, New Era University

VANTAGE EDUCATION MANAGEMENT

(Distance Education)
9 Central Avenue, New Era, Quezon City, 1107, Philippines

Subject : Credit and Collection FM 11-06

Term : 1st Semester, 2018 – 2019
Professor : Elizabeth T. Banan
E-Mail Add. : [email protected]

EDMODO ID :

Topic: THE CREDIT INVESTIGATION PROCESS

Week: No. 04 & 05

Learning Objectives:

1. Present some of the more important factors that should be checked fully
for individuals, partneeships and corporations.
2. Determine the multifarious from which credit a credit investigator could
find and secure credit information.
3. Evaluate the requirements for credit investigation work.
4. Discuss the requirements needed in credit application.

Introduction

There are no specific academic qualifications for a nonsense credit and collection job.
Suffice it to say that persons with academic anchor in business, law, liberal arts education even
engineering discipline as long as one has the patience for the job, the wisdom of Solomon, the
courage of David and the prophetic sense of John. Extent of experience would be necessary,
and this include exposure to the various aspects of credit activity. The creditman must have
creativity, initiative, resourcefulness,and ability to gain confidence of people to be able to elicit
confidential credit information. The credit investigator plays the role of an aide or ally to the
sale/treasury function. Around this, revolve his usefulness, function and responsibbbility.
Basically, he determine the facts in connection with his credit worthiness of credit customers or
credit applicants by gathering data on the standing of an individual or the condition of a
business concern. It is essential that he must know what pieces of information to obtain, where
to get it, and to present and analyze this information for the use of the credit/sales department.
Historically, it was only in recent years that the importance of the investigator’s role received
universal acceptance. Prior to this, creditors waited for information. Now, they go after the
information themselves. This shift in orientation follows the complimentary role of a creditor or
lender. As partner in the business community, he has to keep in paceif it is to sustain economic
activity as well as to maximize its own profits. Locally, credit investigators can be in house
gathering facts and information about a credit applicant for his company withour a fee, whereas,
the outside credit investigator also gathers facts, pieces of information and other credit
information about a credit applicant for fee. Generally, their methods and ways of gathering
credit information are substantially the same.

THE CREDIT INVESTIGATOR

Qualifications of a credit investigator

1. Character/Buttressed by Honesty and Integrity

2. Competence and Capability
3. Constructiveness in approach
4. Consistency/ Decision and Performance
5. Conscientiousness
6. Creativity/ Development of Broad Personal Interests
7. Confidence-Courage
8. Congeniality
9. Considerateness
10. Common sense
11. Contact- Concern
12. Cleanliness/ Charming

Educational requirements For Credit Investigation Work

The Credit Investigator must be given a wide latitude of exposure for the attainment of
proficiency in all phases of credit work. The process is a gradual one from the most fundamental
to the highly complex.

His knowledge in certain special fields however, shall be determined. He is expected to

develop tact, poise, judgement, adaptability, patience, and ability to read character in addition
to the inherent traits of honesty pleasant personality, business-like bearing and neat
appearance. Likewise,he needs to be imbbued with the following traits:

1. Accuracy in thinking process

2. Imagination
3. Good Memory
4. Responsible
 5. Ability to deal with people under different situations

Robert Morris Associates, an association of US bankers dedicated to the ‘encouragement

and protection of Trade and Commerce,” have eloquently set apart the more important fields
necessary to meet the stringent requirements of credit work;

1. An understanding of mathematics and accurate appreciation of the importance of figures

and facility in using them.
2. A basic and true understanding of the principle of economics.
3. A knowledge of accounting, which is not only desirable but necessary, for it is one of the
most valuable financial tools.
4. Development of legal background
5. Broad familiarity marketing technique, principles and practices of corporate finance.
6. Knowledge of psychology

Attainment of Proficiency

The credit investigator becomes proficient in four ways:

1. Theoretical studies
2. Practical studies
3. Through relating these theoretical studies with their practical application in the everyday
work, of credit department
4. Ability and willingness to plan ahead and make work moreinterestings; and the credit
man more valuable to his institution.

