CHAPTER 7

CREDIT MANAGEMENT

LEARNING OUTCOMES
1. Know the importance of credit management;
2. Understand credit investigation and appraisal;
3. Know the credit work;
4. Identify what a credit policy;
5. Explain the credit file;
6. Identify credit policies of commercial houses;
7. Value of granting credit;
8. Understand the importance of sound credit management, and
9. Explain what credit frauds are.

The function of credit may be briefly summarized in the following words: To find profits in the field
of business activity which lies between the area of safe risks and those definitely poor.

For this very reason, the boundless effort of every business organization to increase its profits by
doing and carrying all the business it can on sound footing has given birth to the science of credit
management.

Importance of Credit Management

There is hardly any business concern today which is not engaged in the grant of credit of one type
or another. However, briefly pointed out, granting credit is one thing and collection another. Thus, there
is a need for a system which will insure close collaboration between the grant of credit and its collection.
While it is true that selling goods and rendition of services only to customers who have shown and
demonstrated their willingness and ability to pay on the basis of their past records would doubtlessly
reduce the incidence of risks, nevertheless, such policy Will evidently result in a reduction in sales volume
and ultimately work adversely against the interest of the firm.

On the other hand, precipitous and indiscriminate granting of credit to all types of customers,
while increasing sales volume, could undermine a firm and usher its collapse. Hence, the need as well as
the importance of a sound and efficient credit management.

The Credit Man in the Business World

For quite some time, the credit man was looked upon no differently from a glorified clerk or
bookkeeper whose job consisted mainly of keeping record it, financial transactions of the firm's
customers.

That, of course, is now a thing of the past. Today, there is recognition of the important
contribution of the credit man to the successful operation of the company. So important is he that his
words generally carry much weight. It is who makes recommendations based upon investigations, studies
and analyses, whether credit, should be granted or denied.
 Failure on his part to discharge properly the task and responsibility repos upon him by virtue of
his position in the company could adversely affect i business world in general. Lack of judicious care in the
grant of credit will only, trigger losses for the business concern but, at the same time, result in a diminution
credit to those who are deserving and are actually entitled to it. Undue laxity, whit increasing the volume
of business, could mean one thing: bad debts cluttering the books of accounts of the company which are
difficult, if not impossible, to collect.

On the other hand, the overzealousness of the credit man to prevent losses for the company and
thus become overly strict with respect to the grant of credit could generate the loss of customers and
thus, consequent reduction in the volume of business.

Thus, it is perhaps correct to say that a credit man must be a student of trade and business
equipped with a thorough understanding of the prevailing economic conditions and their implications. He
must have a keen foresight into future conditions that affect business in one way or the other. In the
words of Beebe and Morton, in their book "Credits and Collections", the credit man "has within his power
to drive old customers away just as he could likewise help educate the stubborn customers as to earn
their everlasting goodwill"

Efficiency of the Credit Man in His Work

It is exceedingly difficult to lay down specific criteria for judging the effectiveness of the credit
man in the performance of his task. For while it may be true that bad debts are held to the minimum,
however, such cannot be a safe gauge if at the same time it has resulted in small volume of business. Thus,
it is important as well as necessary, in the case of a retailing or wholesaling establishments to know how
many orders were refused as well as how many were accepted.

It goes without saying that it is far easier to refuse orders than to select reasonable risks or to
handle doubtful customers in such a manner that they Wil be future boosters for the company. Clearly,
then, different cases must be treated in different ways.

The Credit Department

The credit department does not grant or extend credits. Its task and responsibility revolve around
the gathering of all credit information about the applicant and assembling them in such a way that they
could be of help in properly guiding the loan officers in their assessment and analysis for purposes of
establishing correct credit ratings.

In a number of instances, one overriding factor which the credit department must give weighty
consideration is, not only with respect to the degree of profitability to be derived from the credit
operation, but also its influence as a booster in the sale of other goods of the company. As may be
observed, many large establishments which sell goods and/or services on credit maintain credit
departments which attempt to evaluate the paying capacity of present and potential customers on the
basis of information gathered and analyzed.
 Credit and sales departments must cooperate closely with each other. A sales executive who does
not support the efforts and policies of the credit department can do much harm to his company. The same
holds true for a credit executive who is not sales-oriented. The effective use of credit and the proper
application of credit management help develop business operate on a sound basis.

In the particular case of banks, the credit department collects and files every available bit of
information concerning people or firms that borrow money. In a detailed manner, its main work consists
of investigating, assembling, and analyzing and recording credit information for the guidance of the loan
officers of the bank. The officers use the information in processing loan applications and moreover by and
large in reaching decisions with respect to actions it will choose to take.

The functions of a credit department of a bank may be briefly stated as consisting of a systematic
and judicious collection of data respecting the financial responsibility, character, antecedents, and
business qualifications and abilities of the bank's customers, the classification of the data on each
customer in chronological order, and their systematic preservation for future reference and comparison.
Thus, needless to point out, an orderly and well-arranged credit file will immediately disclose at a glance
the entire career and present business standing of any customer.

Not infrequently, the credit departments of banks furnish a valuable if not indispensable service
for customers and friends of the bank by making credit information available for them under proper
circumstances. This courtesy is often of value to non-borrowing customers, to other banks, and also to
business concerns.

The Credit Manager

The credit manager, paradoxical as it may seem, is a man who occupies a very important position
in the structure of a credit economy and yet is little known and least talked about outside the world in
which he lives. Upon his decision rests the success or failure of a credit granting organization. In small
concerns, he is the credit investigator, credit appraiser, credit supervisor, and credit manager (if not a
loaning officer at the same time) all rolled into one.

