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Prelim - Credit and Collection
Bachelor of Science in Business Management Major in Financial Management (North
Eastern Mindanao State University)
Studocu is not sponsored or endorsed by any college or university
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THE FUNDAMENTALS OF CREDIT
WHAT CREDIT IS?
Credit is the privilege of using someone else’s money for a period of time. That
privilege is Based on the belief that the person receiving credit will honour a
promise to repay the amount Owed at a future date.
TYPES OF CREDIT
If you borrow money to be used for some special purpose, you are using loan credit.
If you Charge a purchase at the time you buy the good or service, you are using
sales credit. Trade Credit is used by a business when it receives goods from a
wholesaler and pays for them at a Later specified date.
USERS OF CREDIT
If you as a typical American consumer, you will use credit for many purposes. You
may use Credit to buy fairly expensive products that will last for a long time, such
as a car, house, or major appliance. Or you may use credit for convenience in
making smaller purchases, such as meals and CDs. Paying for medical care,
vacations, taxes, and even paying off other debts are other common uses of credit.
CREDIT INFORMATION
The business that is considering you as a credit risk will generally ask you about
your financial Situation and request credit references.
THE THREE Cs of CREDIT
Character- refers to your honesty and willingness to pay a debt when it is due
Capacity- refers to your ability to pay a debt when it is due
Capital- is the value of the borrower’s possessions
BENEFITS OF CREDIT TO BUSINESSES
Businesses benefit in several ways. By being allowed to buy on credit, customers
will tend to Purchase more, and the business will increase its profits. If the business
buys its merchandise Using trade credit, the merchandise can be paid for after it
has been sold to customers.
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BENEFITS OF CREDIT TO CUSTOMERS
Ways in which consumers benefit from their use of credit:
Convenience- credit can make it convenient for you to buy. There may be times
when you do not have enough cash and have a need for something.
Immediate possession- credit allows you to have immediate possession of the item
that you want.
Savings- Credit allows you to buy an item when it goes on sale, possibly at a much
lower price.
Credit rating- if you buy on credit and pay your bills when they are due, you gain a
reputation for being dependable
Useful in an emergence- access to credit can help you in an emergence. Having an
oil company credit card, for example, can come in handy when you run out of gas
and cash at the time.
PRECAUTIONS FOR USE OF CREDIT
Some problems as a consumer can encounter with unwise use of credit include the
following:
Overbuying- overbuying is one of the most common hazards of using credit. There
are several Ways in which this happens. You may purchase something that is more
expensive than you can afford. Or you may be tempted to buy items you don’t
really need.
Careless buying- careless buying may result if you become lazy in your shopping.
Credit can tempt you not to wait for a better price on an item you want.
Higher prices- higher prices may be paid. Stores that sell only for cash are able to
sell at lower
Prices than stores that offer credit. Extending credit is expensive. It requires good
account to Keep accurate records of each charge sale and each payment.
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Overuse of credit- overuse of credit can result in too much being owed. Buying now
and paying Late may sound like a good idea; but if too many payments are to be
made later, the total amount that must be paid can become a problem.
Credit- is the privilege of using someone else’s money for a period of time
Debtor- anyone who buys on credit or receives a loan
Trust- means that the creditor believes that the debtor will honour the promise to
pay later Goods and services that have been received and used
Loan credit- if you borrow money to be used for some special purpose
Sales credit- if you charge a purchase at eh time you buy the good or service
Trade credit- is used by a business when it receives goods from a wholesaler and
pays for them at a later specified date.
Credit references- are businesses or individuals from whom you have received
credit in the Past and/or who can help verify your credit record
Character- refers to your honesty and willingness to pay a debt when it is due
Capacity- refers to your ability to pay a debt when it is due
Capital- is the value of the borrower’s possessions
Credit rating- if you buy on credit and pay your bills when they are due, you gain a
possession For being dependable. In that way, you establish a favorable credit
rating.
USES OF CREDIT REVOLVING ACCOUNT:
Are purchases that can charged at any time but only part of the debt need be paid
each month? There is usually a maximum amount which is owed at one particular
time. A monthly payment Is required. A finance charge is included to use this type
of credit.
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BANK CARDS—these have become quite popular over the past several years the
most Common used are VISA and MasterCard. There is usually an annual fee for
the privilege of Using these cards.
TRAVEL & ENTERTAIMENT—Carte Blance, Diners Club and American Express are
the most Widely used entertainment credit cards. A yearly membership fee is
charged for use of these Credit cards and it is higher than the annual fee charge by
bank cards. These are used for Motels, hotels, restaurants etc.
OIL COMPANY CARDS—such as Texaco, Chevron, Shell and Stinker Stations issue
their Own unique credit cards. Many oil companies that it costs them way too much
to offer credit. So they have left that to credit card companies which is their
specialties.
