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Credit
SCORE Chapter 570 |
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CONSUMER
CREDIT - COLLECTIONS |
DOCUMENTS MENUINTRODUCTION
Consumer
credit has always been very important to retail businesses. If
you are trying to decide whether you should offer credit to customers, or if
you are thinking about cutting back, or stopping credit, you should ask
yourself the following questions: 1.
How much credit shall I grant, if any? 2.
To whom shall I (or shall I continue to) grant credit? 3.
For how long shall I grant the credit? 4.
What impact will granting of credit have on cash flow and on working
capital I need? 5.
What is (will be) the cost in expenses and effort to grant credit? 6.
What method shall I use for granting credit? 7.
When payment is not being made promptly, what steps shall I take to
collect? In
addition to these questions, it is also important to check, from time to
time, whether credit does indeed bring the benefits it is expected to bring.
If problems exist, you must decide what can be done to improve the credit
operation so that it will bring higher gross profit at lower cost. 1.
What are 6 questions which should be resolved before granting credit? TYPES OF CREDIT PLANS In
a retail establishment you can grant credit primarily on the basis of two
possible systems: 1.
You can honor one or several established credit cards. 2.
You can allow customers to open accounts with you and grant them credit
directly. CREDIT CARDS In
granting credit on the basis of credit cards, you have many choices. You can
honor: *
one or more of the major bank credit card systems *
travel and entertainment cards *
one or several of the major oil company credit cards if you are in an automobile related business Which
card(s) you honor and how many you offer depends on the needs of your
business. It is important to remember though, that the more cards you
personnel having to call the credit card company for approval. Thus,
when a customer wishes to make a purchase on a credit card, the usual
procedure is to first check to assure yourself that
the credit card has not been listed on the latest list of withdrawn cards. If
the card has not been withdrawn, and the purchase amount does not exceed the
store's authorization line, the sale may be charged to the card. However, if
the amount the customer wishes to purchase exceeds the stores authorization line,
then a call must be made to the credit card company in order to gain approval
for the sale. At this time, the credit card company checks the customer's
balance and decides whether or not to allow the customer credit for the
purchase. If the customer's credit standing is good, the credit card company
will allow the store to accept the customer's credit, and will give the store
an authorization number for the sale. Obviously,
if the customer has a withdrawn card, or if the customer wishes to purchase
on credit more than the credit company is willing to lend the customer, then
the store is not authorized to transact the sale through credit. Should a
store fail to obtain an authorization number for a large credit card
purchase, then the store rather than the credit card company,
must bear the loss should the customer fail to pay. The store is also
responsible for checking that the customer's signature on the slip matches
the one on the credit card itself. In
many areas of the country today, merchants who make many sales on credit and
who most frequently check customer credit, install a small direct access
computer terminal in their store. The amount to be purchased is then typed on
the terminal, and the computer checks whether the
card has been withdrawn, and checks the credit company's files to determine
whether the customer has enough credit to cover the purchase. 2.
What is an authorization line? Direct Credit You
may feel that your business would benefit from granting credit directly. Some
credit customers are often more loyal than cash customers Sales and income
may benefit from such a move. As will be discussed later, such a move might
bring higher or lower costs. Your cash flow and the working capital required
for your business would both be affected. If
you decide to grant credit directly, there are two ways you can do so: 1.
For individual purchases--this means that a separate bill will be submitted
for each purchase and full payment against that bill is expected within the
normal credit period, whether it be 10 days, 25
days, 30 days, or even longer. As long as payment is received within the
normal credit period, no finance charge is made to the customer. 2.
On a revolving credit basis--in this method, a separate bill is submitted for
each purchase and a minimum partial payment against that bill is expected
within the normal credit period. The customer must also pay finance charges each credit period,
based on the unpaid balance of his or her bill. In
addition to granting credit, many businesses cash checks for customers. While
this is not directly a form of credit, it can become credit if the check is
not covered and is rejected by the bank. For this reason, most retailers place restrictions on the type
of checks they will cash. They will usually cash checks only up to a maximum
limit which they consider safe, and will cash them only for people they know
or who show them detailed identification. It is becoming
more and more common to ask check writers for both a driver's license and an established
credit card. Few retailers will accept out-of-state checks (because they are
much more difficult to collect if they bounce) and few will cash checks in
excess of the amount required for a purchase. 3.
What alternatives does a retailer have in deciding whether or not to offer
credit cards? 4.