A real good and capable credit manager, in a very correct sense, owes his position to himself. For,
while he was appointed by someone to his the top of organization to his position, such is due in large
measure to his proven ability as demonstrated in every position he has held before in the past. Moreover,
his appointment is a tribute to the organization he represents for having chosen the right man for the
right position.

In a big concern, he is a head of staff trained, experienced, and capable men charged with credit
work. Such men are known as credit investigators, no, appraisers, and credit supervisors. A good credit
manager is progressive in his de and thinking. Moreover, he should be devoid of prejudices against and
biases in favor of any organization. Otherwise his thoughts and views will be colored by them. He should
be, over and above everything else, morally upright and in intellectually honest, and must have a complete
knowledge of the facts surrounding every application for credit, if he is to discharge his responsibilities
well.
CREDIT INVESTIGATION AND APPRAISAL

At this point, let us focus our attention on what a typical bank credit department does with respect
to credit investigation work. Like that of any financial institution that is engaged in the grant of loans or
extension of credits, sound bank management dictates that a thorough and careful credit investigation of
clients and appraisal of security (ies) as collateral be conducted before any accommodations are made.
This task is generally performed by the Credit Investigation and Appraisal Section of the Credit
Department. Doubtlessly, the quality of information gathered is largely dependent on the ability and
resourcefulness of the credit investigators and appraisers.

Credit Investigation

This task is performed by the bank's credit investigator who has, as his main objective, the
verification as well as evaluation of the applicant's character, credit standing and integrity through the
process of data-gathering of all essential facts. Generally speaking, the elaborateness of a credit
investigation as a practical matter depends upon its cost relative to the magnitude of the principal and
interest involved and the security being offered by the applicant. The results obtained from credit
investigation is an essential part of credit analysis for the proper evaluation credit risks which necessarily
cannot be any better than the facts assembled.

The request for Credit Investigation Report (CIS) may come from any officers departments of the
bank for any of the following purposes:

a. On clients seeking loan accommodations or credit line with the Loans Administration Department
through Marketing Management Department;

b. On clients applying with the International Banking Department to secure ailment in the form of
Letters of Credit, Import/Export Bills, Trust Receipts, and other forms of accommodations;

c. On clients opening current/savings accounts with the Cash Administration for the first time
(which, of course, is no longer common nowadays in view of the competitive nature of the banking
business)

d. On clients transferring business with the Treasury Department through the money desk;

e. On co-makers and guarantors for credit;

f. On old clients for updating client information;

g. On insurance companies requesting accreditation or offering to act as surety;

h. On beneficiaries named in the Letter of Credit;

i. On prospective buyers of assets acquired by the bank;

j. On prospective suppliers of office equipment and supplies and contractors of services; and
 k. Others, subject of special cases.

Upon receipt of a request or Credit Investigation Report and supporting papers, an investigator is
assigned to handle the case and to conduct a proper study of the applicant's background. The assigned
credit investigator initially checks the subject with bank's credit files and prepares a tickler where he notes
down initials which he thinks will require some degree of emphasis during the conduct of his investigation.
Within a specified period of time, usually three days, the credit investigator is expected to come out with
a Credit Investigation Report.

The Scope of Credit Investigation.

The scope of credit investigation depends, to a large degree, upon the following factors:

1. Purposes and types of investigation. Whether the investigation is a routine matter or a special
case and the purpose is general or specific.

2. Company credit policy. Whether the policy is a conservative or liberal one, and whether it
requires a comprehensive investigation of cases, or a representative sampling would suffice.

3. Client classification. Whether the client is new or an established one; a past-due account or a
valued one.

4. Amount involved. Whether the amount involved is big or small if it is a small one, chances are a
limited type of investigation will suffice. It involves a fairy large sum, investigation may be rigid
and thorough relative to the risks involved and, of course, with respect to the amount of income
to be derived measure of profitability.

5. Time and resource constraint. The scope depends on such factors (time and resource constraint)
since the report must be finished on the date it is needed by the requesting officer/department
of the bank and also, on the availability of the credit investigator who will conduct the
investigation.

Generally, the scope of credit investigation covers and includes the following.

I. Company's background/history

This covers the complete business record, such as the date of incorporation, the type of business
organization, record of registration with the proper authorities, the names of incorporators, and the
summary of operating records. In the case of an individual, his personal background, business, identity,
and membership in organizations will be necessary together with bank and trade references.

The investigator also takes into account the requirements common in the following types of business
organization:

a) Single proprietorship. He sees to it that the owner has the capacity to enter into a lawful contract.
If the owner is a married woman, she must possess the legal right to transact business as required
under the Civil Code of the Philippines.
 b) Partnership. The first fact to be ascertained is whether it is a general or a limited partnership. This
is important and essential since under a general partnership, all the members are general
partners. As such, they are liable to the whole extent of their separate properties, either
subsidiary and pro rata or solidarity, for partnership debts. In a limited partnership, one or more
members, aside from the general partners, are limited partners who as such shall not be bound
by the obligations of the partnership.

Secondly, whether the contract of partnership is registered or not with the Securities and
Exchange Commission. However, registration with the Securities and Exchange Commission is not
a pre-requisite for the acquisition of juridical personality of a partnership since the juridical
personality begins from the moment of the perfection of the contract.

The credit investigator should also take into account and consider the following characteristics of
a partnership such as:

• There must be a contract;

• The partners must have legal capacity to enter into the contract;
• There must be mutual contribution of money, property or industry for a common fund;
• The purpose must be to obtain pecuniary profits and to share the same;
• The purpose for which the partnership is formed must be lawful; and
• Moreover, the Articles of Co-partnership must not be kept secret.

