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(^234) Financial Management
two factors need to be recognised before a firm implements a collection policy that
equates marginal collection expenditures with marginal reductions in delinquency costs.
Establishing Credit Limits
The fact that the business has a credit policy does not mean that credit terms will be
granted to every customer. It is not always easy to decide whether a particular customer
is ëcredit worthyí in the sense that he has both the ability and the inclination to pay at
the due date. Many companies require cash with order from new customers until their
creditworthiness have been established.
Five Cs of Credit that a bank looks at are the ones that you should also look at while
granting credit:
l Character: Willingness to pay back the credit
l Capacity: Ability to pay back
l Capital: Financial reserves including cash
l Collateral: What assets could be pledged or are pledged to others that hinder
payments
l Conditions: Relevant economic conditions
That means that in assessing the creditworthiness of a customer two things
are absolutely necessary:
(a) Facts about his business, in particular whether it is profitable, whether it is generating
or has access to sufficient cash to met its liabilities, and whether it has suitable
assets available to cover the claims of unsecured creditors in the event of winding
up. In brief, it is necessary to analyse the accounts of the business. It is helpful
also if the customer will supplement these with the sort of information they do not
give; e.g., the current order book, any plans for future development, and the
condition and market value of the assets owned by his business.
(b) Opinions about the business and the people running it, formed from either personal
contacts (director level, or at any reliable and knowlegeable level) or obtained
from third parties such as business associates, mutual acquaintances or employees
changing jobs.
There are other sources from which we can have information about the company
as well as the industry that it is operating in:
(a) Reports from the relevant trade protection association, if one exists;
(b) Trade references from other companies with which the customer does
business;