What are 2 major ways a retailer can grant direct credit? BUSINESS IMPLICATIONS OF GRANTING CREDIT Credit
cards and direct credit affect the two closely related vital financial
factors, cash flow and working capital, though they have widely different
impact. Cash Flow When
you receive immediate payment for merchandise your sales and your collections
are identical. If you grant credit, either through a credit card or directly,
you will, at first, receive less payments than the sales value of the merchandise you have
sold. This is especially true in the first year but also occurs whenever you
increase the amount of credit you grant to your customers, or when you extend
it for a longer time. Whether and how much you will reduce your cash receipts
depends, of course, on the terms of credit and to what extent credit will
increase your sales. For
those customers who pay their bills in full once a month, there will merely
be a delay of one month. For those who pay in installments, however, the
delay can be significantly longer. Working Capital Credit
sales are the same as loans; you must have the money to pay your costs on
these sales. When credit sales are large, this means that capital is tied up
in credit and cannot be used for purchase of inventory or other business
purposes. This is discussed in greater detail later on in this module. CREDIT POLICY There
are two extreme ways to look at credit if you grant credit directly. One is not
to grant credit to anyone, and the other is to grant customers all the credit
they want. Neither extreme is, of course, wise. There is, however, a wide
range of possible credit policies which deserve consideration. The range
stretches from liberal extension of credit with a liberal collection policy
to strict extension of credit with strictly enforced collection dates. A
liberal credit policy involves the granting of credit to people without
extensive checking to see whether they will be able to make payments. In a
strict credit policy, a customer's financial background is checked
thoroughly, before credit is granted. Collection
policies, on the other hand, refers to method of repayment. A liberal collection policy
allows extensions of repayments to later dates, whereas a strict collection
policy demands that payments be made right on schedule. What
combination to choose depends a great deal upon the type of business you are in. If you are a travel agent, for instance, who has to
pay the airlines and steamship companies promptly, and are involved with
large sums and small profit margins, you cannot afford to extend credit
liberally. You must extend credit only to people who can convince you that
they will pay promptly. On the other hand, if you are extending credit for a
highly profitable low cost item, you can afford to be much more liberal. How
liberal your credit policy should be, also depends on the policies of your
competitors and the extent to which your business depends on credit for the
volume you need to be profitable. It also depends on your ability to handle
credit--financially and in the time you have available for collection work. 5.
What are some of the considerations that affect how liberal your credit
and collection policy should be? 6.
What distinguishes a liberal credit policy from a strict credit policy? 7.
What distinguishes a liberal collection policy from a strict collection
policy? EVALUATION OF CREDIT In
evaluating the benefits and costs of granting credit you have to look at both
sides: the benefits which the credit brings you, and the costs. The
benefits are chiefly the extra business you obtain because you grant credit.
If all competitors are conveniently located and they grant credit, you can
assume that you would lose a large proportion of the business that is now
transacted on credit, if you had a no-credit policy. On the other hand, if
only a relatively small proportion of your business is credit business, then
you gain relatively little benefit from offering credit. How
much benefit you derive from offering credit is a judgment that you have to
make based on the conditions in your business. A
simple formula with which you can calculate the benefits which credit brings
is as follows: It
is a much easier process to evaluate the costs of credit. If you are doing
business with a bank credit card or other established credit card, you can
easily calculate how much you pay in discounts to the credit card issuer and
how much the telephone calls and other processing costs amount to. These
costs can then be compared with the benefits which credit brings in
additional sales. In
order to figure the costs of providing credit (if you are providing credit
directly) you have to add:
* the costs of billing customers, including costs of mailing statements
and costs that your data processing organization or wholesaler charges for
services
* cost of credit checks or reference checks
* the costs of credit losses
* the cost of money tied up in credit EXAMPLE:
Determining the Benefit Which Credit Brings Assume
that: *
during the course of a year you find that you are doing $50,000 worth of business on credit * on reviewing this business, it appears to you as
though only $10,000 of the business would be obtained if you did not grant
credit. Therefore $40,000 of your business is a result of the credit you
extend. *
you have a net profit of 20% on your business Your
costs may be as follows:
Annual cost of billing customers and
other $ 600
paperwork connected with credit
Cost of credit reference
checks $
150
Bad-debt
losses
$1,200
Cost of money tied up in credit (10% of
the $ 400
average $4,000 monthly credit balance) __________________
Total
Costs
$2,350 BENEFIT
FROM CREDIT A
simple form which you may use in calculating the benefits derived from credit
is given: 1.
How much business, in dollars, did you do on credit last
year?...................................$ 50,000 2.
Review this business and determine how much of the business you would have
obtained if you did not grant credit....................................$
10,000 3.
Line 1 - Line 2 (indicates the amount of your business which was a direct
result of the credit you extended)................................$ 40,000 4.