Other important matters that must be looked into are those relating to the contribution of each
partner, in what form (property, money or industry), citizenship of partner's agreement with respect to
division of profits and losses, term and designation of officers, etc.

c) Corporation. The reader need not be reminded that a corporation is the most complicated form
of business organization and moreover is classifiable into various types. However, the most
common classes are: public and private corporations, sub-divided into stock and non-stock, and
as to place of incorporation, sub-divided into domestic and foreign.

The legal existence of a corporation begins from the date of the issuance of the certificate
of its incorporation by the Securities and Exchange Commission. Important matters which a credit
investigator should carefully consider in the Articles of Incorporation are the following:

• Name of the corporation. This is essential inasmuch as its name helps to establish its identity and
distinguishes it from the others. The Securities and Exchange Commission in its recent ruling
prohibits the use of the words "Maharlika", "State", etc...
 • Its purposes, objectives, nature, and powers. Although a corporation may be formed for as many
lawful purposes as the incorporators may desire, nevertheless, the corporation law and other
pertinent special laws, expressive or impliedly, prohibit certain corporations from having more
than one purpose. They are corporations "formed" for the "purpose of engaging in the business
of transportation by land or water, or of maintaining a telephone telegraph, or wireless
communication system" and corporations for whit; special provisions are established by law, such
as railroad companies, building and loan associations, religious corporations, trust corporation,
colleges and other institutions of learning. Banking corporations and insurance companies are
governed by the General Banking Act (Republic Act No. 337) and the Insurance Act, respectively.

• The location or place of business.

• The term of duration of corporate existence. Such term is not to exceed so years. While a term
may be decreased, however, it cannot be increased o, subsequent amendments of the articles of
incorporation.

• The names and residences of the incorporators. This determines whether the statutory
requirements that the majority of the incorporators must be residents of the Philippines has been
fully met and complied with.

• Names of incorporating officers.

• The capital stock and the number of shares into which it is divided.

• The names and citizenship of the stockholders and the amount or number of shares they have
actually subscribed to and the amount paid on subscriptions. In cases where capital is divided into
par value shares, at least 20% of the capital stock should be subscribed. Where the entire capital
stock is divided into no-par value shares the 20% requirement shall be computed on the basis of
number of share.

As to corporations granted franchises for operations of public utilities, mining and agricultural
corporations and other corporations organized for the disposition, exploitation, development or
utilization of the natural resources of the country, at least 60% of the capital stock of such corporations
must be owned by citizens of the Philippines.

• The acknowledgment of the duly executed Articles of Incorporations before a notary public.

The company's history also covers the complete record of the men who comprise the operating
management of the business, their respective ages, whether they are married or not, and if they have
children, the number, sex, and age of the children. It also includes information on their educational
attainment, their previous employment, if any, and their particular experience in their respective lines of
business.
 II. Financial Conditions

Herein is represented in summary form a breakdown of the financial statement of the company
reflecting its latest financial condition and the results of operation for the past three or five years.

Aside from the balance sheets and income statements, it may include schedules, explanations or
extraordinary items, breakdown of merchandise and receivables and full explanations of all inter-
company loans and merchandise transactions.

III. Dealings with Government Lending Agencies

a) With lending agencies of the government. The credit investigator concentrates on the size and
degree of fluctuations on borrowings as well as the nature of the security pledged to secure the
loan. In case of long-term loans, the yearly, semi-annual, quarterly or monthly installment
payments to maturity must also be ascertained, (including arrearages, if any).

b) A multitude of facts that could be obtained from merchandise suppliers. They may be very useful
in matters pertaining to incidence of credit, amount owing, amount past due, if any, terms and
payment performance of the subject of inquiry.

c) Other banking institutions. The investigator should focus his inquiries on such matters as the
following

 Nature of the credit accommodation granted.

 Whether borrowings are on secured or on clean basis.

 If secured, whether the security consists of real estate mortgage, shares of stock,
warehouse receipts, chattels, assigned receivables, discounted notes receivables,
assignment of claims under a government contract or some other forms of security.

IV. Bank's Experience with the Subject

Has there been any previous relationship established in the past?

V. Court Cases

From the Credit Management Association of the Philippines data on court cases could be gathered
information about the subject's involvement in, not only collection and other civil cases, but also criminal
cases, as well, if any.
 It is important as well as essential to point out the fact that when a close study is being made, it
is essential to check with trade competitors on the subject (if it is a business concern). In “competitive
checking", the following information must be sought:

a) The importance of the subject in its particular line of business, the genera reputation, the ability
of the management and the quality of the products and or services being offered.

b) The general outlook as to the conditions in the subject's line of business and whether the
operating methods used are considered sound.

c) Whether the subject resorts to unfair method of competition.

d) Names of either concerns to whom the subject may be known.

THE CREDIT WORK

The efficient performance of the credit work revolves around the presence and cooperation of a
staff of trained, experienced and capable personnel whose task and responsibilities are delineated by the
kind of positions they hold in the department, such as credit supervisor, credit analysis, credit appraiser,
and credit investigator. The job description of each is presented in summary form in the following
paragraphs.

A. Supervisor

1. Handles the over-all supervision of his section or department.

2. Receives request for Credit Investigation Report/Appraisal Report and assigns them to senior
credit investigators/appraisers for completion and submission on a certain date.

3. Reviews, edits and makes necessary corrections on the Credit Investigation Report/Appraisal
Report submitted by senior credit investigators/appraisers.

