3) Granting credit and setting up customer accounts

Question 1

What factors will affect the decision of granting credit?

Answer 1

1) Ownership
2) Overseas companies
3) Insufficient information
4) Sales policy

Question 2

Why ownership will affect the decision of granting credit?

Answer 2

Ownership of the customer will often determine the level of risk involved in granting credit. An organisation that has “state” backing will have a low risk status. The same should be true of large companies and their subsidiary companies (which have their backing).

It is the smaller organisations that are seen as being riskier: failure rate in this sector is higher and irrecoverable debts more likely.

Question 3

Why overseas companies are a higher risk when making the decision of granting credit?

Answer 3

Overseas companies are a higher risk because of the possible problems the customer may have in obtaining and sending currency payments. Also, there will be complications with legal systems should it become necessary to take court action to recover debt.

Question 4

Why having Insufficient information will affect the decision of granting credit?

Answer 4

The lack of any form of track record will make a credit decision hard to make.

Question 5

Why the sales policy is a factor affecting the decision of granting credit?

Answer 5

There can be a tension within a commercial organisation between the sales function and the credit control function.

Sales staff will want to obtain as many sales leads and new customers as possible in order to meet targets, even if the credit risks involved are higher than the credit control function would normally tolerate.

The decision of whether or not to grant credit may be swayed by current management policy, whether it be to “play it safe” or to “go all out for new sales”.

Question 6

What should be considered when making the decision of refusing credit?

Answer 6

The organisation taking the decision not to grant credit is in danger of losing business because the potential customer may well go to another supplier.

The potential customer will in turn lose both a supplier and a source of liquidity.

Question 7

What does it means to grant half-way house credit?

Give some examples.

What is the advantage of doing this?

Answer 7

Some organisations, anxious not to lose a customer, might compromise and agree credit terms that are “half-way” to what the customer requested.

Examples of this are:

• Shorter credit periods, 7 days rather than 30 days
• Part payment, pay 25% cash terms and 75% after 30 days.

This will not remove the risk of the customer not paying, but it reduces it, and may help to retain a good customer who would otherwise have gone to another supplier.

Question 8

Which document do all credit decisions must comply with?

Answer 8

All credit control decisions reached must comply with the Credit Control Policy and Procedure Document used by the organisation.

Question 9

What are the factors to examine in the case of a request to increase the credit limit?

Answer 9

In the case of a request to increase the limit, factors to examine will include:

1) The amount of the increase: is it justified? Is it enough?
2) Has the customer kept within the existing limit?
3) The trading history – have invoices been paid in full and on time?

Question 10

What does is mean to be objective in credit control?

Answer 10

A person who is objective will base his or her opinions on facts and must not be influenced by personal beliefs, feelings or by other people.

Question 11

How should be treated each situation in credit control to act with objectivity? Give 3 examples:

Answer 11

Each situation (whether a customer or a debt) should be treated equally and should be given fair consideration, without bias.

For example:

1) New accounts
2) Existing customers
3) Debt collection processes

Question 12

Objectivity and credit control - new accounts

What actions should be taken in credit control to act with objectivity when opening new accounts?

Answer 12

1) Ensure the correct procedures are followed when obtaining references
2) Analyse all sources of information thoroughly and in accordance with the credit control policies and procedures of the organisation

Question 13

Objectivity and credit control:

How should be treated the existing customers?

Answer 13

Treat all customers fairly and equally by offering the allowed terms and any prompt payment discounts available

Question 14

What it means to be objective in credit control when following the debt collection processes?

Answer 14

1) Follow the defined procedures correctly and in a timely fashion for all outstanding debts
2) Report any concerns to the correct person without delay

Question 15

Threats to objectivity in credit control:

What happens when there are conflicts of interest?

What should be done in this situation?

If a person has conflicts of interest can still continue dealing with that customer or not?

Answer 15

Conflicts of interest could lead to the correct credit control procedures not being followed.

It is advisable to report any potential conflicts of interest to the appropriate manager to avoid possible threats to objectivity.

As long as the correct credit control policies and procedures are followed, a person working in credit control may still be able to deal with a customer where there is a potential conflict of interest, as long as the manager is aware of the situation and is happy for it to continue.

