Credit Management Flashcards
What are the benefits of advancing credit?
- Encourage customers to stay with your business
-Potentially make them spend more money with your business
-This will potentially generate more profit
-If a customer receives credit then the business may not have to give them discounts
What are the risks of advancing credit?
-The business will have less working capital available as it will receive money from customers later
-There may be increased costs of administration (i.e. to collect the debts)
There is an increased risk of loss:
- there will be higher amounts outstanding from each debtor
- credit could be given to poorer quality customers
-Losses due to writing off a bad debt - it takes many times its value to cover.
Why is liquidity important for a business?
Liquidity is a measure of the extent to which a person or organization has cash – or can raise cash – to meet immediate and short-term liabilities.
What sources of information are available to us to help our business decide if we want to give or increase credit to a customer?
Bank references Management accounts Sales team Credit control team Credit circles Companies House
What does ‘Undoubted’ mean on a bank reference?
A good risk for the figure quoted
What does ‘good for your figure and purpose’ mean on a bank reference?
A reasonable risk and most probably OK
What does ‘should prove good for your figures and purpose’ mean on a bank reference?
Not so sure about this one - well worth investigating further before making a decision
What does ‘Although their capital is fully employed we do not consider the directors would enter into a commitment they could not see their way to fulfil’ mean on a bank reference?
This business has cash flow problems and should not be allowed any credit
What are the three attitudes the business depends on to run their business?
- Risk
- Liquidity
- Profitability
What does profitability mean?
The ability to generate income which exceeds costs and to repay debts in the future!
What does the current ratio show?
Working capital expressed as a ratio.
- The higher the better
What does quick ratio show?
A ratio comparing liquidity with short-term debts, but excluding inventory (which takes longer to turn into cash)
- the higher the ratio, the better
What does the receivables collection period show?
The number of days on average that it takes for a receivable to pay
What does the payable period show?
The number of days on average it takes to pay a supplier
What does the inventory holding period show?
Number of days on average that inventory is held.
- ideally the figure should not increase over time
What does gross profit margin show?
profit made before deduction of expenses
What does operating profit margin show?
profit made before deduction of tax and interest
- this should remain stable
What does net profit margin show?
Profit made after deduction of all expenses
- this should ideally increase over the years and not fall
What does the interest cover show?
The ability of a business to pay interest out of its profits
- the higher the figure the better
What does return on capital employed show?
profit made related to the capital employed by the company
What does gearing show?
The extent to which the business is funded by debt
- the higher the figure, the less secure the company
What does overtrading mean?
Overtrading is where the business grows its sales then finds it has too little working capital and so not enough cash available to support that level of sales
What are some of the warning signs of overtrading?
- Rapidly increasing sales revenue, extended customer credit terms, trading with customers with a lower credit score.
- Profit margins falling
- Increased inventory and trade receivables increasing funds tied up in working capital
- Reduced margins - business tries to saturate the market
- Reduction in cash or new/ increased overdraft
- Increased level of trade payables is common but not a sign on its own.
What are the solutions to overtrading?
- Reduce sales to a manageable level
- Managing the sales ledger more effectively and renegotiating supplier terms
- Increasing resources through a new investor or extra capital
What must a letter or email refusing credit include?
- Still trade on a cash basis
- Explain that checks were done
- Review in x months time
What would you consider when a customer asking to vary their credit terms?
- Consider why they want it
- Increased limit
- Increased payment period
- Trading history
- Invoices paid in full & on time?
- Customer kept in limits?
What does R.O.T stand for and what does it mean?
Retention of title
Supplier retains title of goods until they are paid for and can be identified
How do you calculate a discount?
(d / 100 - d) * (365 / N - D) * 100 = Annual cost of discount
d = settlement discount % N = normal settlement period in days D = Settlement period for earlier payment in days
What is credit insurance?
Insurance against incurring a bad debt
What is the four different credit insurance policies?
- Whole Insurance Policy
- Annual Aggregate Excess Policy
- Single Account Policy
- Export Credit Insurance
What is the Whole Insurance Policy?