Line 3 x the % net profit you make ($40,000 x .20)..$
8,000 5.
What is your annual cost of billing customers and of keeping the credit
records?..................$ 600 6.
What is the cost of credit reference checks, e.g., credit bureaus,
etc.?..................................$ 150 7.
How much did you lose in debts which customers ever
paid?...............................................$ 1,200 8.
What is the cost of money you have tied up in credit?........................................................$
400 9.
Total cost of granting direct credit (add together lines 5 through 8 and
total)....................$ 2,350 10.
Benefit in net profit, which credit brings you (Line 4 - Line
9).........................................$ 5,650 An
analysis like this can give you an idea of how much you benefit from the
direct credit you grant to customers. Note
that granting credit, in this example, requires that you invest $4000 in
credit to your customers. This $4000 has to be available. If you cannot
obtain it, it will hurt your ability to carry adequate stock. A similar
analysis can be made when you use credit cards. In
the example above, granting credit and the way it was being granted appeared
to be profitable. It is, of course, worthwhile to compare this with alternate
ways of granting credit. For instance, you could use credit cards and, on the assumption that
the credit card company would charge a 5% discount, the calculations might
look as follows: Discount
on credit card charges (5% x $50,000) = $2,500 Cost
of checking larger purchases (phone
calls and time spent calling): = $500 Total
costs: $3,000 Comparing
this cost with the cost of direct credit shows that direct credit brings in
$650 more profit than credit cards for this particular retailer. (Credit
cards cost $3000 annually as compared to $2350 for direct credit.) Still
another way to revise and possibly save on granting of credit would be to
make more detailed checks on credit risks. This could be based on a very
detailed study of the characteristics of people on whom losses have been
encountered in the past. This would result in a somewhat tighter policy, which
may be the least expensive way to operate the business. A tight credit policy
would, of course, result in somewhat less business, but then it takes $5.00
of sales to make up for every dollar of credit lost, in the example shown
above. ($1.00 lost divided by .20 net profit margin = $5.00 of sales) All
these estimates are, of course, difficult to make. Nevertheless, an attempt
to make reasonable estimates can give you a lot of information about the
impact which credit is likely to have on your business. Assume
that a certain retailer (a different one than the one in the previous
example) does $40,000 of business annually on direct credit which is granted
through the store. A review seems to indicate that only $15,000 worth of
business would be obtained if credit were not granted. Also, assume that the
retailer has a 15% net profit margin. The
retailer's costs of providing direct credit are:
Annual cost of billing customers.................$1,000
Cost of credit reference checks..................$ 200
Bad debt losses (and lawyer's fees)..............$2,500
Cost of money tied up in credit..................$ 333 One
simple way of calculating the benefits derived from direct credit using the
form given above is:
1. How much business, in dollars, did you
do on credit last year?......................$40,000
2. Review this business and determine how
much of the business you would have
obtained if you did not grant credit.........$15,000
3. Line 1 - Line 2 (indicates the amount
of your business which was a direct
result of the credit you extended)...........$25,000
4. Line 3 x the % net profit you make...........$ 3,750
5. What is your annual cost of billing
customers?...................................$ 1,000
6. What is the cost of credit reference
checks, e.g., credit bureaus,
etc.?..........$ 200
7. How much did you lose in debts which
customers never paid?........................$ 2,500
8. What is the cost of money you have
tied up in credit?...........................$ 333
9. Total cost of granting direct credit
(Add together lines 5 through 8 and total)...$ 4,033
10. Benefit credit brings (Line 4 - Line 9)......$ 283 8.
In the business presented above how much in sales does it require to make up
for every dollar of bad debt? 9.
In the situation above would the retailer have been better off honoring
credit cards at a 5% discount, rather than granting direct credit? (Assume
the cost of checking large purchases would have amounted to $300.) ON-THE-JOB ACTIVITY 1 1.
In your business, how much in sales does it require to make up for every
dollar of credit lost? 2.
What, in your business, do you estimate to be the cost of communicating with
the credit card organization if you were to use credit cards, or if you do
use them? 3.
If you already grant direct credit, estimate the benefit it brings you by
using the formula already given or the step-by step form. If
possible, discuss your thoughts with a person whose opinion you respect and
see what additional ideas come from such a discussion. CREDIT POLICIES AND PROCEDURES Obtaining Information Before
you decide to grant direct credit to a customer, you will probably want to
know something about that person. Specifically, you will want to know what
your chances are of getting paid for merchandise which you sell this customer
on credit. On the one hand, if you have known the customer for a long time,
and know something about his or her background, you may need to do very
little checking into the customer's credit status. On the other hand, if you
have questions about the customer's credit worthiness or ability to pay, you
will probably want to make a thorough check into the customer's background.