4. Answers credit inquiries from banks, trade firms, bank clients and other financial institutions.

5. Implements procedures and ascertains that all matters as well as inquiries of importance are given
top priority.

6. Undertakes to maintain or improve existing relations with other banking institutions and other
sources of credit information.

7. Supervises the preparation of monthly reports on output.

 8. Performs other related functions from time to time, such as:

a) Trains the new associates of the Section and counsels and guides them in the performance
of their jobs.

b) Prepares a list of assignments for each analyst. This includes gathering of all data required.

c) Recommends to the department head, acquisition of financial books, journals, magazines,

and periodicals relevant to the improvement of analysis preparation

B. Senior Credit Analyst

1. Assumes responsibility of the supervisor in his/her absence.

2. Concentrates on evaluation of Cash Flow Projections based on the projected Income Statement
and Balance Sheet and Feasibility Studies of various companies.

3. Conducts an intensive research on the business prospects of industries for a more effective
financial and credit evaluation of Cash Flow Projections and feasibility study reports, submitted
to the bank.

4. Works continuously on the revision of present and future credit rating sheets of credit evaluation
reports to cope up with the changing economic/ financial situations.

5. Assists supervisor in discharging his/her duty in time of heavy work load.

C. Junior Credit Analyst

1. Assist senior credit analyst.

2. Studies financial statements and other documents submitted by the client and prepare the
following reports:

a) Credit Analysis and Rating. An evaluation of the financial status of the client/company,
industry standing, availability of collaterals for evaluating credit worthiness of the client
and/or to pinpoint other bank services which can be offered.

b) Financial Analysis. An analysis of the post-operating rating performance of the client and
may include a projection of future performance.

c) Cash Flow Evaluation. An analysis and projection of cash generation capacity and future
cash requirement of the client.
 d) Project Evaluation. A complete study of the technical, financial, marketing and
management aspect of a client’s proposal including effects of the project on the economy
as a whole.

D. Senior Appraiser
1. Receives and assigns request for Appraisal Report to appraiser(s).

2. Edits Appraisal Reports prepared by appraisers).

3. Assists the appraiser(s) in carrying out their functions.

4. Conducts inquiries/surveys on the current market value of real and other properties acceptable
to the bank as collateral.

5. Performs such other functions as may be found necessary from time to time

E. Appraiser
1. Conducts ocular inspection of properties offered as collaterals.

2. Sketches the vicinity and location of the property under appraisal.

3. Verifies the authenticity of original/transfer certificates of titles with the Register of Deeds.

4. Summarizes in a report form findings on the ocular inspection made on the properties offered as
collateral.

5. Entertains inquiries/checking of appraisers of other banks.

6. Conducts inquiries/surveys on the prevailing market values of real and other properties
acceptable to the bank as collaterals.

7. Performs other functions that may be assigned from time to time.

F. Senior Credit Investigator

1. Receives and assigns request for CIR to credit investigator and sets date of completion.

2. Initially reviews and edits CIR prepared by credit investigator.

3. Entertains credit inquiries from other banks and commercial houses.

4. Occasionally assists credit investigators in carrying out their functions.

 5. Assists in the development of efficient and comprehensive credit files.

6. Gathers information concerning other banks' credit procedures.

7. Performs such other functions as may be assigned from time to time.

G. Credit Investigator
1. Conducts checking and evaluation of applicants for credit accommodation as well as of existing
clients.

2. Interviews co-makers and employers of applicants/clients to verify data gathered.

3. Undertakes bank, trade, government and court checking regarding credit dealings of the
applicant/s.

4. Prepares Credit Investigation Report, memos, letters, and other correspondence.

5. Assists collection group in locating the whereabouts of clients with past-due obligations and real
estate properties registered in their names.

6. Conducts special investigations, surveys as per requests of other department heads.

7. Performs other functions as may be assigned to him from time to time.

Necessity for Close Supervision

The necessity for a considerable amount of supervision on the part of the credit manager over his
staff is quite apparent. Credit men operate during much of the working time away from the home office
removed from definite and direct executive control. However, one method which could make the credit
men do their job, as expected of them, is to give them a "deadline" for the case they have under
investigation and study.

Psychologists suggest three important appeals for use in attacking the problem of supervision,
such as:

a. Pride in accomplishment.

b. Monetary reward for a difficult job done, like collection of a bill that is about to be written off,
and
c.
 d. Commendation and praises. This may be done through letters of commendation if not through
the awarding of plaque or certificate, of merit.

Bank Appraisal Report

Generally speaking, a bank appraisal report contains, among others the following information:

A. Subject of Appraisal
1. Name of registered owner
2. Location of the property

B. Land Identify
1. TCT number
2. Technical description
3. Lot number
4. Block number
5. Land area

C. Description of Land

6. Shape
7. Frontage

D. Neighborhood Data

1. Commercial
2. Semi-commercial
3. Residential
4. Industrial
5. Raw land
6. Others

E. Public Utilities

1. Electricity, water, telephone, gas, etc.

2. Kind of transportation facilities available

H. F. Improvements
1. Full description of improvements
G. Valuation

1. Market and appraisal values of land

2. Net value of improvements
3. Total appraised value
4. Recommended loan value

H. Encumbrances

1. Names of mortgages and amount

2. Others that might be annotated in the Original or Transfer Certificate of Title

CREDIT POLICY

In most instances, a bank's credit policy evolves from an unwritten set of standards, sometimes
very nebulous, to more specific criteria covering the conditions under which loans are made. Where a
bank is small, such policies are seldom found in writing. However, the policy although not expressed is
given meaning and substance through practice and implementation. As the bank grows in size and more
bank personnel are involved in extending credit to customers, it becomes very essential that appropriate
guidelines and standards should be established in as objective a manner as possible and expressed in clear
and unmistakable terms.

