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Management of Receivables^239

and ability to pay. Payments during the discount period rate 10 per cent. Payments

during the credit period are worth 5 per cent. Habitually late payments rate minus 5 per

cent.

Years in Business: The third factor is years in business (Y) and is a measure of the

ability of the firm to pay. Being in business less than 3 years has no effect on increasing

the limits. If Y is between 3 and 10 years, the limit is increased by 5 per cent. If the firm

has been in existence for more than 10 years, it rates 10 per cent.

Table 5: Heuristic Approach to Establishing the Credit Limit

Profit Margin. The fourth measures is the profit margin (M). If margins are less than

5 per cent, 0 per cent is contributed to the credit limit. Margins in excess of 14 per cent

contribute 10 per cent to the credit limit.

Current Ratios. The fifth measure is the current ratio (R). A current ratio of over 2.2 to

1 is considered to be a good indication of ability to pay and helps contribute 10 per cent

toward the credit limit. A current ratio of less than 1.5:1 is considered to be relatively

weak and does not help increase the credit limit.

Total Debt to Asset Ratio. The sixth measure is the ratio of total debt to total assets (T)

and represents the ability to pay. If T is less than 30 per cent, the applicant is viewed to

be conservatively leveraged and adds 10 per cent to the credit limit.

On the other hand, a T of over 50 per cent implies increased financial riskiness and

rates a minus 5 per cent toward the credit limit.

CONTRIBUTING FACTOR (^) Rating Contribution to Credit Limit : Per
cent of Net Worth
Applicant credit requirements (C) C < 25% 0
25 < C < 50% 5
C > 50% 10
Pay habits (P) Take discount 10
Pays on time 5
Pays late -5
Years in Business (Y) Y < 3 years 0
3 < Y < 10 5
Y > 10 10
Profit Margin (M) M < 5% 0
M% < M < 14% 5
M > 14% 10
Current Ratio (R) R > 2.2:1 10
1.5 < R < 2.2 5
R < 1.5 0
Total debt total assets (T) T < 1.3 10
0.5 < T < 0.3 5
T < 0.5 -5
Inventory Turnover (I) I < 10 10
5 < I < 10 5
I > 5 0
Qualitative (Q) Q = high 10
Q = average 5
Q = low -5