CREDIT

MANAGEMENT
Prepared By:
Ketan Vagh
Saurabh Raval
Nidhi Shah
Kushal Shah
Chirag Parekh

TABLE OF CONTENTS

Terms of payment

Credit policy variables

Credit evaluation

Credit granting decision

Control of accounts receivable

Credit management in India

TERMS OF PAYMENTS
Cash

Terms

Open

Account

Credit
Cash

Period

Discount

Billing

TERMS OF PAYMENTS
Consignment

Bill

of Exchange

Letter

of Credit

CREDIT POLICY
VARIABLES

Credit Standards

Credit Period

Cash Discount

Collection Effort

CREDIT STANDARDS

RI = [S (1 V) - S bn] (1 t) -k I
Where
RI = Change in residual income
S = increase in sales
V
= ratio of variables costs to sales
bn = bad debt loss ratio on new sales
t
= corporate tax rate
k
= post tax cost of capital
t = increase in receivables investment.

CREDIT PERIOD
S *ACP * V
360
S/360 = average daily change (increase) in
sales. The divisor here can with equal
justification be 365, rather than 360
ACP = average collection perid

CASH DISCOUNT

RI = [S (1 V) - DIS] (1 t) + kI
Where
S
V
k
I
DIS

=
=
=
=
=

Increase in sales
ratio of variable cost to sales
cost of capital
savings in receivables investment
increase in discount cost

COLLECTION EFFORT

RI = [S (1 V) - BD] (1 t) + kI
Where
RI
S
V
BD
t
k
I

=
=
=
=
=
=
=

Change in residual income

Increase in sales
ratio of variable cost to sales
increase in bad debt cost
tax rate
cost of capital
savings in investment in receivables

Credit Evaluation

Type I Error : A good customer misclassified as a

poor
credit risk.
Type II Error: A bad customer misclassified as a
good
credit risk.

TRADITIONAL CREDIT
ANALYSIS
Five Cs of credit
Charcter
Capacity
Capital
Collateral
Condition
Sources of informations about five c
Financial statement
Bank references
Experiences of firm

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

Past Payment
Net Profit
Margin

Factor Rating

Factor

Weigh

Score

t0.30

1.20

0.20

0.80

Rating

2.00

Discriminant Analysis
This technique is employed to construct better
risk index.
e.g. ABC company manufacture some product for
industrial customer, they take two financial ratio
into consideration, namely return on Equity and
Current ratio.

Current
Ratio

+ + + +
+ +
O+ +
O
O
O
O
+
O
O
O
Return on Equity

CREDIT GRANTING DECISION

P=Probability that customer pays his dues
1-P=The Probability that Customer can not
Pays his dues.
Revenue=Revenue from sale
Cost
=Cost of good sold

Formula
P(Rev-cost)-(1-P)Cost
Example
ABC company is considering offering credit to a
customer.the probability that customer would pay is
0.8 and the probability that customer would default is
0.2.The revenue from sale would be Rs 1200 and cost
would be Rs.800
Sol:- 0.8(1200-800)-0.2(800) = 160

REPEAT ORDER
FORMULA
{ P1(Rev1-cost1)-(1-P1)Cost1 }
+
P1{ P2(Rev2-cost2)-(1-P2)Cost2 }

SOLUTION
{0.9(2000-1500)-0.1(1500)}
+
0.9{0.95(2000-1500)-0.05(1500)= 660

CONTROL OF ACCOUNTS RECEIVABLES

Two methods for that

Days sales outstanding

Ageing schedule

Days sales Outstanding

Month

Sales

Receivables

January

150

400

February

156

360

March

158

320

April

190

310

May

170

300

June

180

320

DSO= Account receivable

Average daily sales

Quarter
First

320

= 62 days

(150+156+158)/90
Second

320
(190+170+180)/91

= 54 days

Ageing Schedule
In days

Receivables

0-30

35%

31-60

40%

61-90

20%

>90

5%

Collection of Matrix

Whether the Collection is improving stable or reduced .

Collection
Of
payment

January

February

March

13

20

24

CREDIT MANAGEMENT IN
INDIA
Credit

Policy

Credit

Analysis

Control
Room

of Receivables

for Improvement