The Code of Credit Information Exchange

1. The first and cardinal principle in credit investigation is to respect the confidential nature
of the informtion received.
2. The name of the inquirer in whose behalf the inquiry is made should not be disclosed
without permission.
3. In answering inquiries, the source of the information should not be disclosed without
permission.
4. Any betrayal of confidence stamps the offender unworthy of future consideration.
5. Each letter of inquiry sshould indicate specifically the object and scope of the inquiry
6. When more than inquiry on the same subject is sent simultaneously to banks, it should
be indicated that information from their own files is insufficient as other checking are
being made.
7. All letters, including form letters should bear the manual signiture of the inquirer to
establish responsibility.
 8. The recipient of a credit inquiry’s is negligent in his duty if he does not read carefully
each letter of inquiry and answer fruitfully to the best of his ability each specific
questions.
9. In answering inquiries, it is advisable to disclose all material facts bearing on the credit
standing of the subject including the basis upon which credit was extended.
10. Indiscriminate revision of files when there is no real need for information is wasteful and
undesirable.
11. Where periodic revision of the information is made, it may be desirable to give your own
experience in the letter of inquiry in order that duplication and unnecessary
correspondence may be kept to a minimum.
12. In soliciting accounts, it is not permission nor the part of good faith for the soliciting
inquirer to make inquiries from a competitor without truthfully disclosing the nature and
object of the inquiry.

Credit Processing and Evaluation

The work of a Credit Investigator may be divided into three (3) major functions:

1. Gathering of credit information

2. Analysis of credit information
3. Dissemination of credit information

The credit investigator will be primarily concerned with the first and third functions,
while the second is primarily the responsibility of the Credit analyst, if there is such a
person in the Creditor’s office, otherwise, it shall be performed by the head of the credit
department.

The analysis of a credit risk always involves five (5) factors which are follows:

1. Personal factor
2. Performance factor
3. Economic factor
4. Risks factor
5. Security factor

More specifically, the investigation report should consist of:

1. Who is requesting for credit acconodation

2. Amount and type of the credit applied for
3. Purpose
a. Will it have repayment feature
 b. For credit to business, will the credit transaction finance the purchasing or the selling
end? Will the credit applied for enable the business to secure liberal discounts for
cash or to finance its inventories or receivables?
c. Is it to finance stock?to finance for slow turnover of inventory?
d. If the credit will be used to finance increase sales
e. Will the credit be used to repay and service old debts?
f. Will it be used to purchase fixed assets
g. Are the receivables collectible
h. Is the credit applied for,for consumption or to tide over business over temporarily
liquidity difficulties.
4. Collaterals
5. Sources and Mode of Payment
6. Nature of the Business

INSPECTION AND APPRAISAL

Nature and Purpose

Inspection and/or appraisal of property are conducted when they are offered or required for
a secured credit. This phase of the credit work goes hand in hand with the credit investigation.
The object of appraisal and the duty of the appraiser, is to evaluate the property being offered
as collateral, fairly and on the basis of its full cash value at a given point of time. There are
some drawbacks in arriving at a fair and equitable computation of value inspections are
conducted for various reasons; ranging from ascertaining the existence of the property, the true
nature of the property, its location, conditionand, estimating its real value vis-a-vis the one
submitted by the debtor to the creditor.

Types Of Properties

a. Real (immovable) Properties

1. Land(commercial, residential, industrial and agricultural)
2. Improvements on land (buildings, permanent structures, drainagesystems,
sidewalks). Others (heavy machinery or equipment almost permanently attached to
the land on a permanent nature)
b. Personal (movable) Properties
1. Motorvehicles, ships, airplanes,etc.
2. Machinery and equipment not attached to the land on permanent nature
3. Goods Inventory
4. Household appliances, furniture and fixtures
5. Jewelry, painting, shares of stock and similar items
 Creditors must always endeavor to inspect, check and appraise the assets of prospective
debtors; especially when these assets are offered as security or collateral. Inspection and
appraisal are generally conducted by a credit investigator and/or duly licensed appraiser.

The Major Objectives of Inspection and Appraisal are:

1. It is a fall back measure in case of failure to pay by the debtor (if the credit granted is
secured).
2. It is a means to evaluate the property offered as collateral
3. It is one way to determine the capacity of the debtor to meet his obligation when due.
4. Th ascertain the location, existence and value of the property.
5. To pinpoint the legal owner of the collateral and to know any problem affecting the
property.
Vigilance in the monitoring of the performance of a secured account will determine
your degree of success or failure in protecting your accounts receivable.