In either case, you will need some kind of a form which you can ask the
customer to fill out in order to obtain the information you need. Such credit
forms are often adapted from some standard credit form or may be obtained
from an organization with which you work. In
many industries, wholesalers who have their own computer facilities or make extensive
use of computer services, very often offer collection services to their
retailers and can provide charge account application forms. Other places
where you may obtain charge account application forms include credit bureaus
that the retailer may use to check credit of doubtful applicants for you, or a
data processing organization who bills for you. No
matter what application is used, it is likely to ask the following
information of the applicant:
* current address (and previous address if they have lived at
their current address less than a minimum number of years)
* current position (and applicant's previous position if the
time spent in the current position is relatively short)
* salary and other income
* rent or mortgage payments and whether the applicant rents or owns
* major financial obligations
* credit references usually including at least one bank, and one
other credit line, either credit card or other charge account
* number of dependents Applications
are subject to equal credit laws. Therefore, to assure that you do not
violate these laws, it is useful to review applications with the bank with
whom you do business or with somebody who is knowledgeable in credit
applications. Furthermore, since most retailers levy a finance charge for
unpaid balances beyond a certain amount of time, information about these
finance charges must be provided in detail on the application form. Credit Limits The
real important question for a retailer generally is not whether to grant
credit to an individual customer but rather how much credit to grant. When
credit is granted through a credit card, these questions, of course, do not
come up. They are only applicable if the retailer grants the credit directly
and therefore carries the risk of losses if the purchaser does not pay. For
this reason, retailers who establish credit accounts for customers obtain
information on those customers and check their payment performance in order
to decide how much credit to grant. This may be done in any number of ways: *
Many retailers make use of credit bureaus which provide financial information
about individuals and how they pay their bills. Since such inquiries cost
money, retailers who do make use of them, use them judiciously--primarily
when large amounts of credit are involved. *
Some retailers, in granting direct credit, will do so only if the individual
customer has a major credit card. Here the retailer assumes that an
individual must be a good credit risk if a major credit card company approved
the individual for credit. *
In extreme cases, or sometimes with very young people, retailers may ask for
endorsers, usually the parent. In this way, the endorser is held responsible for
the bill if the individual is unable to pay. *
Another variation of reducing the risk could be to insist on a substantial
down payment for a large purchase. *
In deciding on credit limits, some banks, credit organizations and large
retailers use a point system where they give the maximum number of points for
owning a home in the community, some points for a bank account, some points
for length of time on the job, and some points for the level of income. All
these points, when added together would then determine the amount of credit
an individual would be granted. Once
credit has been granted, the customer is informed of the amount and type of
credit granted, and the conditions, if any. The information about finance
charges is then again provided to assure fair and adequate notice. 10.
What are some of the characteristics of a customer which would be checked
when deciding how much credit to grant? 11.
If you were deciding on revolving credit in your business where people are
buying regularly but where individual purchases are rarely more than $100,
how much credit would you allow the following two people? A.
Female applicant: 12 years at the present address; employed for 18 years;
current annual income $12,000; local checking account and local savings
account. She owns a small home estimated at $30,000 with a $10,000 mortgage
remaining. B.
Male applicant: 9 months at current address; 3 1/2 years at previous address;
current annual income is $10,000; local savings and checking accounts. He
rents an apartment for $200.00 a month. He has an open balance of $600.00, a
personal loan with a bank and makes monthly payments of $30.00. Procedures for Authorizing Credit
Purchases Every
retailer, no matter how small, should have a policy for authorizing credit purchases.
This is even true when credit purchases are always charged on credit cards.
That policy should be clearly known to all employees. It should include: 1.
The procedures required by credit card companies such as:
- checking the book to see whether the credit card is valid
- checking for authorization whenever large purchases require such checking
- writing the authorization number onto the credit slip, and
- verifying the signature on the credit slip with the one on the card 2.
If credit is direct, the procedure should specify how much credit can be
granted to an individual with approval from the owner and what steps are
required to assure that an individual does not exceed that limit. 12.
What steps should be in the procedure for authorizing credit purchases when a
credit card is involved? 13.
What steps should be in the authorization procedure for purchases if credit
is given directly? ON-THE-JOB ACTIVITY 2 Prepare
a checklist for employees which will assure that all purchases on credit
satisfy the policy. This should include the statement of the basic policy as
well as all the steps involved in a credit purchase and the records | |
