Management of Receivables^241
past. Past customers can be readily classified into good risk and bad risk categories.
The financial information on customers is used in conjunction with a statistical procedure
called multiple discriminant analysis to develop a statistical credit scoring model.
Discriminant analysis first of all provides an indication of those measures which are
most important in distinguishing between good risk and bad risk customers. That is, the
firm may start out by using 30 ratios and variables in its analysis. Discriminant analysis
might indicate that only five of these ratios and variables are important in characterising
good risk and bad risk customers.
Second, discriminant analysis will develop weights for each ratio or variable to form a
discriminant function that may look like:
discriminant score = 3.5 (current ratio) + 1.7 (profit margins) + 7.1 (debt to assets) +
0.3 (inventory turnover) + 1.9 (quick ratio)
The 3.5, 1.7, and so forth, are weights developed by discriminant analysis. Current
ratio, profit margins, and so forth, are discriminant variables identified as important by
the model. The sum of the products of the weights and the variables is the discriminant
score. The analysis selects weights such that discrimination between good risk and bad
risk accounts is maximised. A perfect set of weights would create a discriminant score
such that all bad risk firms would have scores on one side of the discriminant score.
Once the discriminant credit scoring model has been developed, it can be applied to
credit applicants. The weights can be used to calculate a score for the credit applicant.
The credit applicantís score can be compared with the discriminant score to see whether
the applicant falls in the good risk or bad risk category. If the applicant falls in the good
risk category, a similar type of procedure to that described here can be used to establish
a credit limit for the applicant.
A variety of collection procedures can be utilised by the firm in its efforts to collect on
delinquent accounts. The initial efforts should be very low key and should become
more strict as per the response from debtors. If payment is not received within a few
days, one or more follow up letters should be sent demanding payment.
Telephone Call. If letters are unsuccessful, a credit department employee, preferably
the manager, should call the delinquent debtor and ask for prompt payment. The credit
manager may also wish to communicate that legal action may be taken if payment is
not forthcoming.
Personal Call. Some firms have either collection personnel or sales representatives
visit delinquent debtors. The firms feel that a face-to-face confrontation with a delinquent
debtor provides them with an edge over other creditors.
Collection Agency. If the preceding measures are unsuccessful, the firm may consider
the services of a collection agency. The collection agency fee is typically high-usually