Pointers For Appraising Real Property

Good adjustment is arrived at by determining all relevant facts and/or trends within the
area;

1. Ascertain neighborhood trends and know whether transition is in progress or

forthcoming.
2. Determine the suitability of the property with the site and the harmony or lack of it with
the neighborhood.
3. Give consideration to transportation facilities, transportation arteries and traffic hazards
affecting the property.
4. Consider possible migration of social or economic groups that may after or affect the
profile of the neighborhood.
5. Be aware of imminent or prospective changes in zoning or use or any distresses like
which may affect property values.
6. Be cognizant of income possibilities of the property and to the value of that income as
determined in the market place.
7. Always estimate the remaining economic life of the property’s improvement.
8. Be informed on costs of construction of all types of properties, knowledgeable of
replacement costs, and be trained to determine accurate depreciation.
9. See the adaptability of special purpose property to other uses and the cost or
remodeling for such area.
 10. Determine the highest and best use of the property that use will produce the greatest
return over a given period of time.
11. Strive to be abreast with what is taking place in the market. Determine if sales are based
on free market forces or are affected by favorable or unfavorable conditions.

Credit or Loan Value

There is no hard and fast rule to arrive at a credit or loan value. Banks and financial.

When a business organization sells on credit, the administration of that credit becomes, on
some level, a management function. The type and extent of management required is not the
same in different types of institutions nor is it always handled in the same way in comparable
organizations. The level of management required for the administration of credit in a firm is
determined, more than anything else, by the concept of credit prevailing there. In some
instances, credit is viewed as a simple function of approving credit transactions. Little real
management activity is involved here. In other cases,, as the concept broades, the credit
function embraces sales and finace policy and other top management startegy.

Required Documents for Appraising Real Property

1. Transfer Certificate of title (TCT) or original Certificate of Title (OCT) as the case may
be.
2. Tax delaclaration- will show the existence of the property and a proof of its declaration
for taxation purposes.
3. Receipt or Tax Receipt- Proof of real estate tax for a given year.
4. Location Plan
5. Blueprint of any improvement or survey thereon.
6. Valuation method used and references.
7. Statement of reasonable valuation of the property as to market appraisal or loan or credit
value.
8. Current certificate of zonal valuation.

Gathering of Personal Information

Element of Credit

1. Trust And Confidence- credit and collection trustworthiness and credit worthiness are
often used interchangeably by credit and collection practitioners
 2. Risks-element can cause a creditor sleepless nights especially when he begins having
second thoughts about his decision to lend.

Managing the Credit Risk

All businesses have risk. Credit risk is a problem of setting on terms.
 Pay the obligation served.
 Failure of proper documentation
 Failure to register documents
 Failure of co-obligor, as well as the spouse of the contracting obligor
 Credit risk is composed of
 Performance risk
 Liquidity risk
 Policy ans system risk

Discerning, prudent assessment of the debtor’s management quality is the most

important aspect in arriving at a credit decision. Among the areas one has to check and
evaluate are:

 The debtor’s personal or business principles or practices.

 Integrity and moral standing
 Capacity, capability to earn, save and pay financial obligators
 Economic, financial analysis of the debtor.

Credit Risk Management Process

This involves the judicious, timely and prudent checking of the five basis of
credit, character, capacity, capital, conditions, collateral in applicable cases.

Credit Process

The normal process of credit granting involve the following tasks or activities.

 Determining the market

 Development, formulation of good credit policies, procedures in
consonance with the sales, marketing policies to attain goals, objectives.
 Credit initiation
 Documentation
 Delivery
 Credit administration
 Problem recognition
 Remedial management which include;
 o Problem definition
o Strategy definition
o Tactics or action plan implementation

Organization Staffing

To accept the credit process, emphasis must given attention;

 Good organization and development of manpower

 Judicious staffing, avoiiding putting people in “square pegs in round holes” jobs.
 Continuing, regular educational, training programs for the staff on the jobs
 Providing continuity to the operations.

