Chapter II

Types And Classification of Credit

Learning Outcomes:
At the end of the chapter, the students are expected to:
1. Relate the different types of credit
2. Critique each type of credit; and
3. Appraise the different classifications of credit.
Lesson Proper:
What are the types of credit? Why are there numerous types and classifications of credit?
Credit is divided into various categories based on its intended use. In the modern era, the types
and classifications of credit continue to expand because individuals are broadening their
perspective in terms of how credit can be utilized to foster personal and economic growth.
TYPES OF CREDIT
Personal credit, retail credit, commercial credit, investment credit, and bank credit are the
various types of credit, depending on their intended use. Agricultural credit, export credit,
government credit, factoring, and open market credit are further types of credit.
Personal Credit is availed to satisfy personal necessities or desires. It is subdivided into service
credit, retail credit, and personal loan credit.
Service credit is credit acquired via the use of professional services, such as those of doctors,
lawyers, and accountants. They charge their clients for the delivered service. In contrast, retail
credit is received from retail establishments such as sari-sari stores. A student will purchase one
can of food on credit from a sari-sari store for insurance purposes, with payment due the
following week. Yet, if a person uses a loan to purchase things, this is known as a personal loan
credit. Money is typically obtained from individual moneylenders and financial institutions in the
form of cash. A businessman, for instance, obtains a loan from a Bombay. Service credit and
retail credit do not require interest payments, unlike personal loan credit, which requires interest
payments in addition to the principal amount. The interest is payable by the debtor.
Three Categories of Personal Credit
Charge Account
Charge account is the simplest and most traditional form of consumer credit. It is easiest due to
the fact that one may simply go to the sari-sari store and charge credit purchases to his account.
This method of purchasing is known as "listahan" or "pakilistanga" in the Philippines. This is
also known as the open book account.
With a charge account, the debtor is billed for the products bought on credit, with payment due
between 15 to 20 days of billing. In practice, however, creditors do not supervise billing because
they only provide verbal reminders to debtors.
Revolving Credit
In the case of revolving credit, the credit is not completely repaid within a single time. The
money will be made in installments. A credit card is an example of a revolving credit line. The
granting of credit enhances the company's sales volume. The cardholder can purchase up to a
specified number of products, which are then repaid in equal installments. In the event of default
on a single installment payment, a penalty equal to 5% of the amount to be collected will be
assessed. SM, Citibank, and BPI are among the Philippines' providers of revolving credit.
Installment Plan
Similar to a revolving line of credit where the payment is divided into equal installments. With
the installment plan, however, a down payment is required upon delivery of the products.
Typically, this applies to durable items. The payment duration could be anything from 12 and 36
months, depending on the debtor's ability to pay and the term selected by the debtor. It should
also be mentioned that the longer the debtor chooses to pay, the greater the sum that must be
paid.
Benefits of Installment Purchasing
Installment purchasing has numerous benefits, particularly for the buyer. Initially, the purchaser
is able to obtain the usage of the items he requires before he is able to save enough money to
cover the total purchase price. So, even without cash, one can enjoy the item purchased on
account. Moreover, installment purchasing might be considered a kind of savings. Why invest in
savings? Due to the fact that the debtor is required to set aside a percentage of his wage or
income as payment for the obligation until it is settled in full. Therefore, installment is not only
practical but also essential. People with limited purchasing power are compelled to purchase on
an installment plan, which is their only means of enjoying an abundance of necessary products.
Also, many items purchased on an installment plan "pay for themselves." This is known as a loan
for liquidation. Example: financing the purchase of a refrigerator for use in an ice candy
business. Profits from the ice candy business will be utilized to settle the debt. Lastly, installment
purchasing allows families to spread out their spending. How so? Under an installment plan, only
a percentage of the period's income or wage will be utilized. The remainder will be utilized to
pay for additional family expenses. Consequently, the funds are utilized for multiple purposes.
Installment purchasing has its own disadvantages, so it should be utilized with carefulness. For
one, installment purchases are more expensive than cash purchases. Comparing things obtained
on a cash basis and on an installment plan reveals a significant difference in the amount to be
paid. Often, things purchased on an installment plan are more expensive than those purchased for
cash. The additional amount on the installment plan is used to cover the costs of collecting the
regular payment and to defer the use of the funds from the sale of the products. Also, because
some individuals do not know what to buy or not to buy, they collect liabilities that may be
difficult to satisfy. Even if the item being given is unnecessary, people are enticed to purchase
more when it is available on a payment plan. This is due to the belief among purchasers that the
payment will be broken up into minimal installments equal to a small fraction of their monthly
income. They are unaware that their obligations are accumulating while they continue to utilize
the payment plan. In conclusion, individuals may be persuaded to purchase items that they do not
actually require, resulting in their inability to purchase their true necessities. Moreover, the
classification of a good as a need or want is ignored. We have heard stories of housewives who
