit right away.
• Co-Applicant Income and Credit Information
If you're applying jointly with another person, the credit card issuer will
consider both of your incomes and credit qualifications to set your credit limit.
Bank balances and other assets generally do not affect your credit limit, unless
you're offering money as collateral to secure the credit line as with a secured credit card.
Knowing the factors that credit card issuers use to set credit limits, you're more
likely to receive a low credit limit if your income is low, you have a high debt-to-income
ratio, you're just starting out with credit or are rebuilding your credit history, or the limits
on your other credit cards are low.
When Do You Find Out Your Limit?
Even the timing of finding out your credit limit is totally dependent on the credit card
issuer. You may find out your credit limit at the same time you're approved, or you may not
learn until you receive your new card in the mail.
That means you can't make any concrete plans for using your credit card until you know
for certain what your credit limit will be.

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Getting a Higher Spending Amount
You're not necessarily stuck with the credit limit you start out with. After several
months of using your credit card responsibly, your credit card issuer may automatically raise
your credit limit. For the best chance at getting an automatic credit limit increase, use your
credit card, don't max it out, and pay all or at least most of your bill each month.
Not all credit card issuers automatically increase credit limits. You may have to request
a credit limit increase for a bigger credit limit. It's pretty simple and quick to request a credit
limit increase — just log into your online account or call your credit card's customer service
number. You may have to update your income or provide a specific credit limit amount you'd
like to receive. The credit card issuer will process your request and let you know whether your
credit limit increase request has been approved.
If your credit limit increase isn't approved, your credit card issuer will most likely send
an email or letter letting you know the reasons you weren't approved. If your credit score played
a factor in the decision, you may receive a free copy of the score that was used and any factors
that influenced your score. If your credit report was used, you'll receive information about
ordering a free copy of the credit report that was used in the decision.
If you want to know the pros and cons of raising the credit limit, please watch this video
from YouTube. (8) PROS & CONS OF RAISING YOUR CREDIT LIMIT - YouTube

Implementing Credit Limit Decisions

Credit limits serve a variety of purposes: as a guideline for order approval, to minimize
the upward spiral of orders, and to call immediate attention to any change in a customer's
purchasing or payment behavior. Any order that does not exceed the limit can be approved
without further investigation or analysis. Orders exceeding the limit signal the need for
examination of the account and may lead to holding shipments to the customer until the over-
limit situation has been resolved.

Some companies would rather not establish a firm credit limit, opting instead for a
flexible limit based on previous experience with the account. Flexible limits have the advantage
of being easy to implement with little impact on the customer and the sales department. Unless
payments are not made on time, there may be little need for further involvement at the credit
department level.

Those who favor a more formal system of establishing credit limits point out that the
account may become overvalued quickly. Prompt payments initially are not necessarily
indicative of future payment trends. A formal analysis might set a credit limit high enough to
eliminate the need for a review every time a new order is received. However, after a period of
time, the credit limit may simply become a matter of course, meaning that any order
the customer places is approved. This basis for credit decisions should be reserved for only very
substantial and financially sound customers.

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 An order limit specifies the peso amount that may be released without delay on any
single order. It differs from a credit limit, which is established without regard to the size of any
particular order and is generally set at an amount that can be justified by the available credit
information. Some companies place an order limit on every account. This usually serves as a
secondary credit check, so the customer’s file is reviewed when either the credit limit or order
limit is exceeded. An order limit may be particularly useful in a decentralized credit
organization where it is impractical for order processing points to keep complete records of
receivables. One variation of the credit limit is based upon the amount that the creditor
is willing to have outstanding at any time. This method requires complete records of
unpaid invoices and of orders approved but not yet shipped. When the total outstanding
balance exceeds the limit, any further orders are referred for approval.

