Administration, analysis and credit policies

CHAPTER I GENERAL ASPECTS OF THE CREDIT: 1.1 General Background of the Credit

As is generally known, the institutions that par excellence are dedicated to granting loans of different natures are banks and financial institutions, for which they use a series of procedures and tools for this purpose, but not only banking institutions also grant loans. they make the great variety of existing companies (commercial, industrial, service companies, etc.); with the sole purpose of attracting more customers and increasing their sales levels and thereby obtain utility and the company can survive in the environment in which it develops. But there is also a level of risk in which these entities are immersed,which is the risk of late payment and to a certain extent of bad debt of the operations to the credit that they carry out on which I will deal later with the sole purpose of contributing to reduce this risk by giving some guidelines as a suggestion.

administration-analysis-and-credit-policies

Throughout the entire process of granting a loan, the analysis of the aspects and factors that have to be analyzed, among which we have: becomes extensive and complex:

-Determination of a target market

- Credit evaluation

- Evaluation of conditions in which they are granted

- Approval of the same

- Documentation and disbursement

- Collection policy

- Credit management in reference, etc.

The guidelines, procedures, and policies to grant a credit after studying and evaluating the factors and variables to be taken into account are the objectives of this study and whose content will be developed later.

1.2 World History of Credit

Throughout the evolution of credit risk and since its inception, the analysis concept and criteria used have been the following: since the early 1930s, the key analysis tool has been the balance sheet. At the beginning of 1952, they changed to the analysis of the income statements, what mattered most were the profits of the company.

From 1952 until now, the criteria used has been cash flow. A credit is granted if a client generates enough cash to pay it, since the credits are not paid with profit, nor with inventories, and even less with good intentions, they are paid with cash.

1.3 Credit

A credit is also defined as a prerogative to buy now and pay at a future date, at present it is a modern marketing system through which a person or entity assumes a future payment commitment (debtor) for the acceptance of a good or service before another person or entity (creditor); in which merchandise payments are deferred through the general use of negotiable documents. Eg bills of exchange, letters of credit, conformed invoice, etc.

The credit makes the terms of a transaction more flexible (terms, amounts, interest rate, etc.) facilitating the commercial agreement, both by covering a satisfaction of sale both by the merchant, and the need to buy by the consumer, according to the availability of payment it presents.

1.3.1 Credit Subjects

It is the natural or legal person who meets the requirements to be evaluated and subsequently be favored with the granting of a credit, cash or sale of an item with payment facilities. These requirements are included in the credit policy of the company that grants said credit.

1.3.2 Basic Objective of Granting a Credit

From the business point of view, the main objective of establishing a credit system is to increase the volume of sales by granting payment facilities to the client, and this merchant, industrialist or public consumer may not be available to compare goods or services with cash and in this way, meet the main objective of the organization which is to generate higher income and profitability for the company.

1.3.3 Composition of Credits:

It is composed of:

Credit Applicant (Debtor Clients) Credit Grantor (Creditors) Documents to collect: Invoices, letters, payables; Etc. Debtors Delinquent Real or Pledged Guarantees Interest Rate Agreed Amount of Credit Terms and method of payment.

CHAPTER II CLASSIFICATION AND TYPES OF CREDITS

2.1 Classification of Credits

There is a great variety in terms of classification and types of credits, in this study we will try to group them in such a way that it can be a guide for people who use this marketing system from two points of view: FORMAL CREDITS AND INFORMAL CREDITS.

A.- Formal Credits.-

Formal credits are all those credits that have contractual characteristics; in which the contracting parties mutually obligate themselves to comply with it. In other words, this credit is formalized in writing between both parties. And informal credits, those that do not have these characteristics.

Among the formal credits we have:

- Consumer Credits or Commercial Credits.- They are all those credits granted by companies to the general public under the terms indicated in the credit agreement. And that they are intended to meet the needs of the general public.

- Business Credits.- They are all those credits concluded between companies, whether they are production, marketing or services to supply raw materials, inputs, supplies or to buy products and then sell them or for the provision or acquisition of services, etc.

- Bank Credits.- They are all those credits granted by the companies of the financial system to the different companies to invest either in fixed assets, increase production, pay debts to their creditors, increase their sales, increase their product lines, etc. As well as people who need resources to finance their activities are these natural or legal persons.

