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The optimum level of trade credit extended represents a balance between two factors: ?

The optimum level of trade credit extended represents a balance between two factors:

profit improvement from sales obtained by allowing credit which encourages additional sales

the cost of credit allowed.


What is a credit policy influenced by?

demand for products
 competitors' terms
risk of irrecoverable debts
 financing costs
costs of credit control.


What are the aspects of a credit policy?

(1) Assess creditworthiness.
(2) Credit limits.
(3) Invoice promptly and collect overdue debts.
(4) Monitor the credit system.


Where does information for assessing creditworthiness come from?

 bank references (you'll need to get customers' permission in order to achieve this)

 Credit checks from agencies such as Dun and Bradstreet

 analyzing financial statements to assess liquidity (companies House)- look at levels of cash, working capital cycle, inventory days/payable/receivable days. Also looking at their Long term commitments.

 trade references
 competitors
 published information
 credit reference agencies
 company sales records
 credit scoring


What are bank references in assessing creditworthiness come from?

A customer’s permission must be sought. These tend to be fairly standardised in the UK, and so are not perhaps as helpful as they could be.


What are Trade references –in assessing creditworthiness come from?

Suppliers already giving credit to the customer can give useful information about how good the customer is at paying bills on time. There is a danger that the customer will only nominate those suppliers that are being paid on time.


What are Competitors in assessing creditworthiness come from?

in some industries such as insurance, competitors share information on customers, including creditworthiness.


What are Published information in assessing creditworthiness come from?

– The customer’s own annual accounts and reports will give some idea of the general financial position of the company and its liquidity.


What are Credit reference agencies –in assessing creditworthiness come from?

Agencies such as Dun & Bradstreet publish general financial details of many companies, together with a credit rating. They will also produce a special report on a company if requested. The information is provided for a fee.


What are Company’s own sales records –in assessing creditworthiness come from?

For an existing customer, the sales ledgers will show how prompt a payer the company is, although they cannot show the ability of the customer to pay.


What are Credit scoring –in assessing creditworthiness come from?

Indicators such as family circumstances, home ownership, occupation and age can be used to predict likely creditworthiness. This is useful when extending credit to the public where little other information is available. A variety of software packages is available which can assist with credit scoring.


What is credit limit?

Credit limits should be set to reflect both the:

amount of credit available
length of time allowed before payment is due.

The ledger account should be monitored to take account of orders in the pipeline as well as invoiced sales, before further credit is given, to ensure that limits are not breached.


What are the techniques for 'chaasing' overdue debts?

• Reminder letter
• Telephone calls
• Witholding supplies
• Debt collectors
• Legal action


What is monitoring the system and the methods?

The position of receivables should be regularly reviewed as part of managing overall working capital and corrective action taken when needed.

Methods include:

 age analysis of outstanding debt
 ratios compared with the previous period/target, to indicate trends in credit levels and the incidence of overdue and irrecoverable debts.

 statistical data to identify causes of default and the incidence of irrecoverable debts among different classes of customer and types of trade


What is the formula for annual compound cost of discount formula?

= [ 1+ (discount/(1-discount)^period] - 1

Number of periods= Year or week or months / '' earlier the money is received


What are the steps to calculating whether to take a discount or not?

Compare the cost of the discount with the benefit.


What is the cost of the discount?

Sales revenue x the % predicted to pay early x discount rate


What are the steps in deciding whether to take a discount or not?

(1) Calculate the current level of average receivables & receivables days

(2) Calculate the cost of financing this

(3) Calculate the new level of average receivables (Separated into the % who take the discount and those who don't then totalling to find new average receivables figure)

(4) Calculate the cost of financing this new average receivables figure with the discount with the overdraft

(5) Compare the old cost without discount with the new cost with to determine the benefit

(6) Compare the cost and benefit i.e. cost of offering the discount and the benefit it brings- netting it off essentially .


What is invoice discounting

Invoice discounting is a method of raising finance against the security of receivables. Individual invoices are sold at a discount to their face value. This provides a company with a cash advance simiar to debt factoring.


How does a debt factoring company provide invoice discounting service?

Selected invoices are used as security against which the company may borrow funds (like a house being used as security for a mortgage).
This is a temporary source of finance, as the receivables invoices are only temporary, repayable when the debt is cleared.


What are the advantages of invoice discounting?

It's a confidential service and the customer does not need to know about it.


What is the formula for service fee for invoice discounting?

% x by the total value of the invoice/sale


What is factoring?

Factoring is the outsourcing of the credit control department to a third party.


What is debt factoring?

The debts of the company are effectively sold to a factor (normally owned by a bank). The factor takes on the responsibility of collecting the debt for a fee.


What kind of services do debt factoring companies do?

The company can choose some or all of the following three services offered by the factor:

(1) debt collection and administration – (takes over sales ledger i.e. invoicing, sales accounting & debt collection service

(2) financing
(3) credit insurance - recourse (the company bears the cost of bad debts) or non-recourse (the factor bears the cost of bad debts; they guarantee to recover debts)


..Which type of firms are debt factoring useful to and why?

• Small &medium sized firms as they can't afford sophisticated accounting systems

• fast growing firms- these have substantial and growing investment in inventory & receivables which can be turned into cash by factoring the debts. Factoring debts can be more flexible source of financing working capital than an overdraft/ank loan


What is non-recourse, explain in detail

When factoring is without recourse or ‘non-recourse’, the factor provides protection for the client against irrecoverable debts.

The factor has no ‘comeback’ or recourse to the client if a customer defaults. When a customer of the client fails to pay a debt, the factor bears the loss and the client receives the money from the debt.


What is recourse, explain in detail

When the service is with recourse (‘recourse factoring’), the client must bear the loss from any irrecoverable debt, and so has to reimburse the factor for any money it has already received for the debt.

Credit protection is provided only when the service is non-recourse and this is obviously more costly.


When is credit protection provided?

Credit protection is provided only when the service is non-recourse and this is obviously more costly.


What are the steps in admin and debt collection in debt factoring?

1) Company sells goods to customer
2) Company sells the debt to the factor
3) Customer pays the factor after 30 days
4) Factor pays the company less the admin fee