prioritized purchasing Tupperware and other cookware on installment to stock their cabinets.
Unbeknownst to them, they are already jeopardizing the family's essential requirements.
Retail Credit and Commercial Credit
Retail Credit
Retail credit refers to the buying of merchandise on account for resale. This occurs when a sari-
sari store owner purchases inventory from a wholesaler on account. This sort of loan enables
shops with low resources to offer consumers a diverse selection of goods despite having limited
inventory.
Commercial Credit
Credit commercial is sometimes referred to as mercantile credit and commerce credit. This is a
business credit granted from one businessman to another. It streamlines the flow of merchandise
from manufacture to distribution. A manufacturer offers credit to a wholesaler, who then extends
credit to a store. Because it comes in the form of goods, this is also known as trade credits. A
party might be both the debtor and the creditor in this credit transaction. For instance, a
wholesaler becomes a debtor when he acquires items on credit for resale to retailers. If he sells
the items on account to merchants, he becomes the creditor.
Term of Sale
This is the premise upon which the credit relationship concludes in both commercial and retail
credit. This elucidates the relationship between creditor and debtor. Others referred to this as the
payment terms. When a grocery shop owner purchases merchandise from a wholesaler, he is
concerned with the terms of sale. This indicates that he is interested in whether or not he can buy
the items on credit, the length of time required to pay for the goods, and whether or not he is
eligible for a discount if the goods must be purchased with cash. It encompasses two essential
elements in the commercial sector: the credit duration and cash discounts.
Credit Period
Credit term refers to the time frame within which credit is given. This may vary based on the
nature of the product involved, the rate of stock turnover, the location of the customer,
competitive conditions, the nature of the credit risk, the stages of the business cycle, the types of
customers, regional differences, and the attitude of the credit manager and the seller's policy. If
the goods involved are perishable, such as expensive vegetables, the credit period is shorter than
if the goods are highly industrialized, such as expensive medical equipment/ if the product can be
easily disposed of, such as basic commodities, it typically requires a shorter credit period due to
its ability to be easily converted to cash, in contrast to automobiles and heavy machinery, where
sales are infrequent. It takes time for payments to reach the location of the other party, so the
location of the consumer also impacts the credit term. But, with the assistance of e-banking,
payment is simplified and in real time. In accordance with the nature of credit risk, if the creditor
anticipates a larger credit risk, the credit period must be shorter. Why? Because extending the
credit time will increase the associated risk. For lending firms such as financial institutions, there
is also a credit policy that details the credit period associated with each loan that is accepted.
Often, the credit period varies dependent on the business's objectives and priorities.
Classification of Sales Term
There are various classifications of sales terms based on the desires of both parties, including
cash prepayment terms, cash terms, and standard terms.
Cash Prepayment terms
There are numerous payment methods available for transactions. It may be provided either
before or during the delivery of the purchased goods. This is the term for monetary prepayment.
This can be accomplished in two ways: cash on delivery or cash before delivery.
Cash Before Delivery (CBD)
Cash on delivery is often referred to as cash in advance (CIA). This is offered by a seller
who does not wish to extend credit. This is advantageous for the seller since he will not
be responsible for credit risk and he may use the cash advance to manufacture the desired
product. On the other side, the buyer may be at risk for non-delivery of the purchased
goods, items that do not meet the agreed-upon requirements, and delivery delays.
Cash on Delivery (COD)
In cash on delivery, the payment is made when the items are delivered. Consequently,
there is an exchange of products and payment. Nonetheless, the seller may be responsible
for the cost of shipping the items to the buyer and the return of products if the customer
refuses to accept them.
Cash Basis
Cash terms are given to buyers who are able to pay for the items quickly, typically within
one- or two-weeks following delivery. The payment for the items is as good as cash,
meaning that there is no additional fee, as there is when the things are obtained on credit.
Credit is involved due to the delay between delivery and final payment for the products.
As an illustration, while purchasing a large quantity of books from corporate agents, the
agent provides purchasers with other options due to the high cost of the books. One of the
offers is cash term, which requires a down payment upon delivery of the books and gives
the customer a week or two to pay the remaining balance. The total amount due is
equivalent to the cash price.
 Ordinary Terms
Ordinary terms lack distinctive characteristics. It solely consists of two essential
elements: the credit duration and cash discounts.
Discounts
Discounts reduce the amount of an obligation or a product's price. It is a technique used to
encourage customers to pay on time or buy more. Two sorts of discounts exist: cash discounts
and trade discounts.
Cash Discount vs. Trade Discount
Cash Discount Trade Discount
It is a deduction in the total amount of It is the deduction in the list price of the
obligation to be paid to the creditor. product sold to buyers.
It stimulates debtor to early or prompt It stimulates buyers to avail more goods.
payment.
Parties involved: creditor and debtor Parties involved: seller and buyer
Example: Example:
2/10, n/30 Sale 10% OFF
This means that if the obligation is to be
settled within 10 days the debtor is entitled to
2% discount. However, after the 10th day, no
discount is further given to the debtor.