Classification of Bank Credits

A banking entity grants two types of well-defined Credits depending on the legal nature of the credit operations and the contract, which involve particular risks. This classification of credits is as follows:

Credits or Risks per Cash. - They are direct credits, placements made by financial intermediaries who commit their own funds. Accountingly, these operations carried out by banks are recorded as placements in their financial statements, so that they show us at the end of each period the amount made available to the bank's customers. The main credits per box are: Current Account Credits, Loans or Advances and Bank Discounts. Credits or Irrigation not per Box.-They are those who do not immediately commit the funds of a bank, because it does not entail the support of cash to a client. Accountingly these operations are managed through the Contingent accounts. Thus, the Accounting Manual for Financial Institutions describes them as those accounts that register the operations in which the obligation of the entity (financial institution) is conditioned to whether an event occurs or not; depending on unforeseeable future factors. Operationally two groups of operations are distinguished: Guarantees and Letters of Bonds and Documentary Credits.

Other forms of credit granted by companies in the financial system are:

a.- Documentary credit; which is mostly used in international trade and which we will study in more detail in Chapter V, and

b.- Credit cards

The credit cards

Through the credit card the consumer greatly reduces his operations thanks to the substitution of cash, in addition to having at his disposal a credit instrument that differs the fulfillment of his monetary obligations through his presentation, without the previous provision of funds to the entity that assumes the debt. On the other hand, it confirms an increase in the level of sales. Somehow becoming an article of necessity.

It also offers consumer security since the credit card is a money substitute and is often covered by insurance. According to the new Credit Card Regulation approved with (Res. SBS N ° 271-2000), according to article 3 it defines it as follows:

"By means of credit cards, the company grants a line of credit to the holder for a specified period and issues the corresponding card, in order for the user of said card to purchase goods or services in the affiliated establishments that provide them or, in case to request it and thus allow the issuing company, make use of the cash disposal service or other related services, within the limits and conditions agreed, in turn forcing the company issuing the corresponding card to pay the amount of the goods and services that have been used and other charges in accordance with the provisions of the respective contract.

In itself it is a contract by means of which a specialized company agrees with the client the opening of a credit in their favor with the purpose of making purchases or satisfying services. The legal relationship in this case consists of the consent that exists between the user and the issuing entity, who agrees to satisfy the payment resulting from the operations carried out by the cardholder in exchange for a previously established commission.

In this way, the link that arises between the parties constitutes a true means of payment for the goods or services that are acquired. It is also called plastic money because of the characteristics of the card.

Elements.-

Contracting parties must have full exercise capacity as stipulated by civil law. The financial institution that enters into credit card contracts as issuer is under the supervision of the Superintendency of Banking and Insurance, and must comply with administrative and operating regulations.

Regarding the user, natural or legal person, they must not incur in any cause of nullification or impediment established by the regulations for such purpose, in addition to having full exercise capacity in the case of natural persons. This contract generates various legal relationships between the following subjects:

- The Issuing Entity.- It can be presented in any of the following ways:

Commercial companies that issue their own letters of credit to their clients, through which they identify them, limiting credit to a certain amount of money. Financial entities supervised by the Superintendency of Banking and Insurance.

- The User.- Is the natural or legal person authorized by the issuing entities to use the piggy card that is issued to them, after a good credit examination.

- The Supplier.- Is the merchant who accepts the use of the credit that has been granted.

Credit Card Agreement - Minimum Content.-

Amount of the credit line Maximum amount and commission for the disposition in cash if applicable Commissions, freight and other direct expenses for the services provided or the criteria for their determination Compensatory annual effective interest rate or the criteria for their determination Form and means of payment Permitted Cases in which the cancellation of the credit card proceeds Periodicity in which the account statements are delivered Procedures and responsibilities of the parties in case of loss and theft These are among the most important.

Credit Card Classification.-

- Bank Credit Cards.-

In this type of cards a bank intervenes as a credit financial institution and as the entity that issues the Credit Cards, which will make the cancellation to the merchant or the affiliated provider, for the use that they make of them.

- Non-Bank Credit Cards.-

They are issued by financial or credit entities that are not in the commercial sphere. It is characterized in that it allows the holder to acquire credit in affiliated establishments, which in turn sign those credits to the issuing entity, which in turn is subrogated in front of the user.

Commercial Credit Cards.-

This type of cards can only be used in the commercial establishments that issued them, that is, they are credit cards that were issued exclusively for the own consumption of the users.