A policy has been described as a "decision in advance". Owing to the fact that the entire range of
loan function of a commercial bank is basically interwoven with the decision can but result in the
elimination of flexibility and could work against the interests of the bank. A sound credit policy with
sufficient degree of flexibility could help contribute to the successful operation of commercial banks
insofar as loan functions are concerned.

How Bank Loan Policy is formulated

Any loan policy that may be formulated by a bank reflects but one phase of the over-all policy
program of the institution. Such a policy must obtain the stamp of imprimatur of the board of directors.

As in generally observed, as a common practice among banking institutions, the actual

preparation of policy statements is usually carried out by the president or senior loan and credit officer,
depending in large measure upon the size of the bank and the staff available.

A statement of loan policy, among others, includes reference to types of loans and the basis upon
which loan applications may be considered. Such, however, are circumscribed by the provisions of the
General Banking Act which governs the operations of commercial banks.

Also, the kinds of securities that are considered acceptable by the credit-granting institution are
also the subject of loan policy. And, so with amounts involved. In fact, when a certain amount involved in
a loan application does not exceed a certain ceiling imposed by the board of directors, it is subject to the
approval of the loan committee. Beyond such ceiling, approval is lodged as the exclusive prerogative of
the board.

Briefly noted, in the formulation of a loan policy, the officers are guided by two primordial
considerations: First, the protection of the depositors’ fund. Second, the production of a fair return for its
lending and investment activities. The activities of the credit department contribute a major portion of a
bank’s income. In fact, they represent one of the major areas of top management concern and attention.

Setting a Standard for Control Purposes

It goes without gainsaying that no policy achieves maximum effectiveness, unless is accompanied
by a periodic check up to insure its proper implementation and ascertain its weak spots, if any. In fact, by
having an established loan policy, a program is made possible against which actual performance or
practices can be evaluated for purposes of determining variations, if any, and the necessary application
of remedial action. As already indicated earlier, a sound loan policy should be made flexible to provide for
alternative courses of action and thus enjoy the advantage of the policy serving as a guideline rather than
as a strait jacket.

The loan policy should be stated in clear and unmistakable terms so that its implementation by
the officers of the bank charged with such function will be easy. Moreover, such bank charged with such
function will be easy. Moreover, such loan policy should provide specific guidelines for particular types of
categories of bank credits, such as the following:

1. Agricultural credits

2. Commercial loans

3. Industrial loans

4. Real estate loans

5. Consumer or personal loans

6. Term loans

Dissemination of Loan Policy

The importance of effective communication to the success of any undertaking has been stressed
time and again. Its validity is not in any way diminished regardless of whether the organization is small or
considerably huge. Without it, the organization would be engulfed in an ocean gap that would act as a
monkey wrench that will ruin the entire machinery of the business organization.
 In the particular case of commercial banks, its policies should be disseminated thoroughly and
well understood by all who are concerned with their implementation. Since a loan policy is but one facet
of the over-all policy of the bank, it follows that an internal information drive should be launched from
time to time, it's the occasion demands, with the objective of inculcating upon all those concerned the
need, as well as the importance, of giving meaning the substance to such policy through is effective
implementation.

To ascertain the effectiveness of such a policy, it is essential that a review of its effects upon the
organization be made as well as its impact upon the bank's customers in the light of existing business
conditions. Only then can it be determined whether the policy is sound and judiciously necessary or not.

THE CREDIT FILE

So important is the credit file to any firm extending credit that it behooves upon it to adopt a
system of gathering and putting every information about term credit file customers and applicants into a
folder which is filed in proper order. Hence, the credit file.

As credit information is received by the credit man, he goes over it carefully to make sure it is as complete
as possible. Then he puts it into the credit folder (a large envelope) bearing the customer's name and
address. Necessarily, one folder is assigned to each customer or applicant for credit.

In this manner, through the course of time, there is accumulated eventually a complete credit
history of each customer, to which immediate reference may be made at any time when the need arises.
Arranging the folders in alphabetical order enjoys the advantage of providing easy location.

Experienced credit managers also keep a card record on which are noted the different kinds of
information. Two distinct advantages are obtained from this method. One, a card record could be
examined quickly without taking the time to go through the papers in the folder. Second, in the event that
some records are found missing from the folder for whatever reason or reasons, the company will not be
left in the dark, since it has another means which could help serve its purpose.

It is important that credit files be kept up to date. In some banks, the responsibility for constant
revision of such file as needed by circumstances falls upon the credit department. Others place it under
the charge of the loaning officer.

Regardless of where the responsibility falls, it is good policy to revise such files not more than
once a year unless unusual circumstances prevail. Since credit files tend to get big and bulky, it is necessary
that those with inactive status be transferred to other folders.

A major problem common among credit-granting institutions pertains to keeping track of credit
folders when they are removed from the credit file - especially so when time is of the essence and there
is immediate need for a particular credit folder.

A very practical method, if not to say the best method, to solve such problem and thus serve the interest
of that company is by inserting a board the same size, the credit folder it its place with the following
information’s name of the folder, das it was removed from the file, and the person who has the folder.
 Maintenance of credit files with utmost confidentiality should be the over-riding concern of the
officials charged with this responsibly, Because of the riding concern art or he information contained in
the credit files, folders can only be withdrawn upon prior authority granted by the responsible official.