Question 16

What happens when the request for credit is accepted? How is communicated the decision to the customer?

Why this document is important?

Answer 16

When the decision to grant credit has been taken, the account should be set up without delay and advised in writing to the customer, normally in a formal letter.

This document is an important one for legal reasons. It can be referred to in later documentation and will be binding on the purchaser in the contract of sale which is set up each time a supply is made.

Question 17

Opening a new account: What will this document set out?

Answer 17

This document will set out, in accordance with Policies and Procedures requirements:

1) Credit period and limit
2) Credit terms
3) Discounts and interest rate comparisons
4) Payment details
5) Interest penalties for late payment
6) Retention of title (ROT)

Question 18

When opening a new account what is the credit limit?

How much should it be?

What is the period of the limit?

Answer 18

The limit is the upper limit which will be set on the sales ledger account of the new customer for a set period of time.

A “rule of thumb” calculation is that the limit should be twice the average monthly sales expected to be made to the customer.

The period of the limit is normally twelve months.

Question 19

Opening a new account: What different options are there for the credit terms?

Answer 19

1) Cash terms
2) 30 days from date of invoice
3) Net monthly
4) Net 30 days

Question 20

What are the different discounts given to customers?

Answer 20

1) Trade discount is traditionally given to established customers who buy on a regular basis. The amount will vary according to the product.
2) Prompt payment discount (also known as cash or settlement discount) is a percentage reduction in selling price allowed when settlement is made earlier than normal.

Question 21

What is the formula of the annual equivalent of the cost of the discount related to a simple interest rate?

Answer 21

(d / 100 – d) x (365 / N – D) x 100% = annual cost of discount

Question 22

What is the formula for the annual cost of discount using a compound interest rate?

Answer 22

[(1 + (d / 100 – d))^(365 / N – D) – 1] x 100% = annual cost of discount

Question 23

Opening a new account: How can be made the payments?

Answer 23

Payment can be made in a number of different ways, and these can have a cost implication. Payment by cheque and cash is more expensive both for the customer and the supplier in terms of handling costs and bank charges.

Many organisations actively encourage computer payments through the BACS and Faster Payments systems which transfer money from one account to another by computer.

Question 24

What are the interest penalties for late payment?

What is the interest rate that can be charged?

What is the formula?

Answer 24

It is common practice for organisations to include in their terms and conditions the right to charge interest on late payments. It is also enforceable in law.

The interest rate that can be charged is the Bank of England (base) rate plus 8%.

Amount including VAT x (base rate + 8%) x (number of days debt overdue / 365)

Question 25

What does retention of title (ROT) clause means?

What does ROT allows to the seller?

In which situations is ROT workable?

Answer 25

It means that ownership of the goods sold does not pass to the buyer until payment has been made.

If the buyer becomes bankrupt/insolvent, this will enable the seller to attempt to reclaim the goods and to get some value back.

This is workable when the goods are easily identifiable but causes problems when the goods are raw materials.

Question 26

What is credit insurance?

What will determine the amount of the premium?

Is there an extra requirement for large customers?

Answer 26

Credit insurance replaces cash lost when a debt goes bad. The amount claimed is usually net (excluding VAT).

Premiums will depend on the risk involved and the insurer will insist on credit analysis of larger customers. Credit insurance is an integral part of the credit control process.

Question 27

What does export credit insurance cover ?

Answer 27

This covers:

1) The credit risk of selling to an overseas buyer.
2) The political risk of selling to a country where the political situation is less stable and might produce a revolution, civil war or economic collapse, all of which would reduce the possibility of receiving payment.

Question 28

What are the credit insurance options?

Answer 28

Typical options include:

1) Whole turnover insurance
2) Insurance limited to key accounts
3) Single account insurance
4) Catastrophe: protection against natural disasters

Question 29

What are the factors to examine in the case of a request to increase the credit period?

Answer 29

If an extension of the credit period is required, the important thing is to check out the customer’ liquidity.

If the customer is experiencing cash flow problems, one of the first solutions is to obtain longer credit from suppliers, effectively using the supplier to finance working capital shortages.