RETAIL STORE CARDS—many retail stores are now carrying their own cards. They
carry the Name of the department or retail store involved. These are usually very
high interest and are Referred to as the “single-purpose” credit cards.
USES OF CREDIT CONSUMER LOANS
INSTALLMENT LOANS—is one in which you agree to make a certain amount of
monthly Payment.
SINGLE PAYMENT LOANS—you don’t pay anything until the end of the loan period.
PROMISSORY NOTE—is a written promise to pay based on the “debtor’s” excellent
credit Rating.
COLLATERAL—is a security deposit. Something of value is put against the loan so in
the Event it isn’t repaid the company can acquire the property.
SECURED LOAN—is simply some type of property that is put up against the loan.
COSIGNER—is someone who signs on additionally to a loan and promises to pay if
the person Who is first on the loan does not.
TOPIC 2
CREDIT HISTORY OVERVIEW, DEFINITION, AND BRIEF HISTORY
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Credit history (also called credit report) is a very important aspect of life. Some
people do not Understand the importance of credit history until they are denied
credit. Situations like this do Not happen when consumers have a full
understanding of their credit and credit history. Every Aspect of credit plays an
important role in whether or not creditors lend credit to customers.
Credit History Definition & Overview
Consumers’ credit history is kept in a document known as the credit report. Credit
history is An in depth account of how well lenders manage their credit. When
creditors extend credit to Their consumers, they keep a record of the payment
history and report is to one of the 3 credit Agencies. Late payments and missed
payments are reported to the credit agencies who in Turn record the information
on the credit report. The report of customers’ credit history is Available to them to
see as well as potential lenders who may be considering lending credit to
Customers. Credit history makes up the largest percentage of a credit scores.
Consumers Should know that credit history accounts for 35% of a credit score.
Consumers should know that their credit history consists of past and present
accounts. Do not Think for one second that paying off bills automatically increases
the credit score. Credit history Consists of open and closed accounts on mortgages,
credit cards, and loans. Credit history Can remain on the credit report for many
years after the late or missed payments. Bankruptcies And defaulted loans also play
a part in credit history. Something else can lead to lower credit scores that can
affect credit history: high credit Balances. Just because payments are always on
time does not mean that credit history Remains intact. When cardholders have less
than 50% of available credit on their credit cards, Their credit score lowers. For
example, a credit card with a $1,000 credit limit with only $300 Of available credit
can hurt credit history. The History of Credit Reports/Credit The practice of offering
consumer credit began during the 18th century. Western Union started The first
official credit system of the modern age in 1914. Many other large companies
followed In Western Union’s path. World War II created the need for an established
credit system. Businesses began to grown after World War II so there was a great
need for more credit in the economy. The establishment of the credit system began
to strengthen. Consumer credit use created the need for a universal system that
allowed lenders to share Credit information about their customers in order to make
good credit decisions. The first credit Agencies consisted of non-profit groups
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owned by participating merchants. By the 1970s, there Were over 2,000 credit
reporting agencies around the country. During that same time, large Companies
that offered credit created their own systems to maintain credit records, which
Limited credit decision agencies around the country. The record keeping became
very time Consuming so these large companies moved to consolidating these
agencies on a national And regional basis. By 1998, there were more than 500 credit
bureaus in the United States. The three main credit scores that emerged were
Trans Union, Equifax, and Experian.
Why Credit History Matters
Credit history determines whether lenders extend credit. It is important that
consumers Understand that credit history accounts for the largest portion of a
credit score. The first thing That potential lenders look at is the payment history on
the credit report. Late payments, Defaults, and bankruptcy send up red flags for
potential lenders. Credit history may affect interest rates. Lenders offer their best
interest rates on mortgages, Car loans, and credit cards to those with the best
credit ratings. Those with credit histories that Reflect high credit limits and late
payments may still qualify for credit, but they may receive the Highest interest rates
on the market. Good credit history is necessary for customers who want to
purchase homes. Many people Dream of owning their own home. That dream may
never come for those with a poor credit History. High interest rates can make a
significant difference on large investments such as Homes. Good credit history can
save consumers thousands of dollars in interest along with The monthly payments.
Credit history is important to consumers who want to receive credit. Mistakes on
credit reports That can affect credit history are very common. It is very important
that consumers receive a Credit report from each of the three credit agencies each
year to assure that their credit history Is correct. Once consumers ruin their credit
history, it is extremely hard to get back on track. Always use credit wisely.
TOPIC 3
Credit Banking: Meaning, Functions and Purpose of Credit Banking
Credit: Meaning and Functions: With the introduction and use of money credit also
came into existence. Credit is created when One party (a person, a firm or an
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institution) lends money to another party, the borrower. Thus, Credit is generally
understood to mean the finance provided to others at a certain rate of Interest.