Causes of Credit Risks

 Adverse macro-econommics, business cycle, product cycle

 Capacity to absorb disturbances caused by aberrations in cash flow, leverage,
capital, management experience
 Competition and industry trends
 Integrity and reputation problems
 Law and regulatory developments

Debtors’ Risk Ratings

 Credit allocation
 Credit pricing
 Credit approval level
 Credit covenant orconditionalities
 Average credit loss standards for estimating cost of credit or bad, debt
writeoffs.

Credit Diversification

Most businessses do not have credit diversification guidelines to avoid concentration of

credit in any particular sector of their market. Without a credit diversification guide, financial or
credit turbelencemay wreck havoc in their credit operations.
Effort must be undertaken by creditors to have an effective credit diversification guideline:

1. It’s prudent and good credit management technique.

2. Diversification as to debtors, industry, product line will mean “not putting all your eggs in
one basket”.
3. Target market criteria has procedure over diversifiction.

Basis of Credit

1. Caharacter
2. Capital
3. Capacity
4. Condition
5. Collateral
6. Connection

Financial factors

1. Liquidity Ratios – measures the firm’s ability to meet its maturing short-term obligations
Ratios Formulas Relevance
a. Current Ratio current assets/current liabilities measures adequacy
of working
capital

b. Quick-acid quick assets/current liabilities measures ability to

Test ratio immediately meet to
Short-term obligations

c. Cash Flow to cash flow from operations/ measures ability to

Current debt debt service generate enough
Service cash from regular ope
Ratio to service
2. Leverage Ratios – measures the extent to which the firm has been financed by debt.
Ratios Formula Relevance
a. Debt to equity ratio total liabilities/stockholders measures how much debt
Equity was incurred in relation to
The owner’s investment

b. Debt Ratio total liabilities/total assets measures percentage of assets

Financed by debt
 3. Profitability Ratios- measures management’s effectiveness as shown in returns
generated from sales and investments
Ratios Formula Relevance
Net profit Margin net income/sales measures the proportion of
Revenue that finds its way into
Profits
Return on Assets net income/average measures how much profits are
Total assets generated from investments
Resources
Return on Equity net income to common measures returns generated by
Stock/ ave. Common common shareholders
Equity
Earning Per Share net income to common Determine earnings generated
Stock/ No. Of outstanding per share of common stock
Common shares

4. Efficiency Ratios – measures how efficiency and effectively the firm is using its
resources
Ratios Formula Relevance
a) Asset turnover ratio sales/ave.total assets shows how hard the firm’s
Assets are being put to use.
b) Ave. Collection period Ave. Receivables/ ave. Measures the speed at which
Daily sales customers pay their bills
c) Inventory Turnover cost of goods sold/ Monitors the rate at which
Average inventory the company replaces the
Inventory

Generally Used Ratios in Financial Analysis/ Evaluation

1. Quick (acid) Test Ratio

Computation: total cash on hand, short term, marketable securities, and net receivables
divided by total Currebt liabilities.

Result: the ratio measures the short-term liquidity availability to pay-off current debts.
1:1 proportion is the ideal.
2. Current Ratio
Computation: total current assets (less allowance for bad debts) divided by Total
current Liabilities.
Result: the ratio is a measure of the ability of a debtor to meet his current debts.
 Principle: 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.
3. Fixed Assets to Networth
Computation: net fixed assets ( plant equipment less reserves for depreciation) divided
by tangible networth.
Result: it indicates the proportion between investments in capital assets and the
owner’s (debtor’s) capital in the business.
Principle: 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.
4. Debt to Networth
Computation: Total Assets divided by tangible networth.
Result: the ratio indicates the relationship between capital contributed by creditors to
the owner’s capital. This ration is also known as “what is owned to what is owned”.
Principle: the lower the ratio, the easier the pressure and the greater protection of the
creditors.
5. Debt to Capital Funds
Computation: total unencumbered debt (all current plus secured long-termdebt) divided
by capital funds (tangible networth plus, long-term unsecured debt).
Result: The ratio expresses the proportion between secured creditor’s capital and that
provided by unsecured creditors and the debtor.
Principle: 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.
6. Sales to Receivables
Computation: Net annual sales divided by Total trade receivables.
Result: The ratio expresses the relationship between the volume of business and the
outstanding trade receivables arising from sales.
Principle: A higher ratio- a higher turnover of receivables as it’s sometime called –
Totalindicates a more rapid collection of credit sales during the period, and a greater
liquidity of the receivables.
7. Number of Days Sales
Computation: Total receivables divided by net annual sales ( this fraction is then
mutiplied by 360 days).
Result: the result indicates the average time (in days) that sales remained uncollected
or are deliquent.
Principle: A comparison of this figure with terms of sales for the industry will show the
extent of the debtor’s control over his credit and collection operatons. The greater the
 number of day’s outstanding, the greater is the probability of delinquents in accounts
receivables.
8. Cost of sales to Inventory
Computation: cost of sales divided by Total Inventory (merchandise)
Result: The ratio expresses the proportion of cost of sales to inventory at the end of the
accounting period.
Principle: to measure selling capacity. The higher the ratio, the greater production
capacity and the more probable the freshness, salability and liquidating value of the
inventory.