Credit files give historical account of transactions and are generally observed subdivided into a
number of sections. For instance, the first section is used for statements. As may thus be logical to expect,
the latest financial statement of the company is found with the bank's comparative statement form. The
second section contains a compilation of reports on interviews conducted by the loaning officer of the
bank and his staff. Correspondence and other related matters with banks and business firms are contained
in the third section. The fourth section contains an up to date file record of borrowers as well as
prospective ones. In the case of the former, also their latest balance is included. The fifth section contains
reports from credit agencies whose services and assistance have been sought by the bank.

CREDIT POLICIES OF COMMERCIAL HOUSES

To say that a credit department is essential in every organization engaged in the grant of credit is
to elaborate on the obvious. On the part of small concerns, a credit department may exist merely as a
section. Or it may seem not to exist at all. At any rate, even in the absence of any, credit functions are
discharged by a responsible official in the organization. In fact, in the particular case of sari-sari store
which sells goods on credit, owing to its size and the close contact between the owner and his customers,
the existence of a credit department appears superfluous. However, the owner himself performs the
credit investigation and evaluation of his customers.

Credit policies may vary from one business enterprise to another. One relates to the type of
customers who are to be granted credit. One firm may be primarily interested in increasing the volume of
sales. It therefore grants credit to all applicants and runs the risk of some losses. Others take extraordinary
precautions in granting credit that could reduce their sales volume.

It could be stated categorically that there is no simple yardstick or criterion that could be used to
guide the business enterprises in the formulation of their respective credit policies. Be that as it may,
certain fundamental principles could prove helpful when taken into account and applied accordingly. Their
observance operates as an instrument of control.

Scope of Credit Policy

After adopting a credit policy, the business enterprise must decide just what its credit terms are
and what credit period it will adopt as well as its credit limits.

By credit terms is meant the terms or conditions under which the credit is granted. It includes the
time, when payments must be made and the discounts, if any, that will be allowed for prompt payment.
In other words, credit terms pertain to the period when credit obligations will remain subsisting; for
instance, payment shall be made one week after delivery, or 30 days as the case may be in accordance
with company policy. In many instances though, this is not strictly enforced thus resulting in considerable
delay in payment of credit obligations.
 By credit period is meant the length of time within which the customer is expected to remit in
part or in full. If this period expires before such payment has been made, the account becomes delinquent.

If a long term of payment is allowed, a greater number of prospects can be appealed to, but more
capital will be required and tied up for quite sometimes. On the other hand, if a short term of credit is
made, the number of customers is reduced, but less capital is needed.

Some credit-granting companies impose a limit with respect to the amount or value that a
customer can obtain from the firm. This is known as credit limit. In other words, a seller places upon a
customer's credit standing an indicated limit- insofar as it relates to his own firm. Expressed in another
way, it indicates the seller's judgment of the amount of debt that a customer can incur and pay his firm.

As a sound practice, the credit limit of every customer is recorded in the ledger card. This
eliminates the necessity of reviewing the customer's file each time an order of goods is placed (or a loan
is sought). In the particular case of a loan, many important considerations exert profound bearing on the
amount that may be granted by the creditor company.

Doubtlessly as conditions are constantly changing, it would be unwise for any company selling
goods on credit to establish too definite limits as to the amount of credit which will ordinarily be extended
to a customer. The capacity to make money and promptness in paying one's obligations will, by and large,
be significant factors in deciding the matter. Obviously, the customer who can sell the goods which are
shipped to him, and can promptly make payment therefore, is a very safe credit risk.

At this point, it should be pointed out that the problem of mercantile credit is somewhat different
from that of bank credit. This is so, since under mercantile credit, each transaction may be self-liquidating.

On the other hand, loans obtained from as bank are liquidated out of a composite or series of individual
transactions. Thus, bank loans generally cover a longer period of time than those of mercantile credit.

Purpose and Advantages of Credit Limits

As aptly pointed out by Theodore N. Besting and Ronald S. Foster in “Credit and Collection”,
although limits are sometime danger signals, just like warning posted at approaches railroad crossings.

By and large, the principal purpose of credit limits is to serve as guides b credit management and
control. In fact, through its use, before the determination. Credit limits, there is a need for careful
investigation and comprehensive analyst of the elements composing a given risk. In a nutshell, then, this
is conducive to improved credit granting.

From the foregoing, it appears quite evident that credit limits operate as an overall device for the
control of credit extensions. More specifically, credit limits aid in reducing the cost, of credit management
and in enhancing its efficiency. Limits also work to the advantage of debtors. It serve as a check against
reckless buying spree which if unchecked could ruin the lives of debtors and as such suffer the disgrace of
being labelled as poor debtors.
Principles of Controlled Credit

The following fundamental credit principles could serve as the cornerstone of a controlled credit policy.
They are:

1. Only after a thorough investigation of the credit worthiness of the customer seeking credit may
credit be granted.
2. Each new customer should be made acquainted with the terms and conditions as promulgated
and implemented by the business firm with respect to terms ot payment; discounts, if any;
credit period; and credit limit.
3. It is necessary that the first reminder be sent immediately, i.e., the next day after bills become
past due.
4. Continued use of the credit privilege should be suspended in respect. to slow paying customers.
Such privilege may be given back to them only after they have paid their existing indebtedness.
5. Decisions and actions should be characterized by firmness but short of being rude and arrogant.
6. When it becomes absolutely necessary, the services of collection agencies must be sought or
legal services enlisted as the case may be.

The Problem of Credit Extension

Few merchants ever escape the problem involving the extension of credit to customers. As
previously pointed out, some use credit to increase profitable sales. Others, however, incur losses due to
unwise credit extensions. Thus, due caution and extreme care should be exercised in granting extension
of the credit period to customers. The longer the credit period is, the greater is the incidence of
delinquencies. The credit extension problem is by far one of the most difficult phases that confront many
a businessman.

