2. TABLE OF CONTENTS
Terms of payment
Credit policy variables
Credit evaluation
Credit granting decision
Control of accounts receivable
Credit management in India
3. TERMS OF PAYMENTS
Cash Terms
Open Account
Credit Period
Cash Discount
Billing
6. CREDIT STANDARDS
∆RI = [∆S (1 – V) - ∆S bn] (1 – t) -k ∆I
Where
∆RI = Change in residual income
∆S = increase in sales
V = ratio of variables costs to sales
bn = bad debt loss ratio on new sales
t = corporate tax rate
k = post tax cost of capital
∆t = increase in receivables investment.
7. CREDIT PERIOD
∆S *ACP * V
360
∆S/360 = average daily change (increase) in
sales. The divisor here can with equal
justification be 365, rather than 360
ACP = average collection perid
8. CASH DISCOUNT
∆RI = [∆S (1 – V) - ∆DIS] (1 – t) + k∆I
Where
∆S = Increase in sales
V = ratio of variable cost to sales
k = cost of capital
∆I = savings in receivables investment
∆DIS = increase in discount cost
9. COLLECTION EFFORT
∆RI = [∆S (1 – V) - ∆BD] (1 – t) + k∆I
Where
∆RI = Change in residual income
∆S = Increase in sales
V = ratio of variable cost to sales
∆BD = increase in bad debt cost
t = tax rate
k = cost of capital
∆I = savings in investment in receivables
10. Credit Evaluation
Type I Error : A good customer misclassified as a
poor credit risk.
Type II Error: A bad customer misclassified as a
good credit risk.
11. TRADITIONAL CREDIT
ANALYSIS
“Five C’s of credit”
Charcter
Capacity
Capital
Collateral
Condition
Sources of informations about five c
Financial statement
Bank references
Experiences of firm
12. Numerical Credit Scoring
Identify factors relevant for credit evaluation
Assign weights to these factors
Rate the customer on various factors using
suitable rating scale.
Multiply weights with the rating scale.
Add all score to get consumer rating index
Based rating index classify customer
Factor Facto Rating Factor
r Score
Past Payment Weigh 4
0.30 1.20
Net Profit
t
0.20 4 0.80
Margin
Rating 2.00
Index
13. Discriminant Analysis
This technique is employed to construct better
risk index.
e.g. ABC company manufacture some product for
industrial customer, they take two financial ratio
into consideration, namely return on Equity and
Current ratio.
Current
Ratio + + + +
+ +
O O+ +
O O
O + O
O
O
Return on Equity
14. CREDIT GRANTING DECISION
P=Probability that customer pays his dues
1-P=The Probability that Customer can not
Pays his dues.
Revenue=Revenue from sale
Cost =Cost of good sold
15. Formula
P(Rev-cost)-(1-P)Cost
Example
ABC company is considering offering credit to a
customer.the probability that customer would pay is
0.8 and the probability that customer would default is
0.2.The revenue from sale would be Rs 1200 and cost
would be Rs.800
Sol:- 0.8(1200-800)-0.2(800) = 160
16. REPEAT ORDER
FORMULA
{ P1(Rev1-cost1)-(1-P1)Cost1 }
+
P1{ P2(Rev2-cost2)-(1-P2)Cost2 }
SOLUTION
{0.9(2000-1500)-0.1(1500)}
+
0.9{0.95(2000-1500)-0.05(1500)= 660
17. CONTROL OF ACCOUNTS RECEIVABLES
Two methods for that
Days’ sales outstanding
Ageing schedule
18. Days’ sales Outstanding
Month Sales Receivables
January 150 400
February 156 360
March 158 320
April 190 310
May 170 300
June 180 320
19. DSO= Account receivable
Average daily sales
Quarter
First 320 = 62 days
(150+156+158)/90
Second 320 = 54 days
(190+170+180)/91