- Most common policy
- Can cover entire sales ledger, but amount paid out would be up to 90% of the claim
- Can be key accounts e.g. up to 40 customers for whole amount
What is the Annual Aggregate Excess Policy?
- Covers all loses above a certain “excess”
What is the Single Account Policy?
- A selected receivable may be insured
What is Export credit insurance?
- Credit risk of being able to chase up bad debts overseas
- Political risk of country you sell to
What is the problem with credit insurance?
It is only any good when you can get it in the first place.
How should the interest rate be calculated?
Bank of England base rate + 8%
What are the four key elements of a contract and how do you remember it?
COAL
- Offer
- Legal Relations
- Acceptance
- Consideration
How can an offer be terminated?
- Running over a predetermined time limit or a reasonable period of time
- the offeror cancelling the offer before it is accepted
- a counter offer
- acceptance or rejection of the offer
What is a void contract?
Against the law e.g. contract ‘hit’
What is a voidable contract?
Contract can be ignored as one party has been pressured to sign
What is an enforceable contract?
Contract is valid but court will not enforce e.g. prostitution
What is two examples of third parties that collect debts on your behalf?
- Debt Collection
- Solicitor
What are some key points about using debt collectors to collect your debts?
- Independent
- Highly Skilled
- 70% success rate
What are some key points about using a solicitor to collect your debts?
- Usually employ a specialist solicitor.
- Enforce repayment of debt, via courts or threatening letter!
- Bring about bankruptcy or liquidation – realise assets & hope some money left over to pay you!
What is the difference between bankruptcy or liquidation?
Bankruptcy is for an individual or partner in a partnership. Liquidation is for a limited company.
How much money do you go to the small claims track court for?
£10,000 or less
No solicitors fess awarded - you do it!
How much money do you go to a fast track court for?
£10,000 - £25,000
How much do you go to a multi track court for?
£25,000 and over
More than 1 day - complex &/ or under £25,000
What are the five types of ways for your debtors to pay?
- Attachment of Earnings
- Garnishee Order
- Warrant of Execution
- Administrative Order
- Charging Order
What is Attachment of Earnings?
regular amount deducted by employer from salary
What is a Garnishee order?
debt paid directly by a third party who owes the debtor money e.g. bank or building society. Only applies on that day – when does money go in?
What is a warrant of execution
court bailiff seizes and sells receivables’ goods on behalf of the business (retention of title clause) cannot break down door or take ‘tools of trade’
What is an administrative order?
receivable makes regular agreed payments into court to pay off the debt.
What is a charging order?
register a charge on customer’s property.
What is the stages of the insolvency process?
All assets will be sold to then pay off creditors (payables). Trade (unsecured) payables often receive little or nothing.
- Ensure the debt is £750 or more
- Make a statutory demand to the debtor on an official form
- If payment not received within 3 weeks send in a ‘creditors petition’ to the court, including ‘proof of debt’
- Creditor meeting may be called
- Court declares a bankruptcy order
What is the order or a priority when paying debtors?
- Costs of the bankruptcy/liquidation proceedings
- Secured creditors with fixed charges
- Preferential debts: (Pension contributions, Employee wages, etc, PAYE, NI, VAT.)
- Secured creditors with floating charges (generally a bank)
- Unsecured creditors (trade payables)
- Shareholders (if limited co)
What is the difference between administration or administrative receivership?
Administration – court appoints someone who runs business
Administrative receivership – bank who has floating charge to secure overdraft appoints someone to sell assets to repay overdraft.
What are two ways to manage liquidity?
Factoring
Discounting
What is factoring?
Money advance to a company on the basis of the security of its debtors.
Factors provide three main services:
- Provision of finance (give you money quicker)
- Administration of the sales ledger (they will take over all aspects, but they will charge
- Insurance against bad debts (depending on whether the factoring is with or without recourse)
What is invoice discounting?
Money is lent against the invoices issued to selected customers of the business
Invoice discounting in practice works like this:
- When an invoice is issued to a customer, details are passed to the discounting co
- Invoice discounting co will immediately lend between 60% and 90% of the invoice value
- When the customer pays the invoice the company repays the invoice discounting co
- The discounting co charges interest on the amount borrowed and also makes an admin charge
