|
Once a company has decided the degree of risk it plans to assume it must analyze potential customers to determine whether credit should be ex¬tended to them. Obviously, this investigation must be thorough enough for the purpose but must be done with reasonable dispatch. The amount of investigation that can be undertaken depends on the potential volume of business expected. For isolated orders the determination is often based on no more than a cursory examination and the checking of a few refer¬ences. For large orders and continuing business, both general and specific information will be obtained and data will be secured from the special¬ized credit agencies. Purpose of Credit Analysis. The purpose of credit analysis is to determine the degree of risk that an account will not be collected, that is, the degree of credit risk. This requires a study of the willingness to pay debts when due; and is reflected in part by the experience of other sup-pliers to the firm. Willingness to pay must be supplemented by an ability to pay as shown by adequately liquid resources and a flow of working capital that will permit repayment. Adequacy of capital is also important from die point of view of ability to continue operations while paying obligations; sufficient equity capital is considered essential. If other factors are weak the ability of a debtor to pledge collateral may permit the extension of credit that would otherwise be denied. Clearly the economic conditions at the time and the prospects for the future will influence the extension of credit and the terms under which it is granted. Just as a firm analyzes its own accounts receivable to determine their average age and the success of its collection procedures, so it may analyze the purchases and accounts payable of a customer to ascertain the relationship between the terms of purchase and payments. Once an investigation has shown that extension of credit of a certain maximum amount is warranted, that same amount is permitted to continue unless income statements or reports by credit agencies show a change that warrants an increase in the maximum or a reduction therein. All sorts of measures may be employed such as limiting credit to a percentage of net worth, requiring certain current and acid test ratios, or holding credit to a given percentage of net working capital. None of these limitations should be treated in a mechanical fashion; they should accompany specific analysis. Sources of Information. The creditworthiness of an applicant for credit may be investigated more or less directly by a seller through his local bank which can check with correspondent banks on the credit standing and banking relationships maintained. Financial statements, with supporting schedules, may be requested to obtain details about financial details of the customer. A visit to the plant and a discussion with the financial officers of those seeking credit can give an experienced credit manager a useful impression of the techniques of operation and methods of handling accounts. Although a company's sales representatives are interested in selling its products rather than questioning the credit rating of buyers, experienced salesmen can accumulate information and impressions that will be useful in analyzing a company's financial position and its prospects as a recipient of credit. In their visits to many plants these salesmen can observe the differences in the manner in which various businesses are conducted. Information is available from business bureaus, trade associations, and associations of commerce. More specific data are furnished by the National Association of Credit Management through its interchange service which shows the payment record of debtors. Some agencies, like the National Credit Office, specialize in particular fields of activity. Classof1.com offers Finance Assignment Help
Related Articles -
Analyzing, Credit, Applications,
|