The act of lending and borrowing creates both credit and debit. Whereas debt
means the Obligation to pay the finance borrowed, the credit means the claim to
receive these money Payments from the other party. Every credit involves debt,
that is, obligation to pay money and Therefore creates claim. The act of borrowing
and lending and thereby the creation of credit is a special type of Exchange
transaction which involves future payment of the principal sum borrowed as well
as The rate of interest on it. The lending and borrowing of money and the
institution of money Lending came into vogue ever since money was invented by
man. In the modern times there Are a variety of institutions which specialise in
borrowing and lending of money. The bank credit is only one form of credit. Money
lenders, indigenous bankers, credit Cooperative societies, commercial and
cooperative banks, industrial financial institutions, L.I.C. export finance houses etc.
are all credit institutions and do the business of borrowing And lending money.
Different credit institutions lend money for different purposes and are Collectively
called the financial system. Thus commercial banks are only one segment, though
An important one, of the financial or credit system of an economy. Credit
institutions can be differentiated according to the type and purpose of credit they
offer. There are credit institutions which lend money only for agriculture. There
are others which Provide credit only to industries and still others to finance exports
only. Credit institutions also differ in respect of the duration of period for which
they lend money to Their clients. Some provide short-term credit, some mediumterm credit and others only long-term credit. We shall study only one type of creditinstitution, namely, the commercial banks.
Functions of Credit:
The main function of credit is to relieve the constraint imposed by balanced
budgets on Economic agents, that is, to meet the financial requirements of
investors who have to spend More on trade and investment than their own savings.
Accordingly, it is through the means of credit that the surplus funds with some
individuals and
Institutions are made available to the deficit spenders, that is, those who are
required to spend More than their resources, for instance, traders, companies,
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investors. It is the performance of this function, that is, the transferring surplus
funds of some to meet The spending by the businessmen and investors, that the
banking and other segments of the Financial system are able to promote savings
and investment, to ensure better allocation of Financial resources and thereby to
encourage economic growth in the economy. But, for the Credit system to perform
these functions, it needs to be efficiently managed and controlled. If credit is not
efficiently managed, it can cause inflation or deflation, recession and
Unemployment in the economy. Besides, the mismanagement of credit can lead to
Misallocation of investible resources and thereby hinder economic growth. It can
also cause Concen-tration of economic power in a few hands and exploitation of
weaker sections and thus Work against the achievement of social justice.
Purpose or End-Uses of Credit:
Credit is required for different purposes and by all sectors of the economy.
Therefore, there is Need for the proper allocation of credit between different uses
and sectors if the society is to Achieve its objectives. When credit is demanded and
used for productive purposes, it may be Used to finance the needs of working
capital or for fixed investment (i.e. capital equipment, Machinery etc.). The broad
categories of economic activity for which credit for productive pur-poses is
Demanded are:
(a) Agriculture,.
(b) Industry,
(c).Construction, and
(d) Trade, both domestic and foreign
Further, in each of these categories, the allocation of credit between different users
is of crucial Importance from the viewpoint of economic growth and social justice.
Thus, in agriculture Allocation of credit between large landowners and small
farmers has been a matter of serious Debate. Likewise, the allocation of credit
between the large-scale industries and small- scale
Industries has been a major concern in India’s credit policy. Credit policy in India in
recent years has emphasised certain priority sectors such as Agriculture, small
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scale industries, export and weaker sections of society such as small and Marginal
farmers, young entrepreneurs for whom greater amount of credit is to be made
available.
TOPIC 4
CLASSIFICATION OF CREDIT
The major sources of credit can be classified into institutional or formal and noninstitutional Sources.
Non-Institutional
The non-institutional or informal sources are those which do not have any
uniformity in their Lending procedure, their interest rate or their collateral
requirement. Loan from such sources Are usually made directly to the borrower
by the lender and are prevalent in areas where Individuals are quite familiar with
and share confidence in one another. In other words, the Lender knows the
borrower and reasonably vouch-safe for his (borrower’s) integrity. The Relative
ease of obtaining the loans devoid of administrative delays, non-insistence by the
Lender on security or collateral from the borrower and flexibility built into
repayment Programmes has made the non-institutional sources very popular
among the peasant farmers.
Non-institutional sources however have such limitations as smallness of loan, high
interest Rates etc. Notable examples under this source include
-Merry go rounds
These are funds to which a group of individuals sharing common characteristic
make a Contribution of a fixed amount of money, handed to one person. Each
member is able to make Use of the money in turn, making allowance for a member
in dire need of a loan or advance. These are granted without interest payment.