Informing Customers of Credit Limits

There is considerable debate about whether to inform customers of their credit limits.
There is no law or regulation that requires such compliance. Of course, a credit grantor cannot
discriminate when approving credit, and certain rules apply whenever an adverse action
is taken, either upon approval or after the account has been established. Review the Equal Credit
Opportunity Act (ECOA) rules when facing these circumstances. In some companies, the credit
limit is the maximum amount that will be shipped to the customer before initiating a review of
the credit file for that customer. In other companies, it is simply the maximum amount that will
be shipped to the customer before that amount is paid down or paid in full. The definition
depends on the creditor’s policy regarding credit extension. There are distinct advantages and
disadvantages of advising customers of credit limits. The decision to advise or not to advise is
dependent on each creditor’s company policy and management philosophy.
Here are some advantages and disadvantages to consider:
Advantages
• Opportunity to discuss and possibly adjust the limit in order to sell more.
• Opens discussion about payment expectations and to obtain more information.
• Reduces embarrassment of holding orders when/if a customer is over the limit.
• Creates a chance to help a marginal customer become more solvent.

Disadvantages
• Possibly damages goodwill.
• May restrict purchases to the credit limit imposed.
• Customer may be offended/insulted by what it perceives to be an insufficient credit
limit.
• Raises questions as to how or why the credit limit was determined.

Exceeded Credit Limit

Orders that exceed the customer’s credit limit require a review to determine whether the
customer will pay and when it will do so. The credit professional will need financial and
background material that justifies additional credit. Answers must be obtained to such
questions as:

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• Do current liabilities exceed current assets on the customer’s balance sheet?
• Are trade payments prompt?
• What is the experience of other suppliers on the risk?
• Are other suppliers placing undisputed claims for collection?
• Is there any evidence of careless or unreliable performance by the customer?
If satisfactory answers to these questions cannot be obtained, it may be possible to work
out collateral security or other special arrangements to reduce or eliminating the credit risk.
However, if the available information indicates the ability to pay but not within terms, the
question is whether the additional cost of the expected delinquency will make the receivable
unprofitable.

CREDIT CONTROL
• Credit control, also called credit policy, includes the strategies employed by
businesses to accelerate sales of products or services through the extension of
credit to potential customers or clients.
• Likewise, it is the lending strategy used by businesses and central banks to
make sure that credit is given only to borrowers who are likely to be able to
repay it.
• In simple terms, it is a lending strategy that banks, and financial institutions
employ to lend money to customers.
• Credit control might also be called credit management, depending on the
scenario under review.
• At its most basic level, businesses prefer to extend credit to those with “good”
credit as those customers with a good credit report generally have an excellent
track record of repaying their debt. This allows lenders to bring down the risk
of defaults when issuing a new line of credit to customers. On the other hand,
limit credit is given to those with “weak” credit, or possibly even a history of
delinquency.

Understanding Credit Control

A business's success or failure primarily depends on the demand for products or
services. As a rule of thumb, higher sales lead to bigger profits, which in turn leads to higher
stock prices. Sales, a clear metric in generating business success, in turn, depends on several
factors.
Some, like the health of the economy, are exogenous, or out of the company’s control,
other factors are under a company’s control. These major controllable factors include sales
prices, product quality, advertising, and the firm’s control of credit through its credit policy.

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 In general, credit control seeks to extend credit to a customer to make it easier for them
to purchase a good or service. This strategy delays payment for the customer, making
the purchase more attractive, or it breaks the purchase price into installments, also making it
easier for a customer to justify the purchase, though interest charges will increase the overall
cost.
The benefit for the business is increased sales which leads to increased profits. The
important aspect of a credit control policy, however, is determining who to extend credit to.
Extending credit to individuals with a poor credit history can result in not being paid for the
good or service sold. Depending on the business and the amount of bad credit extended, this
can adversely impact a business in a serious way. Businesses must determine what kind of credit
control policy they are willing and able to implement.
Credit control helps banks and financial institutions to recognize delinquent customers
with a poor credit report and ensure that such borrowers are extended a line of credit. This can
eventually help the lenders ensure to minimize the customers’ probability of not repaying them
debt on time and increase profitable lending.
Credit Control Policies
A company can decide on the type of policy it wishes to implement when drafting its
credit control policy. The options typically include three levels: restrictive, moderate,
and liberal.