Credit Card Features.-

Credit cards will be issued non-transferable and must contain the following minimum information:

Name of the company that issues the credit card and, if applicable, the identification of the credit card system to which it belongs.Coded number of the credit card.Name of the credit card user and his signature, in the event that the cardholder is a natural person. When the owner is a legal entity, the name of the owner must be stated, as well as the name and signature of the user authorized to operate the credit card. The signatures may be replaced or supplemented by a secret key, electronic signature or other mechanisms that allow the user to be identified. Expiration date Express identification of the geographical scope of validity of the card, in the country and / or abroad, as appropriate. In the event that such indication does not appear, it is presumed,without admitting proof to the contrary that it has international validity.

Impediments and Cancellations.-

According to the Credit Card Regulations, companies may not enter into contracts with those individuals or legal entities to which current accounts have been closed for writing checks without funds or credit cards have been canceled for the following reasons during the term from closing to cancellation of current accounts:

When the holder of the credit card has not complied with paying 2 successive amortization installments to the same company, in the form of credit card. When some of the obligations of any nature assumed by the holder of the credit card against the issuer thereof are classified in the doubtful or lost category.

In all cases, the company must give immediate notice of the cancellation to the affiliated establishments. Holders of credit cards canceled for these reasons may not request another credit card from any company in the Peruvian financial system, for a period of one year from the date of the respective cancellation.

2.1 Types of Credits.- Credits can be of the following types according to:

a.- Due to its Enforceability and Payment Terms

Short-Term CreditsMedium-Term CreditsLong-Term Credits

Here are consumer loans, investment loans, bank loans, b.- By its Origin

Sales Credits Other Credits

Credits granted for operations typical of a company's business line, for example: commercial credits.

c.- By its Nature

With Guarantee: The Credit with a Guaranteed Bill of Exchange.- It is a security that guarantees compliance with the obligation.

The Credit with Simple Letter Not Guaranteed.- It is a value title that lacks the security that the guarantee gives.

I will pay Credit Backed by Note.- Contract of recognition of debt with solidary guarantee to give it greater solidity.

Without Guarantee, here are the credits that are granted without any guarantee, only with the good reputation of the client. This type of credit is exceptional, it is not very common in the market.

c.- For its Modality

Direct Modality.- According to the type of treatment to obtain the credit. The applicant for the credit and the company that is going to grant the credit intervene. Indirect Mode.- A third person intervenes in this type of credit, in the case of financial leases, documentary credit (the letter of credit), etc.

CHAPTER III ADMINISTRATION OF CREDITS

3.1 Credit Administration.

In order to retain customers and attract new customers, most companies find it necessary to offer credit. Credit terms may vary between different industrial fields, but companies within the same industrial field generally offer similar credit terms. Credit sales, which result in accounts receivable, typically include credit terms that stipulate payment over a specified number of days. Although all accounts receivable are not collected within the credit period, most of them are converted into cash in less than a year; consequently, accounts receivable are considered as current assets of the company.Every company that grants credits to its clients through any of the modalities described above must have:

Credit risk departments.

This department must pursue the following objectives: that the risks of the financial institution remain at reasonable levels that allow it to be profitable; The training of personnel in credit analysis allows for solidity when issuing a criterion. The main function of the departments and / or areas of credit risk is to determine the risk that the institution will grant to grant a certain credit and for this it is necessary to know through a careful analysis the financial statements of the client, analysis of the various points both qualitative as well as quantitative that together will allow to have a better vision on the client and the capacity to be able to pay said credit.

Objectives and functions of the risk area or department .

- Maintain relatively low levels of a credit risk, in addition to allowing good profitability and permanence.

Features:

- Create standard credit evaluation systems

- Detect those credits with higher-than-normal risks to monitor them more thoroughly.

- Prepare analysis for future account executives

3.2 Credit Policies.

These are all the technical guidelines used by the financial manager of a company, in order to provide payment facilities to a specific client. The same that implies the determination of the credit selection, the credit norms and the credit conditions.

A company's credit policy sets the tone for determining whether and how much credit should be granted to a customer. The company should not only deal with the credit standards that it establishes, but also with the correct use of these standards when making credit decisions. Adequate sources of information and credit analysis methods must be developed. Each of these aspects of credit policy is important to the successful administration of the company's accounts receivable. The inadequate execution of a good credit policy or the successful execution of a poor credit policy do not produce optimal results.

3.3 Accounts Receivable?

These are the assets that a company owns, as a consequence of having granted credits to its clients, regarding its presentation in the balance sheet, the Financial Information Regulation, CONASEV Resolution No. 182-925-EF / 94.10 must be taken into account. dated 01/29/92, Art. 15 business accounts receivable item that indicates the following: documents and accounts receivable from operations related to the business line must be included in this item.