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-Money Lenders
These people usually make their money outside the rural community but later
settle down in Villages giving loans to farmers at exorbitant interest rates. Some
farmers who pledge their Lands, crops and buildings have lost them due to their
inability to pay the high interest rates Charged on the principal when due.
-Friends and Relatives
This is part of cultural heritage whereby the prosperous help their less fortunate
relatives and Friends with loans. In some cases, the loan is not collected back.
Institutional Sources
The institutional sources are those recognized institutions which follow
standardized Procedures of lending. They lend at regulated interest but normally
require some collateral. The loans from this source are always large compared with
those obtained from non institutional sources. Under this sources include
-Cooperatives
Formal cooperatives can be regarded as a transition or an interphase between
formal and Informal credit sources. Cooperatives especially savings and credit
cooperatives (SACCOS) Also play an important role in saving.
-Commercial Banks
These are institutions set up by the government or group of private individuals with
the aim of Accepting savings and deposit from members of the public as well as
granting them credit Whenever they are in need. Those farmers who keep their
money in such banks may be able To get loan from the bank. But due to the inability
of most farmers to offer suitable collateral Security coupled with the risky and
uncertainty nature of agricultural business, commercial Banks often prefer to lend
to borrowers engaged in non – agricultural ventures which are less Prone to risk
and uncertainty.
-Specialise Banks
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These are institutions specially set up to meet the need of a particular sector of
the economy. For instance, the Agricultural Finance Corporation (AFC) was
specifically established to cater .For the agricultural sector of the economy
1. Short-term Loans.
The short- term loans
purchases like
are generally advanced to meeting annual recurring
Seeds, feeds, fertilizers, hired labour, expenses on herbicides, pesticides and
machinery Service charges. It is therefore termed “seasonal loans or production
loans or crop loans” and It is usually expected that the loans (principal) and the
interest would be repaid through the Income received through the enterprise in
which it is invested. Time limit to repay such a loan Is usually one year or at most
18 months.
2. Medium-term Loans
Are advanced for comparatively longer span assets like machines, wells, threshers,
sheds for Livestock, shelter, farm structures, irrigation structures etc. The returns
accrued from the use Of such assets are usually spread over more than one
production season. Repayment period Spans between 15 months and 5 years.
3. Long-term Loans
These are related to long life assets like land, farm buildings construction of
permanent Drainages or irrigation system etc. which require large sum of money
as initial investment. Benefits generated through such assets are spread over the
entire life span of the asset. Repayment period ranges from 5 years to 20 years.
Classification according to Purpose of the Loan
Credit could be classified based on the purpose of the loan such as crop loan,
Poultry/dairy/piggery loan, machinery and equipment loan, forestry loan, fishery
loans etc. This Type of loan signifies relationship between time of usage and the
rate of returns (profitability).Sometimes loans could be classified as “production
loan” or “consumption loan.
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Classification according to Security offered
Loans can be classified as secured and unsecured loans. Securities are usually
advanced Against tangible assets like land, livestock or any capital asset, as either
medium or long term Loans. Note that credit worthiness may sometimes count
much more than the security offered, Which if doubtful, may result in wilful
default. Secured loans can be further classified on the Basis of the type of security
offered as:
Mortgage loans: Where legal mortgage of tangible and intangible properties like
land, land Improvement and other infrastructures are offered.
(ii) Hypothecated loans: Where legal ownership of assets e.g. machinery and
equipment, Financed remains with the lender though physically possessed by the
borrowers.
Promissory Note
A promissory note is the primary legal document in most loan contract. It is the
written promise Of the borrower to repay the loan. When advancing loan funds,
the lender receives in exchange A note signed by the borrower promising to pay
the lender a certain stated principal with Interest on a certain date as specified in
the note.
Mortgages
This is ranked second to the promissory note. It is not only an additional note but a
Complement. A mortgage is a list of certain property set aside to guarantee the
payment of a Loan which is set in a promissory note. Mortgages are identical to
promissory note in their chief Provisions. They are also sometime called indentures.
The mortgage in addition to identifying The property to back up the promissory
note contains provisions which establish a priority of Claims among lenders
according to the filling or according the mortgage in a court of law. Sometimes a
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bond and not a promissory note accompanies the mortgage but the general Effect
is the same.
There are several types of mortgages
1. Real Estate Mortgage: Real estate in law is land and laded property. The
important Feature of real-estate mortgage is the unchanging character of the
security.
2. Chattel Mortgage: These are mortgage on movable property such as animals.
Purchase on Contract
This is sometime simply referred to as hire purchase contract. This involves the
transfer Contract Property to the buyer or the purchaser while with the title of the
property remains with the seller Until the last instalment is paid. Hence purchase
on contract is sometimes referred to as Conditional sales contract.
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