✓ A restrictive policy is a low-risk strategy, limiting credit only to customers

with a strong credit history.
✓ A moderate policy is a middle-of-the-road risk strategy that takes on more
risk.
✓ While a liberal credit control policy is a high-risk strategy where the
company extends credit to most customers.
Businesses that aim to gain higher levels of market share or that have high-profit
margins are typically comfortable with liberal credit control policies. This also applies
to companies that have a monopoly in their industry so that they can hold onto the monopoly.
That said, if the monopoly is firmly rooted, the firm may be inclined to adopt a restrictive policy,
given the low threat of entrants to the market. A firm in this enviable position does not need to
worry much about upsetting its customer base.

Credit Control Factors

Credit policy or credit control, primarily focuses on the four following factors:
• Credit Period
Length of time that is given by the lender to the borrower to pay off the amount
of the product that the borrower has purchased from the lender.

• Cash Discounts
Some businesses offer a percentage reduction of discount from the sales price if
the purchaser pays in cash before the end of the discount period. Cash discounts
present purchasers an incentive to pay in cash more quickly.

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 • Credit Standards
Includes the required financial strength a customer must possess to qualify for
credit. Lower credit standards boost sales but also increase bad debts. Many consumer
credit applications use a FICO score as a barometer of creditworthiness.

• Collection Policies

Collection policy involves the methods adopted by the organizations for

the recovery of accounts receivable. It also prescribes the late fees, interest, and
other charges payable if the payment is delayed. Also, these measure the aggressiveness
in attempting to collect slow or late paying accounts. A tougher policy may speed
up collections but could also anger a customer and drive them to take their business to
a competitor.

A credit manager or credit committee for certain businesses are usually responsible for
administering credit policies. Often accounting, finance, operations, and sales managers come
together to balance the above credit controls, in hopes of stimulating business with sales on
credit, but without hurting future results with the need for bad debt write-offs.

Who Use Credit Control?

Banks, financial institutions, retailers, and manufacturers use this strategy to ensure
profitable lending and lend to only those customers who have a high probability of repaying
their debt. The risk committee of the company monitors credit control to minimize losses due
to poor loans. Credit control is also referred to as control management among the lenders.

In many companies, the treasurer has direct control over the credit policy and, indeed,
over the entire credit granting function. This is a wise placement of responsibility, since the
treasurer can now see both sides of the credit policy-both the resulting change in sales and the
offsetting change in required working capital funds.
The treasurer can set up a considerable number of credit controls to reduce the
probability of default by customers. Here are some possibilities:
• Issue credit based on credit scoring. There are several credit-monitoring services,
such as Experian and Dun & Bradstreet, which provide online credit scores on most larger
businesses. The treasury staff can create a credit-granting model that is based on a mix of the
credit scores of these services, the company's history with each customer, and the amount of
credit requested.
• After payment terms. If a customer requests an inordinate amount of credit, it may be
possible to alter the payment terms to accommodate the customer while still reducing the level
of credit risk. For example, one-half of a sale can be made with 15-day payment terms, with the
remainder of the order to be shipped upon receipt of payment for the first half of the order. This
results in payment of the total order in 30 days, but with half the risk.
• Offer financing by a third party. If the treasury department is unwilling to extend
credit, then perhaps a third party is willing to do so. This can be a leasing company or perhaps
even a distributor with a loose credit policy.

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 • Reque guarantees. There are variety of possible payment guarantees that can
be extracted from a customer, such as a personal guarantee by an owner, a guarantee by a
corporate parent, or a letter of credit from a bank.
• Perfect a security interest in goods sold. It may be possible to create a
Security agreement with a customer in which the goods being sold are listed, which the
company then files in the jurisdiction, where the goods reside. This gives the company a senior
position ahead of general creditors in the event of default by the customer.
• Obtain credit insurance. Credit insurance is a guarantee by a third party against
nonpayment by a customer. It can be used for both domestic and international receivables. The
cost of credit insurance can exceed one-half percent of the invoiced amount, with higher costs
for riskier customers and substantially lower rates for customers who are considered to be in
excellent financial condition.
• Require a credit reexamination upon an initiating event. The treasury staff should
review customer credit at regular intervals to see if they still deserve existing credit limits. These
reviews can be triggered when the current credit limit is exceeded, if a customer places an order
after a long interval of inactivity, if there is an unjustified late payment, or if a customer stops
taking early payment discounts.
An active treasury staff that manages the credit function can use the preceding list of
credit practices to retain the appropriate level of control where accounts receivable and the
corresponding amount of working capital funding.
Why is Credit Control Important?
Credit control plays an important role when it comes to maintaining lending
companies’
cash flows.
Consider an instance where a lender takes an uncoordinated decision and loans credit to
a borrower with a poor credit record. Chances are the borrower is likely to miss out or delay the
payments with respect to the past credit record.
If this continues on a wider scale where the borrower is unable to repay the debt and
default on the payments, the lender could eventually end up with inadequate liquidity and in the
worst-case scenario might have to shut down its operations.
Credit control ensures that only prospective customers who have a good credit history
of making their debt repayments are preferred. This will ensure that the company will have
enough cash flow and liquidity to maintain its operations.
Tips for Effective Credit Control
Cash flow is the very lifeblood of a business. In this regard, each business should
consider whether it is doing everything it can to ensure that its customers are paying on time.
Furthermore, the recovery of business debt can be frustrating, time consuming and often
unsuccessful.
It is better to put in place proper procedures, which enable the early identification of
potential bad debts. Key to getting paid on time is having an effective credit management
policy.