3.4 Basic Principles of Credit Policy .

The type of client must correspond to the target market defined by the institution since the evaluation and administration is completely different. The target market must at least define the type of clients with which it will operate, the irrigation it is willing to accept, the minimum profitability with which it will work, the control and follow-up that it will have.

With few exceptions, credit should not be granted to non-profit companies, such as cooperatives, clubs, etc.

3.4.1 General Policies

Credit analysts frequently use the Five Cs of Credit to focus their analysis on the main aspects of an applicant's creditworthiness.

In this regard, Lawrence J. Gitman, in his book "Fundamentals of Financial Administration"; He describes them as follows:

Reputation (of the English character): the record of the fulfillment of the past obligations of the applicant (financial, contractual and moral). Past payment history, as well as any settled or pending legal proceedings against the applicant, are used to assess their reputation. Capacity: the applicant's ability to Refund the required credit. The analysis of the Financial Statements, highlighting above all liquidity and debt ratios, is carried out to assess the applicant's capacity. Capital:the applicant's financial strength, which is reflected by its ownership position. Often, an applicant's debt analysis is performed, relative to equity and its profitability ratios, to assess his capital. Collateral: The amount of assets that the applicant has available to secure the credit. The greater the amount of assets available, the greater the chance that a company will recover its funds if the applicant does not meet the payments. A review of the applicant's balance sheet, calculation of the value of her assets, and any legal claims brought against the applicant help assess her collateral. Terms:the current business and economic environment, as well as any peculiar circumstance that affects any of the parties to the credit transaction. For example, if the company has a surplus inventory of the items that the applicant wants to buy on credit, it will be willing to sell on more favorable terms or to less solvent applicants. The analysis of the economic and business situation, as well as the special circumstances that could affect the applicant or the company, is carried out to evaluate the conditions.

The credit analyst focuses his attention, above all, on the first two Cs (reputation and ability); because they represent the basic requirements for granting credit. The last three (capital, collateral and conditions), are important to prepare the credit agreement and make the final credit decision, which depends on the experience and judgment of the credit analyst.

3.4.2 Credit Operations

There must be a request for intent in which the client's requirements are clearly specified (term, type of repayments, grace periods, residual values, interest rate, funds, object, and the form of payment). Once the loan is approved, it is necessary to prepare the corresponding contract where the obligations of the borrower and the financial entity will be clearly established. The amortization payment schedule must be established.

It is necessary to be in complete follow-up of the credit since the economy of the client is quite changing and we have to permanently have information that corroborates us with the credit

Necessary aspects in the analysis.

- Seriousness

- Simulation of payment capacity

- Patrimonial situation

- Guarantee

- Credit Risk

From the point of view of credit (risks that may arise).

- Risk such as viability of credit return

- Risk as probability of loss

- Country or institutional framework risk

- Sector risk

- Financial risk

- currency value maintenance risk vs. Prices

- exchange rate risks (macroeconomic –global)

- risk of fluctuating interest rates

- risk of mismatches of terms

- Operational risk

- market risk

- technological risks

- efficiency risk (costs)

- supply risks

- collection risk

- risk of management or managerial capacity

- Special operational risk

- risk of granting advances

- repeated overdrafts

- unusual or excessive requests

- continuous arrears in principal and interest payments

- breach of contracts

3.4.3 Factors to Consider.

The financial manager must take into account the following factors:

a.- The credit reputation of the client

b.- Credit Reference

c.- Average payment periods

d.- Natural person (average income)

e.- Legal Person (Financial Statements)

3.4.4 Credit Standards.

The company's credit standards define the minimum criteria for granting credit to a customer. Issues such as credit evaluations, referrals, average pay periods, and certain financial ratios offer a quantitative basis for establishing and enforcing credit standards. When carrying out the analysis of the standards, a series of fundamental variables must be taken into account, such as office expenses, investment in accounts receivable, the estimation of bad debts and the volume of sales of the company.

In this regard, the Author Lawrence J. Gitman, in his book “Fundamentals of Financial Administration”; indicates that the variables to be considered and evaluated are:

- Office expenses

If credit standards are made more flexible, more credit is awarded. Flexible credit standards increase office costs, on the contrary, if credit standards are more rigorous, less credit is granted and therefore costs decrease.