9. Days Sales
Computation: The closelyratio expresses the average lenght of time (in days) that of
merchandise inventory is stored in the company before these are sold.
Principle: the number of days must correspond closely with the production time.

10. Average Collection Period

Computation: 1. Daily creditsales equals annual sales on credit divided by the number
of days during that period. 2. Then, average collection period equals trade receivables (
accounts and notes receivables) divided by daily credit sales.
Result: the figure will indicate wheather or not the collection time or period is within
allowable limit vis-a-vis the credit term granted or wheather it is within the industry’s
average.
Principle: This testis to determine how fast cash will flow from the collection of accounts
receivable. The lower the number of days with reference to the usual credit terms, the
better it is for the company and the creditors since there is very little likehood that the
receivables are old and worthless. Where the average collection period is higher than
the usual credit terms, this indicates an unfavorable state and will therefore require a
larger allowance for uncollectible accounts. This will tend to make the debtor highly
dependent on borrowed funds to finance inventory operations and will resort to
stretching.

11. Sales to Working Capital

Computation: Net annual sales divided by Net Working capital (or excess of current
assets over current liabilities).
Result: The ration indicates the turnover or annual activity of that portion of net capital
not devoted to fixed and other non-current assets.
Principle: 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.
Relating sales to working capital suggests the number of turnovers in working capital per
 annum. A low ration may indicate unprofitable use of working capital while a high ratio
often indicates over trading – a vulnerable conditions for creditors.

12. Sales to Networth

Computations: Net annual sales dividded by the tangible networth.
Results: The ratio reflects the activity of debtor’s capital during the year.
Principle: Capital is invested in a business activity for an expected profit of return
thereon, Profitability is largely dependent upon a reasonable activity of the investment or
the capital. This ratio is one measure of such an activity. A ratio that increases annually
indicates that the debtor’s capital is being used more frequently during the year. Ayear
high ratio may indicate under-capitalization, lack of sufficient ownership or debtor’s over
trading.
13. Profit before taxes to Networth
Computation: Amount of Net profit before taxes divided by tangible networth.
Result: The ratio expresses the relationship between the debtor’s share of operations
(before taxes) and the capital already contributed by him.
Principle: Capital is generally invested in a company in the anticipation of a return on
such an investment in a form of profit. The hope of profit is the attraction for the original
and new capital. The higher the profit before taxes to networth the greater is the
probability of increasing the debtor’s capital after payment of dividends and taxe.

14. Profit Before Taxes to Total Assets

Computation: The amount of net profit before taxes divided by the total assets of the
company.
Results: The ratio expresses the debtor’s profit (before taxes) in relation to the
resources contributed by both debtors and creditors.
Principle: It indicates the net profitability of all resources of the business.

15. Cash Flow to Current Maturing Long Term Debts

Computation: The net profit plus depreciation and amortization divided by the current
portion of long-term liabilities.
Result: This is a test to determine the ability to pay long term debts each year from cash
generated by operations.
Principle: Cash flow is the primary source of regular repayment of long-term debt and it
measures the coverage of such debt service. Generally, much, If not all, of the
depreciation will be needed for fixed asset replacement and expenditures.
Similarly, some parts of net profits maybe for dividends, It will be misleading to assume
that all cash flow is available for debt service. The ratio is a valid measure of the
optimum coverage and a very useful calculation in all considerations of term lending.