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 Setting a Credit Management Policy
When a company sets a credit policy, there are several factors which it needs to
consider. One of the more important factors to consider is the level of profitability
inherent in each sale.
Companies that have a low gross profit margin, such as livestock exporters,
cannot afford significant bad debts, and thus they need to have a vigorous risk
assessment regime in place. Companies with high gross profit margins, such as
software companies, can afford a more relaxed approach to risk assessment.
Another factor for a company to consider is if it has a “monopoly” product/service or a
“commodity” type product/service. Monopoly suppliers are in a better position to dictate terms
and conditions of trade than a commodity supplier.
Below is a checklist that highlights “Best Practice” tips for more effective Credit
Control. Whilst by no means exhaustive, it will help you to re-examine your own company’s
procedures and practices and identify any deficiencies that exist.
• Order Stage
1. Ensure sales staffs are familiar with company’s credit policy.
2. Use a credit application form.
3. Make a credit check on each new customer (bank references –v/s- trade
references v/s Management accounts). This can be as simple as downloading
recent accounts from the Companies Registration Office.
4. Obtain a personal guarantee from “doubtful” customers.
5. Set a “minimum order” level for credit sales. It is important to remember that
there is a cost involved in setting up a credit account
6. Decide which customers will receive credit – credit is not an automatic
entitlement.
7. Assess if you need credit insurance.
8. Set a credit limit for each new customer. (There are two aspects to consider your
company’s exposure to bad debts and you credit control)
9. Conduct regular credit checks on your main customers.
10. Use fully documented Terms of Trade.
11. Ensure Terms of Trade include a Retention of Title Clause. Have this drafted
by a solicitor familiar with your business.
12. Ensure your Terms of Trade allow you to charge interest on Late Payment.
13. Ensure your Terms of Trade have procedures to deal with disputes.
14. Ensure your Terms of Trade specify Credit Terms. Best terms are 30 days
from date of invoice – not 30 days from end of month.