- Accounts receivable investment

There is a cost related to managing accounts receivable. The higher the average accounts receivable of the company, the more expensive it is to manage and vice versa. If the company makes its credit standards more flexible, the average level of accounts receivable should be raised, while if there are restrictions in the standards, they should therefore decrease. So we have that the more flexible credit standards result in higher handling costs and the restrictions in the standards result in lower handling costs.

The changes in the level of accounts receivable related to modifications in the credit standards come mainly from two factors, in the variations with respect to sales and the other with respect to collections that are closely linked, since it is expected that sales will increase. As the company makes its credit standards more flexible, resulting in an average number of accounts receivable, but if, on the other hand, credit conditions become less flexible, few individuals are given credit by conducting a thorough study of their payment capacity, therefore the average of accounts receivable decreases due to the decrease in the number of sales.

In conclusion, sales and collections changes operate simultaneously to produce high accounts receivable management costs when credit standards are made more flexible and are reduced when credit standards are made more rigorous.

- Allowance for doubtful accounts

Another variable that is affected by changes in credit standards is the estimation of bad debts. The probability or risk of acquiring a difficult to collect account increases as credit standards become more flexible and vice versa, this also given by the study of clients and their ability to pay in the short and long term..

- Sales volume

As noted in previous paragraphs, as credit standards become more flexible, sales are expected to increase and restrictions decrease, so the effects of these changes have a direct impact on the company's costs and income. and therefore the expected profit.

3.4.5 Evaluation of Credit Standards.

To determine if a company should establish more flexible credit standards, it is necessary to calculate the effect these have on marginal earnings on sales and on the cost of marginal investment in accounts receivable.

Cost of marginal investment in accounts receivable

The cost of marginal investment in accounts receivable can be calculated by establishing the difference between the cost of managing accounts receivable before and after the implementation of more flexible credit standards.

The financial ratio of the average accounts receivable must be calculated first.

Average of C x C = Annual sales on credit / Accounts receivable turnover

The average investment in accounts receivable is then calculated, calculating the percentage of the sale price that represents the costs of the company and multiplying it by the average of accounts receivable.

Finally, the cost of the marginal investment in accounts receivable must be calculated by making the difference between the average investment in accounts receivable with the proposed program and the current one.

The marginal investment represents the additional amount of money that the company must commit to accounts receivable if it makes its credit standard more flexible.

3.4.5.1 Decision making.

To decide whether a business should make its credit standards more flexible, marginal profit on sales must be compared to the cost of marginal investment in accounts receivable. If the marginal profits are greater than the marginal costs, the credit standards should be made more flexible; otherwise those that are applied in those moments within the company must be kept unchanged.

34.6 Credit Analysis.

Credit analysis is dedicated to collecting and evaluating applicants' credit information to determine if they are up to the company's credit standards.

- All credits must go through a preliminary evaluation stage, however simple and fast it may be.

- All credit, easy and good and well guaranteed, may seem to have risk.

- The credit analysis is not intended to end 100% of the uncertainty of the future, but rather to decrease it.

- It is important to have good judgment and common sense.

Necessary aspects in the evaluation of a credit:

- In the process of evaluating a loan for a company, an in-depth evaluation of both its quantitative and qualitative aspects must be considered.

- It is necessary to consider the past behavior of the client both as a client of the same institution and of other institutions

- The credit decision must be made based on historical or present history.

- It is necessary to consider in credit analyzes different considerations that can be given in order to anticipate problems.

- After having carried out a thorough analysis of the credit, it is necessary to make a decision, so it is recommended to choose 4 or 5 variables from the many that were given for its preparation.

Regarding collateral cases, it must be treated in the best possible way to have the best collateral and to have a relationship with the loan of 2 to 1, in order to be able to cover the credit widely.

Continuing with the study that is being carried out of the effective and efficient administration of accounts receivable and applying the tools that have already been described, this time the merits that the client has for the credit will be studied, but also calculate the amount by which he can answer. Once this has been done, the company can establish a line of credit, stipulating the maximum amount that the client can owe to the company at any time. Lines of credit are established to eliminate the need to verify a major customer's credit each time a purchase is made on credit.

Ignoring whether the company's credit department is evaluating the credit merits of a customer who wants to make a specific transaction or a regular customer to establish a line of credit, the basic procedures are the same, the only difference it is the thoroughness of the analysis.

A company would act with little prudence when spending more money than the amount that its clients acquire to grant them a credit. The two basic steps in the credit investigation process are obtaining credit information and analyzing the information to make the credit decision.