16. Accounts Payable Turnover in Days

 Computation: Accounts payable divided by Purchases ( If available from the
statements) them multiplied by the number of days in period or accounts payable divided
by the cost of goods sold, then multiplied by the number of days in the period.
Result: Discloses the trend of time taken to repay the trade creditors.
Principle: To provide a statistical base for comparing actual payments to vendors as
opposed to terms offered. It can be compared to industry data provided. It is a key to
determine whether or not a debtor (compaany) is taking discounts offered or conversely ,
living off their vendors (creditors) or stretching credits too far.

17. Credit Sales Index

Computation: Credit Sales divided by Total Net sales
Result: The ratio will show the proportion of cash and credit sales
Principle: This Ratio reveals the extent of credit sales in comparison to cash sales
transactions.

18. Funds Flow or Statement of Sources and Application of Funds

Computation: Increase in equities plus decrease in assets equals increase in assets
plus decrease in equities.
Results: This must be computed from, comparetive balance sheets. The difference
between sources and uses reflects the increase in worrking capital. (If it is a positive
difference) ad a decrease in working capital (If it is a negative difference).
Thus, sources minus uses equals working capital changes.

 Objectives and Goals in Financial Statements Preparation

 Provide information for cash flow projection
 Provide information about the business for financial condition for its stockholders,
owners and shareholders.

What will the financial statements provide

o A balance sheet summarizing the business financial position

o Income statement summarizing
o A cash flow statement summarizing the business cash flows from operating,
financingand investing activities;
o The retained earnings statement that explains any changes in the company’s retained
earnings;
o The stockholder’s (owner’s) equity describing changes therein.
Types of Financial Statement Analysis

1. Time Series Analysis

Used when the financial data are classified on basis of time intervals, contains vital
information as to the control and operations of business.

2. Correlation Analysis
Focuses on the relationship between two variables, one known, the other unknown to
estimate the unknown variable and measure the extent of the relationship between the
two.

Generally, computed from the various sub-elements within the financial statements more
particularly the ratios on; liquidity, leverage, profitability and efficiency.

The Credit Scorecard – A tool for Credit Evaluation

There must be some objective \, practical way for creditors to personally talk,
discuss with its credit applicant to be able to assess more intimately the credit applicant
and arrive at generally objective credit decision whether or not to grant credit. Generally,
the results of the field credit investgation and/or the salesman’s assessment most often,
results or contribute to deliquency or worst, to bad debt.

A way must bee developed to be able to avoid substantially the prejudices,

biases and subjectivity toward the credit applicant.

Creditors must develop from it’s past sales (loans), credit and collection data the
material, relevant and pertinent objective profiles of its customers; as well as the
questions to ask of the credit applicant as to their possession of the elements of credit.
These are; trust and confidence; the risk on the credit applicant; his business his
community the term of payment and previous performance with previous creditors; and
last but the least, any trade-off or exchange of temporal and/or moral values for the
credit applied for or granted.

Necessarily, by developing the pertinent logical questions for the credit interview,
the questions on the basis of credit, such as; character, capacity, capital, condition and
collateral must necessarily be asked of the credit applicant.The result of the interview
shall be compared with the result of the field crediit investigation. In this way there is
 more information, assessment and recommendation of the salesmen and results of the
credit investigation.

The profiles of the debtors (customers); and one’s past sales or loans, credit and
collection experiences in them, may thus be taken into account in a credit scorecard;
one of the fast emerging tools of credit exaluation, assessment.

The credit scorecard is a credit rating system used to assess, evaluate individual
credit applicants.

