Management of Receivables^235
(c) Bank references - these may not give a lot of information but they tend to use a
series of standardised replies, and experience of these will indicate the relative
credit grading of the customer in question;
(d) Reports published in trade journals or the financial press dealing either with the
customer company or with the type of business in which it is engaged.
In assessing the creditworthiness of overseas customers, reports from bankers are an
important source of information. It is also necessary to weigh up the risks of the customer
being prevented from paying either through political or exchange control restrictions.
On all these matters the Export Credits Guarantee Department can usually give
guidance.
If the customerís creditworthiness appears to be established, the next stage is to decide
the amount of credit to be given.
Theoretically there are three possible ways of doing this:
(a) The income or cash flow method, which requires knowledge of the amounts of
cash becoming available to the customer, and how he proposes spending them,
thus indicating his ability to pay the supplierís invoices - this method is possible
between a bank manager and his client seeking an overdraft or loan, but seldom in
business life;
(b) The capital structure method, under which the value of uncharged assets in the
customerís last balance sheet is established, and the credit limit will be a percentage
of this value. This is a necessary calculation when the proposed value of future
transactions will involve a major increase in the customerís total indebtedness,
but it is not an indicator of liquidity, and is not particularly relevant to small
transactions in the ordinary course of trade;
(c) The requirement method, which is almost always used in practice. If the customer
is creditworthy then we should be able to rely on him to pay any amounts arising
from the ordinary course of business. The amount of credit granted, therefore, is
based on the value of business which the customer expects to place with the
supplier each month. The forecast monthly sales to the customer are multiplied by
a number of monthsí credit laid down as company policy to give that customerís
credit limit. If, for example, a customer proposed placing orders totalling Rs.1,500
per month with a supplier whose credit terms required payment by the end of the
month following the date of invoice (say, two monthís credit) the credit limit granted
him might be 2xRs.1,500 = Rs.3,000 outstanding on the ledger accounts at any
time.
For customers of international repute it may be decided that no limitation of credit is
necessary, but the financial difficulties faced by several major companies in recent