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 15. Agree the payment terms in writing.
16. Give each customer a unique account number.
17. Confirm the following details:
✓ Identify the company you are trading with.
✓ Name of person within the company to contact over payment.
✓ Contact address.
✓ Phone/Fax/Mobile numbers/e-mail addresses.
✓ Company VAT number.
✓ Company registration number (if a limited company).
18. Record the date when payments are due.
19. Find out when your customers normally pay their bills. Do not be caught out
by the old chestnut ‘our computer run is on….”
20. Specify the most appropriate payment method:
check/electronic payment/credit.
• Invoicing
1. Check the accuracy of all invoices sent out.
2. Include the following on all invoices:
✓ Your bank details.
✓ Terms and conditions of sale.
✓ Name of the organization you are trading with.
✓ Address for payment.
✓ Order number.
✓ Order description.
✓ Delivery date.
✓ Unit price.
✓ VAT number, amount and rate.
✓ Total amount due.
✓ Due date for payment.
✓ Payment terms.
✓ Discounts given.
3. Issue an invoice within 24 hours of delivery of the goods or services.
4. Check that your delivery is in line with the order to avoid invoice disputes.
5. Confirm receipt of invoice for large accounts.
6. Issue monthly Statements of account showing invoices paid and
still outstanding.
• Collection
1. Divide your customers into Good, Average and Bad, and set a Collection
Policy for each category.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
 2. Properly allocate payments against specific unpaid invoices.
3. Phone major accounts before the due date of payment to ensure there are no
disputes and that the way is clear for payment to be made on time.
4. Chase overdue payments within a week of them being due.
5. Conduct an aged debt analysis each week.
6. Prioritize your collection activity and chase the highest values first.
7. Levy a charge for “bounced checks/direct debits”.
8. Use a set policy for further chasing, for example, standard letters, calls, and
faxes, visits referring to Solicitors or a Debt Collection Agency.
• Recovery
1. Consider stop supplying when payment has not been made by a set time past
the due date. Have a different stop policy for different categories of customers.
2. Put the matter in the hands of a Solicitor or Debt Collection Agency.
3. Pursue the claim through the Courts.
• Management
1. Have documented procedures including timescales for handling and resolving
disputes.
2. Establish a system for measuring the success of your credit control function.
Establish “tight but attainable” targets. Best measurement is Days Sales
Outstanding (D.S.O.)
3. Have a regular monthly review to identify problem accounts and define courses
of action.
4. Have regular meetings with your sales team.
5. Ensure your staffs are well trained, e.g.: trained to prepare, listen, question,
persuade and negotiate.

To conclude, credit control is the system used by a business to make certain that it gives
credit only to customers who are able to pay, and that customers pay on time. Credit control is
a critical part of a well-managed business as it helps the firm in managing the cash flow, and
ensuring it runs smoothly and profitably.

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
REFERENCES

Apolo, Jose T. Credit and Collection Management in the Philippine Setting. National
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Bigler, T., & Parthasarathy, A. (1987). Country Risk Assessment in International Lending.
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Bragg, Steven M. Treasury Management, The Practitioner’s Guide. John Wiley & Sons, Inc.,
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Bragg, S. (2020, December 12). Credit analysis definition. Accounting Tools.

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Brian Jung. (2019, March 8). PROS & CONS OF RAISING YOUR CREDIT LIMIT.
YouTube. https://www.youtube.com/watch?v=2-UgXCxXeHw

Brozic, J. (2020, November 21). How does age of credit history affect credit scores? Credit
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CFI Education Inc. (n.d.-a). What is credit risk? Corporate Finance Institute. Retrieved from
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CFI Education Inc. (n.d.-b). What is the credit analysis process? Corporate Finance Institute.
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Chapter 13: Making credit decisions. (n.d.). In Making Credit Decisions (pp. 13-1-13–20).
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Credit Analysis Process - Overview and Evaluation Stages.

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process/

Credit insurance overview. (2010). Export Risk Management, Inc.

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Hagen, K. (2020, January 29). 7 factors lenders look at when considering your loan
application. The Motley Fool. https://www.fool.com/the-ascent/personal-
loans/articles/7-factors-lenders-look-considering-your-loan-application/

Kagan, J. (2020, October 20). Credit limit definition. Investopedia.

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Kenton, W. (2020, October 23). Credit Control. Investopedia.

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Irby, L. (2020, October 15). What is a credit limit? The Balance.

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CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD
Manoukian, J. (2020, July 15). Risk Appetite and Risk Tolerance: What’s the Difference?
Enablon®. https://enablon.com/blog/risk-appetite-and-risk-tolerance-whats-the-
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Miranda, Gregorio S. Credit and Collections 4th Ed. National Bookstore, 2002.

T. (2016, May 2). The Five Things Lenders Look at to Approve a Loan.
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13 Making Credit Decisions - NACM.

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Credit Control - Definition, Understanding, and Why Credit ....

https://cleartax.in/g/terms/credit-control

Acknowledgement to the following:

Donabelle S. Santiago FM 3-1

Racyl Joyce R. Tobias FM 3-2

Jon Ehroin L. Barawid FM 3-3

Angelika S. Santos FM 3-4

CMCP Adviser: Prof. Ragrciel Grafil Manalo FOR CLASSROOM AND READING PURPOSES ONLY
AND STRICTLY NOT FOR PUBLIC UPLOAD