(^240) Financial Management
Inventory Turnover. The seventh factor is the inventory turnover (I). A higher inventory
turnover implies high efficiency; I can help contribute anywhere from 0 per cent to 10
per cent toward the credit limit, as shown in Table 5.
Qualitative Factor. The last factor is a qualitative factor (Q) and lets the credit manager
use discretion in subjective evaluation of the credit applicant's willingness and ability to
pay.
It should be kept in mind that the factors mentioned here and their contribution to the
credit limit are based on a particular firm's actual experience. The factors and their
contributions to the credit limit may vary from accounts payable, and the economic
environment would also be considered in developing a heuristic credit evaluation decision
model.
As an example we an apply the heuristic model presented here to evaluate Kartik
Metal. Assume that Kartik is requesting a credit line to buy less than 25 per cent of its
raw materials requirements. What is the maximum credit line to establish for Kartik?
The contributions of the various factors to the credit limit are shown in Table 6. The last
factor, Q, is rated average.
Table 6: Application of the Credit Limit Model Kartik Metal Products
a Based on sales; Rs 177, 250/Rs14, 619 = 12
Kartikís credit limit = Rs 42,961 0.55 = Rs 23,600.
Additional credit for Kartik = Rs 23,00 ñ Rs 7500 = Rs 16,100.
because of Kartikís dependence on only 12 customers. Total contribution of the eight
factors to the credit limit is 55 per cent of tangible net worth, or Rs 42,961 ◊ 0.55 = Rs
23,600. Since the existing credit lines total Rs 3,000 + Rs 2,500 = Rs 7,500. Kartik can
be extended additional credit up to Rs 23,600 ñ Rs 7,500 = Rs 16,100.
Statistical Approach. In quantitative approaches to credit analysis, the firm relies on
financial information as well as on the payment records of firms it granted credit in the
Factor Kartik’s Rating Contribution to Credit
Limit (per cent)
- Kartik’s requirement (C) C < 25 % 0
- Pay habits (P) Takes discount 10
- Years in business (Y) Y > 10 10
- Profit margins (M) M = 4.6 % < 5 % 0
- Current ratio (R) R = 2.89 > 2.5 10
- Total debt to total assets (T) T = 0.28 < 0.3 10
- Inventory turnover (I) a I = 12 > 10 10
- Quantitative (Q) Average 5
Total Contribution 55