GRANTING CREDIT

Aptly observed, granting credit to the individual is one thing and to a business firm is entirely a
different matter. Since, like most anything, credit could either be misused or abused, it behooves upon
everyone who extends credit to exercise proper care and caution and thereby be able to prevent their ill
effects not only to the parties concerned but to the nation's economy as a whole.

Careless and unjustified granting of credit merely serves to fan the strong desire to buy goods in
amounts one does not need nor could well afford to pay. In fact, while delinquent debtors are largely to
blame for their wrong doings, however the creditors are not entirely without fault. At times, they are the
culprits for making credit both easy and quite cheap.

The procedure by which a credit manager handles an order from an old customer of the firm
appears quite clear. However, it may be asked: What is his procedure with respect to a new customer
whose first order involves purchases on credit?
 Three major considerations immediately come into the picture all of which merit attention. The
first relates to the size of the order. Not infrequently, a number of business firms may be willing to take
certain risk, that is readily allow a small first order without 'a thorough and complete credit checking than
they will in the case of large order. However, small losses may be due to non-payment of obligations by
debtors when accumulated together could turn out to be a staggering sum. It must exercise caution and
providence.

The second refers to the identity of the applicant for credit and his references. The business firm
should be sure of the reputation and integrity of the applicant as well as the references which accompany
the order. The seller must have some strong and intelligent basis for granting the credit. Perhaps, a sound
basis is - the experiences of other firms in their relationship with the new customer.

If a prospective customer is unable or does not provide the necessary trade, references requested
of him, such a circumstances could be valid reason to deny the grant credit which must clearly understood
as privileges conferred and never a right.

The third is the customers rating appears in the register to some merchant agencies. This is not
always possible especially so when the customer is new in the business and therefore has not yet
established a name or reputation for himself.

If the applicant is an individual, the credit manage has been the sable, of employment of the
applicant and the length of time he has been residing, his present residence. Frequent change of residence
could be a cue as to the true character of the prospective debtor. When coupled with other factors the
requested purchase on credit may be turned down.

Wholesale and Retail Credit

Essentially, a big difference lies between wholesale and retail credit. Wholesale customers usually
buy for resale to others while retail customers buy for their own consumption. Wholesale customers are
able to realize income from the resale of their purchases which will serve as major source in the settlement
of their obligations.

Retail customers, on the other hand, must pay for their purchases out of their income which
generally consists only of salaries or wages. Inasmuch as retail customers buy for their own consumption
and not for resale, it follows therefore that the credit manager should exercise effort and caution to
protect his store from being imposed upon by unscrupulous customers. This is the very reason why the
credit manager generally prefers to conduct a personal interview of the applicant for credit so as to be
able to obtain the necessary and valuable information about him as, for instance, his honesty and
straightforwardness in answering questions and others which could be one gauge whether he is worthy
of credit or not.

If the applicant is a married woman, it must be ascertained from her whether she has a job of her
own from which she expects to pay her purchases on credit. It not, whether such purchases carry with it
the sanction and approval of her husband Moreover, inquiring into the position that the husband holds in
the company where he is connected with, as well as the length of service he has rendered in said company,
would prove quite helpful.
The Principal Objectives of Credit Management

As pointed out in earlier discussions, credit is not only very important but moreover a scarce resource.
This fact underscores the need for this judicious and wise use. Hence, credit management becomes very
compelling indeed. Aptly said, credit management is not unlike the management of any major business
function which seeks the attainment of its laudable objectives, such as:

a. Maximizing sales. For a firm not only to continue its operations but moreover have a strong toothold
in the business, it must be able to maximize its sales. More and more sales assure the company with
increasing volume of business and the continuous flow of income and consequent receipt of profits.
Accordingly, credit management is charged with that important task: help increase the volume of sales
while minimizing losses. Increased sales and profits are the by-products of a better understanding and
skillful handling of all credit functions.

When a business firm sells on credit, the important role of credit management becomes
altogether very apparent. The level of management required for the administration of credit in any
business firm is determined in no small degree by the concept of the function prevailing there. In some
instances, credit is viewed narrowly as a simple function of approving credit transactions and making the
corresponding collections. Relatively little real management activity may be involved there. But as the
concept broadens, the credit phase of the business embraces sales and finance policy and other top
management strategy and, consequently, becomes a management responsibility of a much higher order
and of substantial magnitude.

Viewed correctly, one test for an effective credit management hinge among others, on the
attainment of the first objective stated above.

b. Controlling the amount of receivables. The basis of effective control is a plan for control based upon
some realistic set of standards. As pointed out in" Credit Management Handbook", a publication of the
National Association of Credit Men (USA), the best statement of the purpose of control is the simple
definition: "To assure performance in accordance with plans." The price of performance is everlasting
follow-through. One of the skills of leadership is the art of getting desirable responses and results for
individuals and groups in conformity with the established goals and objectives. Hence, a necessary
qualification of a credit manager is the ability to review and appraise the operations of his department
and the performance of his staff in terms of desired results. Also, to maintain conditions which encourage
his staff to produce results to the best of their abilities. Toward the achievement of these ends, it is
necessary to develop, interpret and maintain effective controls and standards which will assist all
concerned to: (1) project desired results more accurately, (2) identify and forecast major trends that effect
significant credit activities; (3) determine the need for changes in policies and/or practices; (4) detect
credit problems, insofar as possible, in time to take corrective action before they become critical; and
conserve time and effort on the part of all concerned.
 A primary problem of establishing effective controls in the credit department is to determine what
is significant. Hence, the need for periodic appraisal. This is particularly so since the economic climate in
which business operates is fluid and complex. It is almost in a state of change or subject to change.

c. Controlling costs of credit and collection. Every company incurs expenses in the extension of credit and
in the collection of accounts receivables. These expense include (1) bad debt losses; (2) wages and salaries
charge with credit and collection function (3) cost of funds tied up in receivables; (4) cost of fees and dues
for credit information; (5) charge incurred for outside assistance in making collections; (6) rent or space
occupied by credit and collection personnel. And, of course depreciation of credit and collection by credit
and equipment and fixtures,

Control of credit and collection expenses does not necessarily, however, mean minimizing
expenses. Rather, it refers to cost per unit, that is, decrease; cost per unit or work which results from
improved planning, direction and supervision.