Purposes of the Credit Scorecard

1. To make certain that all the elements and basis are asked,scrutinized and evaluated to
avoid nothing and making it expeditious to obtain generally objective credit score from
the credit interview with the credit applicant.
2. To be ableto assign a generally realistic value or point to the answers to each of the
questions asked and be able to obtain an overall impression of the credit applicant as
well as transaction to be financed.
3. To have a greater degree of objectivity and neutrality in the process of assessing,
evaluating the credit applicant, thus avoiding polarization and subjectivity on issues of
personalities biases and prejudices against the person and avoid overlooking other
more important issues or matters.
4. To enable and allow the creditor as well as the credit applicant to look for ways and
means in improving the credit and the transaction applied for specially with regard to
risks reduction or elemination, if possible.
5. To have standard credit evaluation yardstick for the creditman to use in approving or
denying a credit.
6. To be able to collect, develop credit information data on credit applicants.

Specific Needs for a Credit Scorecard

1. To determine the risks level or degree on the credit applicant.

2. To evaluate the adequacy of risks cover or security and collateral.
3. To assist in developing the credit transaction or payment modes for the transaction.
4. To assist in determining the credit levels or amount to be granted, the credit term or
period to be extended.
5. As a source of auditing information to the credit transactions.

Why Use a Credit Transaction

1. You must decide why yoy want a credit scorecard system.

2. Decide whether or not the scorecard is just for one or more purposes.
 3. Availability of the credit and collection information or data

Designing a Credit Scorecard System

The main objective of the system is to bring out from the credit applicant the good and bad
aspects of trustworthiness, confidence in him the risk on his person or business or employment.

A sample of the credit analysis questionaires may be on the following aspects.

o Credit applicant’s personal bakground or circumtances

o Credit, legal records, cases for or against the credit applicant
o Sales, credit performance, projections
o Risk factors on the persons, business and community
o Term or period of past financial obligations with creditors
o Security or collateral package in applicable cases
o Exchange or trade-off of temporal and/or moral values for the credit applied for;
o Other relevant, pertinent questions to buttress the favorable possession of the various
good attributes of the elements and basis of credit by the credit applicant.

Whichever system or design you may adopt and use its important to remember that, the
scorecard is always open to adjustments or amendments to reflect the pragmatic
aspects of securing, evaluating the credit information obtained.

Guides in Assigning Credit Scorecard Points

Scoring is the process of assigning a numerical point or score to each question

or information obtained from the credit applicant.

1. Collecting of random samples of customers’ classes that the scorecard will distinguish
i.e.;
a. Good Risks
b. Medium Risks
c. Fair Risks

2. Determining which characteristics are consistently associated with one or the other class
of accounts;
3. Weighing the risk factors by assigning high points to those characteristics associated
with the good accounts and low points to the negative characteristics associated with
bad accounts;
 4. Comparing the points against independent samples of good and bad accounts to
determine whether the score sustains the credit decision.

It must be considered seriously that the credit scorecard must not only be to attain
and protect the financial interest of the creditor, rather as tool to discern more
accurately the credit applicants to have and consummate more good collected sales
with, which eventually will secure and fortify the financial sustainability of the
creditor’s credit (sales) operations.

 Leverage Ratios
 Liquidity Ratios
 Profitability Ratios
 Efficiancy Ratios

Advantages of Credit Scorecard

1. Credit policies maybe revised more objectively to meet sales marketing, credit situations.
2. It may provide a better guideline to less experienced creditman in arriving at a credit
decision;
3. It may mitigate costs of credit investigation.
4. May provide good monitoring and control over the risks of new accounts.

The anlaysis of the key credit characteristics and the assigned points are generally based on
the analysis of post credit performance of the accounts.

Credit scorecard is a sort of mathematical evaluation of credit risk based upon the law of
averages. The system reduces the possibility of judgement being influenced by
irrelevant, subjective factors.

Samples of Credit scorecard for individual with Capacity Capability Bias

A. Credit applicants personal circumstances, background............................................10

B. Personal credit records performances either creditors..............................................15
C. Capabilities.................................................................................................................20
D. Financial perfomance, projections..............................................................................20
E. Risks factors...............................................................................................................10
F. Payment Terms Mechanics........................................................................................15
G. Security Package........................................................................................................15
100
Sample of Credit Scorecard for Individual with Character Attribute Bias

a) Credit applicant personal circumstances,

Character background--------------------------------------------------------------------------25
b) Personal credit records performance with creditors -----------------------------------15
c) Financial Performance projections---------------------------------------------------20
d) Risk Factors-----------------------------------------------------------------------------10
e) Payments or Terms Mechanics-------------------------------------------------------15
f) Security Package-----------------------------------------------------------------------15
100