A.- Obtaining Credit Information.

When a customer seeking credit comes to a business, the credit department typically begins a credit evaluation process by asking the applicant to fill out different forms requesting financial and credit information along with credit references. Working on the basis of the credit application, the company then obtains additional credit information from other sources.

If the company has previously granted the applicant credit, it already has its historical information about the applicant's payment patterns. The main external sources of credit information are provided by the financial statements, by the commercial reference offices, the credit information exchanges, the bank verification and the consultation of other providers.

- Financial statements

By asking the applicant to supply their financial statements for the past few years, the company can analyze the financial stability of the applicant, its liquidity, profitability and debt capacity. Although no information regarding past payment rules appears on a Balance Sheet or Income Statement, knowledge of the company's financial situation may indicate the nature of full financial management.

The willingness of the applicant company to supply these statements can be an indicator of its financial situation. Audited financial statements are a must in credit analysis for applicants who wish to make major purchases on credit or who wish to have lines of credit opened.

- Reference exchange offices (RISK CENTRALS)

Businesses can obtain credit information through referral exchange systems, which is a network that changes credit information on a reciprocal basis. By agreeing to supply credit information to this credit bureau about its current clients, a company acquires the right to request information from the credit bureau related to prospective clients.

The reports that are obtained through these credit information exchange relationships are more than analytical about defined cases. Fees are commonly charged for each request.

- Bank verification

It may be possible for the company bank to obtain credit information from the applicant's bank. However, the type of information obtained is likely to be very vague unless the applicant assists the company in its pursuit. An estimate of the company's cash balance is normally provided.

- Another suppliers

This consists of obtaining information from other providers who sell the loan applicant and asking them about the payment rules and their inter-business relationships.

B.- Analysis of Credit Information.

A credit applicant's financial statements and accounts payable ledger can be used to calculate his average accounts payable term. This figure can then be compared with the credit conditions that the company currently offers. A second step may be the term of the applicant's accounts payable to get a better idea of their payment rules.

For clients applying for large loans or lines of credit, a detailed ratio analysis of the company's liquidity, profitability and debt should be made using the company's financial statements. A cyclical comparison of similar ratios in different years should indicate some developmental trends. A business can establish credit assessment ratios or programs tailored to its own credit standards. There are no established procedures, but the company must tailor its analysis to its needs. This gives a feeling of confidence that you are taking the desired types of credit risks.

One of the main contributions in the final decision of the credit is the subjective judgment of the financial analyst about the merits that a company has for the credit. To determine credit merit, the analyst must add their knowledge of the nature of the applicant's administration, references from other providers, and the company's historical payment rules to any quantitative figures that have been established. Based on your own subjective interpretation of the company's credit standards, you can then make a final decision about whether the applicant should be granted the credit and probably the amount of it. Very often these decisions are made by one person, but by a credit review committee.

C.- Determination of the Degree of Acceptable Risk.

Let's see it with an example for a better visualization:

As we move from groups of clients who are most likely to pay their debts, clients less likely to pay their bills can do two things:

modify our cash inflows receivable from our clients increase our cash investment in accounts receivable.

The increase in our cash inflows will equal the additional sales over time, less the increase in collection costs and bad debts. As it is noticeable we are considering sales over time. For example an order of S /. 50.00 cannot be viewed only as an order of S /. 50.00; We must consider the present value of the future sales volume that can be obtained from this customer if we accept her initial order. Obviously this calculation is difficult to perform.

The amount added to the expenses includes the production and marketing costs that were increased as a consequence of accepting the order (administration, sales and additional collection expenses).

Let's see that we are talking about additional or incremental income and costs. When we sell something for S /. 100.00, the additional costs attributable to this sale may amount to only S /. 60.00, the difference of S /. 40.00 could represent profits and fixed expenses, such as the salary of the company manager and depreciation, expenses that would exist regardless of whether or not we made this particular sale.

Therefore, when considering whether to sell to a group of customers whose bad debt is 10%, from a conceptual point of view we can calculate additional annual income and expenses as follows:

Increase in sales when accepting clients from the risk group of 10% 2000

Bad debts (10%) 200

Additional income 1800

Production and marketing costs (60% of sales) 1,200

Additional collection costs 300

Additional outlays 1,500

Additional annual net cash flow 300

By accepting this group of clients with higher risk, we add S / 1800.00 to our cash inflows and S /. 1500.00 to our cash outflows. Despite the losses involved in granting credit to these accounts, we can improve our net annual cash flows by S /. 300.00.