The collection man's job is to keep his ear close enough to the ground to detect every indication
of lapses from satisfactory standards and to act accordingly.

There are a number of expenses that are unavoidable in credit and collection work. One pertains
to the cost of traveling. Some credit men however do not do enough traveling for one reason or another.
Where such is the case, they deny themselves of opportunities of gathering useful information that could
guide themselves and their company in respect to their credit work. Credit men who spend considerable
time in the field are able to establish in most instances contacts with prospective clients that could prove
beneficial.

One other expenses that is unavoidable in credit and collection work pertains to legal fees. Legal
services are needed principally in connection with collections and protection of accounts receivable.

Importance of Credit Limits

It cannot be stressed too strongly, that one pressing problem which taxes the minds of credit
managers is not only the decision when to extend credit but a complementary problem of how much
credit must be extended. Inasmuch the very nature of credit gives rise to corresponding risk, it follows
that utmost care and prudence be exercised in order to determine the proper credit limits that must be
imposed by prospective creditors as a tool of protection not only on his part but also for the benefit of
economic society as well.

Imposing credit limits could be a service to buyers on credit since it could prevent them from
falling hopelessly into huge debts that they may not be able to pay regardless of the means they employ
to weed themselves out of such a precarious predicament. In other words, the creditors may be doing
them a favor which at the moment they do not realize. As one businessmen sadly remarked, it is
oftentimes the liberality with which companies grant credit that pushed them into economic difficulties if
not ruin.
 In a number of cases, the liberal treatment accorded them by grantors of credit have worked
against their interest because of its undue influence on over expansion of business. Credit limits work as
bars to over expansion of business. Hence, their importance and necessity.

Types of Credit Limit

In studying credit management, two types of credit limits may be noted: quantitative credit limit
and temporal credit limits. Both have their importance in granting credit.

By quantitative credit limits is meant the maximum amount of credit which may be permitted to
remain outstanding on account. The amount is determined by a proper analysis of the C's of credit which
is not be exceeded.

On the other hand, instead of imposing a maximum ceiling on the amount of credit which a debtor
may be able to obtain and use, temporal credit limits impose certain requirements which is a borrower or
prospective debtor must comply before he could be granted credit. This temporal credit which does not
indicate the maximum amount that an individual or business firm can obtain from the creditor-granting
company as long as the debtor is able to fully comply with conditions set."

SOUND CREDIT MANAGEMENT

Sound credit management principles revolve around three E's, such as:

A. Estimation

1. All available sources of credit information must be tapped and utilized so that a proper estimation of
the credit risk can be obtained.

2. For individuals who buy for consumption, character and their ability to pay sere as important bases of
credit; for business concerns, it is the net worth and condition of the business as well as reputation for
paying their bills.

3. All credit information gathered and received must be kept in strict confidence. Only those who are
authorized must have access to it.

B. Enforcement

1. Granting credit is but one phase of the credit function, collection is another collection of accounts
should start from the moment they become due. There should be no room for vacillation insofar as
collection is concerned.
2. The task and responsibility of every collection deprad withs to get the Thorney due the company. if the
money can be collected without offending the customer, doubtless, this should be done.

3. Collection records must be kept and maintained and siould indicate when Collection resent; dates when
calls were made by collectors; payments made, balances due; and action taken, if any.

C. Evaluation

1. Sound credit management principles dictate that results must be evaluates against company policies
and procedures.

2. If a situation should arise in the future which preclude good paying customers to discharge their
obligations on time, policies and procedures may be modified without losing sight of company goals and
objectives.

3. Records must be periodically reviewed and kept up to date.

CREDIT FRAUDS

If only all individuals are honest, then no credit manager would develop wrinkles or grow gray
hairs prematurely. But that is perhaps wishful thinking While it is true that most credit manager's relations
are those with business firms and individuals who operate above board, nevertheless, there are a few
who do not.

These dishonest firms and individuals are known by various names and employ various tricks.
Some of them become successful in their "line of trade" while others fall by the wayside and become
apprehended even in their first try. Some of them appear decent enough. Some of them in fact are
married to men who are in the top rung of the organization to which they belong just as others are wives
of prominent government officials. They appear' in expensive clothes and ride in swanky automobiles and,
as such, create the impression of their respectability as well as decency. Others are just plain Miss, and
Mrs. So and So. The men in the same group are not different. They appear honest and reliable.

Some of these crooks operate alone because of the belief that it is much difficult to cover the
tracks of one man and thus escape apprehension. Others, on the other hand, operate in a ring - a big time
syndicate - who victimize business firms involving large sums of money. As to so-called business
establishments - they operate through "fly-by-night" schemes. After obtaining the loot (goods sold) on
credit), they disappear into thin air until they make their re-appearance - trying to victimize another
business firm. And this goes on and on, until the law catches them, for crime does not pay.