328 Corporate Finance
The aging schedule shows that about 40 percent of receivables are in the less-than-30-days category
(in 1996)—which is a good sign. The schedule also shows that about 37 percent customers are in the less-
than-90-days category (in 1997)—which is a cause for concern.
Classification of Customers
Customers can be classified into various risk categories (Exhibit 17.3) on the basis of creditworthiness.
Customers may be placed into five or six categories so that credit limit and follow up action may be tailored
suitably. A company could follow a credit rating system adopted by agencies like CRISIL.
Exhibit 17.3 Classifications of customers
Category Symbol Explanation
Negligible risk AAA Companies with reputation for prompt payment.
Strong market and financial position
Cash rich
Governmental organizations
High safety AA Credit risk marginally lower than AAA customers
Adequate BBB Companies which are normally prompt.
Risky BB Companies in extreme volatile businesses,
profitability based on dubious schemes, etc.
High risk C Companies in distress, financial reorganization
Each customer may be awarded a symbol (Exhibit 17.3). It is quite possible that customers may jump
from one category to another due to improvement or deterioration in financial condition. This calls for up-
gradation of classification at periodic intervals. Formal guidelines may be developed to guide executive
decision-making. For instance, a company may restrict itself to the first two or first four categories—based
on its risk-taking ability. It is important to communicate the company’s policy to executives who actually
transact. In the absence of guidelines executives may grant credit to companies with dubious record. The
amount involved in each trade may be small at the individual level. At the aggregate level, the amount is
involved could be substantial forcing a company into distress. In 1997, FABR had 409 debtors. In the clas-
sification of these debtors into different risk categories on the basis of their standing in the different age
group (Exhibit 17.4), customers are classified into four categories: Normal, Low Risk, Medium Risk and
High Risk. The classification suggests that about 21 percent customers fall in the high-risk group and an-
other 21 percent fall in the medium risk group.
Exhibit 17.4 Risk classification of the customers of Fort Aguada Beach Resort
Category Credit period Percentage
Normal 30 >=CP 31
Low risk 30<CP<=60 27
Medium risk 60 <CP<=120 21
High risk 120<CP 21
To t a l 100
Components of Credit Policy
A firm’s credit policy has four variables: credit period, cash discount, credit standard and collection effort.
Changing any of these variables will require additional investment. For instance, lengthening the credit