It will be worth fighting for these S /. Additional 300.00, this will depend on what our investment in accounts receivable will be and the return we expect to obtain on our investments.

3.4.7 Credit Conditions.

The credit conditions help the company to obtain more clients, but great care must be taken since discounts can be offered that could sometimes be harmful to the company. Changes in any aspect of the company's credit conditions can have an effect on its total profitability. The positive and negative factors related to such changes and the quantitative procedures for evaluating them are presented below.

Discounts for prompt payment.- When a company establishes or increases a discount for prompt payment, changes and effects on profits can be expected, this because the volume of sales must increase, since if a company is willing to pay the price per unit per day decreases. If the demand is elastic, sales should increase as a result of the decrease in this price.

Also the average collection period should decrease, thus reducing the cost of managing accounts receivable. The decrease in collection comes from the fact that some customers who previously did not take payment discounts now do so. The estimate of bad accounts should decrease, because as on average customers pay sooner, the probability of a bad account should decrease, this argument is based on the fact that the longer a customer takes to pay, the less likely it is that Do it. The longer that time elapses, the more opportunities there are for a customer to declare itself technically insolvent or bankrupt.

Both the decrease in the average collection period and the decrease in the bad debt estimate should result in an increase in profits. The downside of an increase in a cash discount is a decrease in the profit margin per unit as more customers take the discount and pay a lower price. The reduction or elimination of a discount for prompt payment would have opposite effects. The quantitative effects of changes in discounts for prompt payment can be evaluated by a method similar to the evaluation of changes in credit conditions.

Discount period for prompt payment

The net effect of changes in the discount period for prompt payment is quite difficult to analyze due to the problems in determining the exact results of the changes in the discount period that are attributable to two forces that are related to the average period of payment. When an early payment discount period is increased there is a positive effect on profits because many customers who did not take the early payment discount in the past now do so, thus reducing the average collection period.

However, there is also a negative effect on profits when the discount period is increased because many of the customers who were already taking the early payment discount can still take it and pay later, delaying the average collection period. The net effect of these two forces on the average collection period is difficult to quantify.

Credit period

Changes in the credit period also affect the profitability of the company. Profit effects can be expected from an increase in the credit period as well as an increase in sales, but it is likely that both the collection period and the bad debt estimate will also increase, so the net effect on earnings may be negative.

3.4.8 Fixing of the Credit Terms.

If you decide to grant a credit, the following guidelines must be taken into account:

- Regarding the credit term, a term policy must be established, taking into account the collection period that can be 30 days, 60 days to 90 days, etc. the collection of these accounts must go hand in hand with the grace period that providers give us to pay our claims otherwise we will be in big financing problems.

- The discount percentage must be established if the client pays before the indicated date in such a way that they are not harmful to the company.

- Standard credit amounts must be established according to the type of client with whom the deal is made.

- It must be established that the beneficiary of the loan assumes responsibility for complying with the clauses established in the contract.

- Interest rate, generally an interest rate according to the period and the amount of the credit granted.

3.4.9 Granting of Credit.

Once all the terms of the credit are stipulated and established, the credit is granted, which can be in cash, goods or services according to the client's request. The conditions in which the delivery is made must be taken into account, taking care to demonstrate in front of the client the benefits of the product or service granted on credit.

3.4.10 Financing Costs.

Financing costs, also called capital costs, occur when a company makes the decision to grant loans, therefore, it must finance said investment since the company has to pay staff, suppliers, cleaning staff, payment of public services., I pay the personnel who administer the company as well as the personnel who are in charge of selling the products as well as the personnel who are in charge of collecting them.

These financing costs increase as long as the accounts remain uncollected as the company must pay interest for each day that has passed.

CHAPTER IV CREDIT ANALYSIS TO LARGE COMPANIES AND

MEDIUM (BUSINESS CREDIT)

4.1 Credit Analysis to large and medium companies.

It should be taken into account:

General Background of the Credit

Destination of the credit.- It is necessary under all circumstances to know the destination of the funds granted by the financial institution since this can help the institution to:

-To check consistency with the institution's credit policies

-To be able to correctly evaluate the credit

-To be able to set conditions according to needs

-to be able to exercise control over the debtor

Most common causes for a credit application:

-Increase in Current Assets

-Increase in Fixed Assets

-Expenses

-Decrease in liabilities

First credit interview

- Amount and purpose of the credit

- Primary sources of payment

- Secondary sources

- Suppliers

- Financial data

- Insurance

- Plant and equipment

- Business history

- Nature of business

- Business banking relationship

Availability of information to evaluate a credit

- Information from other clients in the same sector

- Supplier information

- Consumer information

- Creditors information

- Bank databases, etc.

