2/26/22, 11:47 AM Code 386- Credit and Collection - https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_as… Home Code 386- Credit and Collection Midterm Week 1 Credit Evaluation, Financial Analysis and Credit Decision WARNING: No part of this E-module/LMS content can be reproduced or transported or shared to others without permission from the University. Unauthorized use of the materials, other than personal learning use, will be penalized. ONLINE LEARNING COURSE FMGT 1083 (Credit and Collection) This Week’s Time Table: (Feb.22- Feb.26) For this week, the following shall be your guide for the different lessons and tasks that you need to accomplish. Be patient, read them carefully before proceeding to the tasks expected of you. HAVE A FRUITFUL LEARNING EXPERIENCE Date Topics Activities or Tasks Credit Evaluation, Financial Analysis and Credit Decision Feb.22-26 Read Lessons - Credit evaluation - Financial analysis Accomplish your task in the worksheet of this module Feb.26 Preparation of Task Essay Lesson 7: Credit Evaluation, Financial Analysis and Credit Decision Credit Evaluation Factors used to evaluate application Topics: Financial Analysis Financial ratios Learning Outcomes: At the end of this module, you are expected to: 1. Use various factors in evaluating credit application 2. Explain how various ratios can be used to arrive at a credit decision 3. Create a credit decision https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_assignment%2Fshow%2F30992313&lesson_id=15074259 1/5 2/26/22, 11:47 AM Code 386- Credit and Collection - https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_as… LEARNING CONTENT Introduction: After all the necessary credit information have been collated and written in a report form (CIR), the next task is to evaluate the credit risk. Aside from examining and evaluating the different factors , an analysis of the financial statements submitted by the applicant and duly verified by the credit investigator should also be made. Lesson Proper: Credit Evaluation Credit Evaluation simply means that process of finding out by proper analysis of what constitute the acceptable degree or amount of risk the company, bank, or other financing institutions is willing to undertake in a particular case. The following basic questions should be answered: Is the risk sufficiently good to be acceptable at all? If the risk is satisfactory, to what extent should credit be granted? And, under what conditions or terms should credit be granted? The first task is to evaluate the different credit factors as reported in the CIR. These credit factors are what are generally known as the 5 C’s of credit. This has been described in the previous lessons. Financial Analysis Many types of financial ratios may be used. The purpose for which the analysis is made usually will suggest emphasizing one set of ratios in preference to another. For example, a lender of short term credit places emphasis on the current position of the borrower. The rationale for this point of view is the short term nature of the loan and the size of the loan, which is large relative to the current flow of funds from net earnings. Hence, profitability is less important than the availability of the borrower’s current assets. In contrast, the long term investor in a business places far greater emphasis on earning power than on the pledge of assets and the past and present earnings upon which the present value of the firm’s shares are based. https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_assignment%2Fshow%2F30992313&lesson_id=15074259 2/5 2/26/22, 11:47 AM Code 386- Credit and Collection - https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_as… Generally used ratios in financial analysis/ evaluation computation Quick (acid) test ratio Current ratio Fixed assets to networth Debt to networth Total cash on hand, short term marketable securities, and net receivables divided by total current liabilities Total current assets (less allowance for bad debts) divided by total current liabilities Fixed assets(plant equipment less reserves for depreciation) divided by tangible networth Total debts divided by tangible networth result The ratio measures the short term liquidity availability to pay off current debts. A 1:1 proportion is the ideal principle The quick ratio is of particular benefit to short term creditor as it gives the extent to which cash and other assets readily convertible into cash can meet the demands of current liabilities. Any ratio that is less than 1:1 is indicative of dependence on other current assets, like inventory to liquidate short term debt The ratio is a measure of the ability of a debtor to meet his current debts In comparing an individual with the industry, a higher current ratio indicates that more current assets are free from debt claims of creditors and that more up-to-date payments are possible. It indicates the proportion between investments in capital assets and the owner’s (debtors) capital in business The higher the ratio, the less is the debtor’s capital available for working capital. The lower the ratio, the more liquid is the networth and the more effective is the debtor’s capital as a guarantee of payment in case of the liquidation of his business. Substantial leased-fixed assets on the balance sheet may apparently lower the ratio. The ratio indicates the relationship between capital contributed by creditors to the owner’s capital. This ratio is also known as “what is owned to what is owed” A debtor’s total assets represent the total capital at his disposal. His assets may consist of his networth, his equity or capital. The creditor’s capital is provided by those outside the business for the debtor’s temporary use. The proportion existing between debt and networth or leverage, records the debt pressure. Debt to capital funds Total unencumbered debt (all current plus secured long term debt) divided by capital funds(tangible networth plus long term unsecured debt) The ratio expresses the proportion between secured creditor’s capital and that provided by unsecured creditors and the debtor. This is a refinement of debt to networth ratio, records debt leverage in relation with the capital base (sometimes referred to as the borrowing base). It recognizes the capital provided by creditors whose rights are subordinated under contract to other creditors Sales to receivables Net annual sales divided by total trade receivables The ratio expresses the relationship between the volume of business and the outstanding trade receivables arising from sales A higher ratio- a higher turnover of receivables as it is sometime calledindicates a more rapid collection of credit sales during the period; and a greater liquidity of the receivables. Total receivables divided by net annual sales (this fraction is then multiplied by 360 days) The result indicates the average time (in days) that sales remained uncollected or are delinquent A comparison of this figure with terms of sale for the industry will show the extent of the debtor’s control over his credit and collection operations. The greater the number of days outstanding, the greater is the probability of delinquencies in accounts receivables Cost of sales to inventory Costs of sales