Credit for Investment and Bank Credit

Individuals or businesses in need of short- or long-term additional capital might obtain
investment credit or bank credit. Investment credit is specifically obtained for long-term capital
requirements. This sort of finance is available to those who wish to start a business or grow an
existing one but lack the necessary capital. Investment credit is comprised of bonds, long-term
promissory notes, mortgages, and other long-duration pledges with a maturity date. Credits
granted by financial entities such as commercial banks are considered bank credits. The funds
taken from depositors by these banks are utilized to provide loans to fund users. Often, this is
used to cover short-term deficits in working capital requirements.
This distinguishes them from other types of credit such as charge accounts, commercial credit,
and retail credit.
Other Forms of Credit
In addition to the previously stated forms of credit, there are further types of credit that are
differentiated according to purpose. They include agricultural credit, export credit, government
financing, factoring, and credit available on the free market.
Agricultural Loan
The purpose of this sort of lending is to finance agricultural production. This might be in the
form of goods or cash and is available on a short- or long-term basis. Farmers utilize it to fund
their agricultural efforts.
Export Loan
This sort of credit is used to ease the transport of products from their point of origin to their final
destination. It is an exchange between exporters and importers. When an exporter transacts
beyond the borders of his own country, he requires substantial capital to fund the movement of
commodities.
Government Credit
Even the government and its agencies are in need of credit to finance its respective programs and
projects which are social and economic in nature. Aside from availing credit from financial
institutions within the outside the country, it can also issue debt instruments with varying
maturity such as treasury bills, treasury notes and treasury bonds.
Factoring
Transferring accounts receivable is possible, particularly if the creditor is in need of cash and
cannot wait for the credit to mature. This can be accomplished by factoring, as indicated by the
transfer of accounts receivable. The factor purchases the accounts and is responsible for their
collection.
In a credit transaction involving Ricardo and Julia, respectively the creditor and the debtor, the
following example applies. Ricardo has an immediate need for finances, but he cannot demand
payment from Julia because the maturity date of the receivable is a month away. What he can do,
however, is sell or assign the receivable. If Dina has an interest in the receivable, she will pay
Ricardo a lesser sum than the obligation's whole value. Julia is regarded obligated to pay Dina
the same amount upon reaching maturity.
Open Market Credit
This occurs when an institution relies heavily on commercial paper to finance temporary
working capital shortages. This is accomplished through commercial paper houses, which may
act as a broker to arrange a loan with banks or other financial institutions, or may purchase the
notes of respectable enterprises outright.
There are numerous categories of credit. They include its form, term or maturity, security, mode
of release, method of repayment, origin, and proof.
As to Form
Credit may be obtained in the form of commodities, services, or cash, depending on the terms
agreed upon by both parties. A refrigerator purchased on installment for personal use falls under
the category of good. On the other hand, if a person has borrowed money from an individual or
financial organization, it is in the form of cash.
As to Term or Maturity
Credit terms can be either short-term, intermediate or medium-term, or long-term. The duration
depends on the intent and amount involved. One year or less is the maximum maturity time for
short-term credit. A medium-term loan expires in more than one year but less than five years,
whereas a long-term credit runs for more than five years. It should also be noted that as the
amount of money involved increases, the maturity tends to increase to provide the debtor more
time to repay the obligation.

As to Security
For the creditor's protection, the obligation must be covered by collateral in the event that the
debtor is unable to pay. This is what is known as a secured loan. Moreover, the value of the
collateral should exceed the amount of the obligation. The use of collateral will depend on the
borrower's credit rating. Not all loans, however, require collateral. This type of borrowing is
known as an unsecured loan or a character loan. Others refer to it as a clean loan. This is based
only on the creditor's faith and the debtor's reputation. This loan is secured solely by a
promissory note or future payment agreement. If the loan involves a considerable quantity of
cash or is obtained from a financial institution, collateral is necessary to mitigate the risk
incurred by the lender.

As to Method of Release
A loan may be released once or multiple times. A lump sum is a little amount that can be given
all at once. However, if the quantity is considerable and it is necessary to release it in lesser
quantities as a form of control, this is referred to as staggered release. A lump-sum loan is
obtained from a financial institution. The manner of release is staggered when the government
obtains a loan from foreign banks such as the World Bank to fund a property relief program. The
release of the remaining portion of the loan must be supported by the program's progress report.
This is one approach for the bank to monitor the debtor's progress in respect to achieving the
program's objective.

As to Repayment
There are loans designed to finance particular business projects. The operation's profits are then
utilized to settle the debt. This type of debt is known as a self-liquidating or self-paying loan.
This is typically observed in corporate settings. If the loan is of a personal character and
repayment is based on the borrower's income, this is a non-self-liquidating loan. This is a non-
self-liquidating loan if Maria wants to borrow money for her birthday celebration.

As to Source
Loans are available from various sources, including private sources, government sources, and
commercial sources. Private sources include institutions and organizations that are neither
administered by government agencies nor founded by private persons. When one purchases one
kilogram of sugar on credit from a sari-sari shop, this is a transaction with a commercial firm.
This is from a government source if an employee obtains a salary loan from the Social Security
Administration (SSS).

As to Evidence
As to evidence, there are credits with and without evidences. Credit completed verbally and there
are no written documents proving its existence is called un-evidenced credit. A credit evidenced
by a promissory nor or written agreement is an evidenced credit.