Sample of credit Scorecard for Individual with Character Attitude Bias

a. Credit applicant personal circumtances character background................... 25

b. Personal credit records performance with creditors .................................. 15
c. Financial performance projections ............................................................. 20
d. Risks factors ............................................................................................... 10
e. Payments or term Mechanics ..................................................................... 15
f. Security Package ........................................................................................ 15
100

The Credit Equation

The ingredients of a credit decision is judged mentally and pragmatically rather than
mathematically reducing it into formula however though the use of a credit scorecard is now
fast being resorted by some credit grantors.
Here is one rating used by some clients.
Character.........................................................................30%
Attitude toward financial obligation ............................ 10%
Ability to pay ................................................................ 20%
Business History .......................................................... 10%
Prospects for the future ................................................ 2%
Ratio value of property to annual income.................... 7%
Ratio of monthly debt service to income ..................... 6%
Others ........................................................................... 5%
Total 100%

Suggested practical combination of the credit equation without attempting to reduce the equation
to mathematical formula:
On the presumption that normal transactions and the same conditions apply to the credit risk of a
creditor, the credit equation matbe as follows.

Character + Capacity + Condition = Good Credit Risk

If however any of the basis of credit factors is impaired but not totally absent the nature of the
credit risk involved may be as follows:
1. Character + Capacity + Insufficient Capital = Fair Risk
2. Character + Capital + Insufficient Capacity = Fair Risk
3. Capacity + Capital + Impaired Character = Doubtful Risk
4. Character + Capacity – Capital = Limited Risk
5. Capacity + Capital – Character = Dangerous Risk
6. Character + Capital – Capacity = Marginal Risk
7. Capital – Character – Capacity = Poor Risk
8. Character – Capacity – Capital = Very Bad Risk
9. Capacity - Character – Capatil = Fraudulebt Risk

Whereabout/ Skip Tracing

Locating a bad debtor is a challenging, fascinating task, ingenuity, imagination, persistence,
daring and gutsiness are the personal traits one must possess to be able to locate an individual or
company that do not pay their debts. It’s a detective kind of work. No amout of a single
outstanding maneuver, cleverness or astuteness can conpensate for the lack of thoroughness. One
must have the patience to undertake painstaking pursuit of all leads, rumors which are the
motivation and foundation on which successful skip or whereabouts investigator anchor their
task.

General Steps for Whereabouts/ Skip Tracing

1. Avoid thoughtless plodding through series of routinary tracing or unverified information
gathering.
2. Exercise good judgement in selecting the more promising leads from earlier
investigations
3. Don’t be rigid in your sequence or steps
4. Procees from those inquiries which are most likely to bear fruit to those which are less
likely to do so.
5. Be objective, consider the costs of whereabouts/ skip tracing, its expensive.

Suggested Activities

1. Explain briefly the process of credit investigation?

2. What is the difference between market value and appraised value.
3. Give examples of existing credit business and discuss their sales in credit information
gathering?
4. What is your understanding of a credit scorecard?
5. Who is a skip?
6. Where do you check skips?
7. Why is property checking important in collection? Explain briefly?
 8. How important are the financial ratios in evaluating the financial condition of a credit
applicant.

Textbook:
1. Credit and Collection Management in the Philippine Setting, byJose T.
Apolo, latest edition
2. No-Nonsense Credit and Collection Discipline- Power by Erdulfo S. Sison

References:
• http://finance.lycos.com
• Credit and Collection by Gregorio S. Miranda, Latest Edition
• Fundamentals of Credit and Collection by Mercedes Euleterio
• www.wikepedia.com
• www.investopedia.com

Submission:
e-mail : [email protected]
EDMODO Code : (please sign-in for discussions)
filename : Week 04 & 05
subject (Re) : Credit and Collection Management
Note:
+ 0.25 – EARLY BIRD (submitted the prior to scheduled
deadline)
No additional point – Submitted on time
– 0.25 –l

Criteria:
Contents 60%
Timeliness of submission of report/assignment 30%
Presentation/Organization 10%
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100%