divided by total inventory (merchandise) The ratio expresses the proportion of cost of sales to inventory at the end of the accounting period. To measure selling capacity. The higherthe ratio, the greater the production capacity and the more probable the freshness, salability and liquidating value of that inventory. Days sales Total inventory multiplied by 360 days and divided by cost of sales The ratio expresses the average length of time (in days) that merchandise inventory is stored in the company before these are sold. The number of days must correspond closely with the production time. 1. daily credit sales equals annual sales on credit divided by the number of days during that period The figure will indicate whether or not the collection time or period is within allowable limit vis-a-vis the Number of days sales Average collection period This test is to determine how fast cash will flow from the collection of accounts receivables. The lower the number of days with reference to the https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_assignment%2Fshow%2F30992313&lesson_id=15074259 3/5 2/26/22, 11:47 AM Code 386- Credit and Collection - https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_as… 2. then, average collection period equals trade receivables (accounts and notes receivables)divided by daily credit sales Sales to working capital Sales to networth Net annual sales divided by net working capital (or the excess of current assets over current liabilities) Net annual sales divided by the tangible networth credit term granted or whether it is within the industry’s average. usual credit terms, the better it is for the company and the creditors since there is very little likelihood that the receivables are old and worthless. The ratio indicates the turnover or annual activity of that proportion of net capital not devoted to fixed and other non-current assets Net working capital represents the basic support for those assets undergoing conversion cycles (like inventory to receivables to cash) during the selling period or year. A low ratio may indicate unprofitable use of working capital while a high ratio often indicates over trading- a vulnerable condition for creditors The ratio reflects the activity of debtor’s capital during the year. Capital is invested in a business activity for an expected profit or return thereon. Profitability is largely dependent upon a reasonable activity of the investment or the capital. A very high ratio may indicate undercapitalization, lack of sufficient ownership or debtor’s over trading. Profit before taxes to networth Amount of net profit before taxes divided by tangible networth The ratio expresses the relationship between the debtor’s share of operations (before taxes) and the capital already contributed by him. Capital is generally invested in a company in the anticipation of a return on such an investment in the form of profit. The higher the profit before taxes to networth, the greater is the probability of increasing the debtor’s capital after payment of dividends and taxes Profit before taxes to total assets The amount of net profit before taxes divided by the total assets of the company The ratio expresses the debtor’s profit (before taxes) in relation to the resources contributed by both debtors and creditors. It indicates the net profitability of all resources of the business Cash flow to current maturing long term debts The net profit plus depreciation and amortization divided by the current portion of long term liabilities This is a test to determine the ability to pay long term debts each year from cash generated by operations The ratio is a valid measure of the optimum coverage and a very useful calculation in all considerations of a term lending. Accounts payable turnover in days Accounts payable divided by purchases (if available from the statements) then multiplied by the number of days in the period or accounts payable divided by the cost of goods sold, then multiplied by the number of days in the period. Discloses the trend of time taken to repay trade creditors. To provide a statistical base for comparing actual payments to vendors as opposed to terms offered. It can be compared to industry data provided. Credit sales index Credit sales divided by total net sales The ratio will show the proportion of cash and credit sales This ratio reveals the extent of credit sales in comparison to cash sales transactions Increase in equities plus decrease in assets equals increase in assets plus decrease in equities. This must be computed from comparative balance sheets. The difference between sources and uses reflects the increase in working capital,(if it is a positive difference) and a decrease in working capital (if its is a negative difference). Thus sources minus uses equals working capital changes. It is an invaluable tool for analysing movements of working capital and tracing the causes of balance sheet item changes. Funds flow or statement of sources and applicants of funds Credit Equation The ingredients of a credit decision is judged mentally and pragmatically rather than mathematically reducing it into formula however through the use of a credit scorecard is now fast being resorted by some credit grantors. On the presumption that normal transactions and the same conditions apply to the credit risk of a creditor, the credit equation maybe as follows: Character + capacity + capital + condition= good credit risk https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_assignment%2Fshow%2F30992313&lesson_id=15074259 4/5 2/26/22, 11:47 AM Code 386- Credit and Collection - https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_as… If however any of the basis of credit factors is impaired but not totally absent, the nature of credit risk involved may be as follows: Character + capacity + insufficient capital Fair credit risk Character + capital + insufficient capacity Fair credit risk Impaired Character + capacity + capital Doubtful credit risk Character + capacity - capital Limited risk capacity + capital – character Dangerous risk Character + capital – capacity Inferior credit risk/ marginal risk Capital – character – capacity Distinctly poor risk Character – capacity – capital Inferior credit risk/ very bad risk Capacity – character - capital Fraudulent credit risk In case the credit evaluator finds that the risk is below average, or, that there is a necessity to improve the credit rating, the transaction can still be salvaged by asking either for an acceptable guarantor or by requiring additional collaterals to improve the risk. The credit decision thus made may then be classified according to the degree of risk involved in each case as: A or above average or excellent risk B or Fair or satisfactory risk C or below average or unsatisfactory risk END of LESSON 7 Textbooks Sison, Numeriano. (2004), No nonsense credit and collection discipline-power. BAGCO Credit, Makati City Apolo, Jose T(2003). Credit and Collection in the Philippine Setting, National Bookstore Briones, J. (2005). Credit and Collection Management Made Easy. National Bookstore https://usl-tuguegarao.neolms.com/student_lesson/show/3143302?from=%2Fstudent_quiz_assignment%2Fshow%2F30992313&lesson_id=15074259 5/5