4.2. Step-by-step procedures for granting and / or granting a credit

- Customer information request: companies or legal entities

- Request for the operation

- Business profile highlighting the activity of the company, its strategic management plan and / or curriculum vitae

- Self-appraisals of the assets to be granted as collateral, whether movable or immovable

- Financial statements of the company (recommended from the last two steps)

- Projected cash flow with the assumptions considered in said projection (recommended for the credit period)

- Forms: basic information, financial statements, information.

- Legal documentation of the company (constitution, powers, RUC, Business Registration, Municipal Register, Board minutes, statutes, board election minutes, etc.)

4.3 Circuit of credit:

- Presentation of application and credit portfolio

- Credit evaluation by the credit manager

- Preparation of the recommendation and / or compliance report.

- Presentation to the credit committee or credit risk department

- Forecast of funds whatever their destination

- Preparation of credit agreement based on the originally negotiated conditions

- Signing of the contract by the applicant and the representatives of the institution

- Presentation of an insurance policy for the property granted in mortgage with the due subrogation of rights in favor of the bank

- Preparation of a file or credit folder with the client's full name

- Preparation of the roadmap for corresponding disbursement either by check or credit to the customer's account

- Preparation of the payment plan with their respective due dates

4.4 Credit analysis (quantitative and qualitative analysis)

QUANTITATIVE ANALYSIS

Important Considerations:

The macroeconomic variables that affect a country must be considered, such as import or export incentive policies, tax policies, cost of money, capital movement of capitalist entities, monetary policy, international prices, international conflicts, inflation, economic growth, Mediterranean a country, poverty and underdevelopment, dependence on other countries, social development of a country, union strikes or social problems, etc.

Other variables of great importance are the analysis of the company sector, variable such as vulnerability of the sector, development, SWOT, dependence on other sectors, stagnation for different reasons, little government incentive, little investor interest, strong investment initial etc.

Preferably, the balance of the last three steps should be analyzed.

Balance older than 6 months

Audit qualification, it should be noted that not all auditors qualify

4.5 Debugging and analysis of balance sheet accounts .

Before analyzing a balance it is necessary to take into account the following aspects:

Data cleansing (Eg uncollectible accounts receivable must be eliminated against equity, the same if there is an overvalued asset, current accounts partners must be eliminated against equity, etc.)

- Sector to which the company belongs

- Description and detail of each of the balance sheet items

- Form of accounting of accounts

- Valorization

- Administration policy

- Evolution of trends (the higher the amount, the greater the importance of analysis)

- Preferably request balance audited by a reliable auditor

- Make sure that the balance being analyzed has the signature of the person responsible for the balance.

4.6. Analysis of trade accounts receivable .

- Forms of documentation of accounts receivable for sale, what proportion and what is the support of each one of them in case they cannot be collected.

- Use of Factoring in the collection or to have immediate liquidity

- Main debtors

- Degree of concentration that exists in each of them

- Past behavior of those accounts

- Percentage of bad debt in the last months

- Comparison of the client portfolio with other companies in the same sector.

- Accounts receivable administration policy (Benefits of maintaining accounts receivable, interest vs. its administration costs

- It should be taken into account that the volume of accounts receivable depends on the percentage of credit sales, volume of sales and average term of sales.

Credit policies: refers to the way of selecting your clients, evaluation criteria.

- Credit conditions: percentage of credit sales, term, forms of interest rate readjustments, forms or types of documentation, types of discounts for prompt payment, guarantees if requested.

- Collection policies: prejudicial type, which I treat clients with a delay of 30 days or more, what type of actions are taken, how they are collected, via fax, letters, etc., Judicial collection, types of procedures, embargoes, etc.

4.7 Inventory analysis .

Analysis of the items that make up the inventory is necessary. Raw material products in process, finished products, supplies, spare parts, raw materials in transit. Each of them must be analyzed.

- Rotation time

- They have incontinence insurance

- A visual inspection of said merchandise must be carried out.

- You must know the way of accounting for inventories

- Correct valuation and the currency used for its accounting

- It is necessary to know the inventory administration policy: with whom they are supplied, how safe it is, concern for having low prices and better quality; how many months of sales do they maintain in raw materials, products in process and finished products; what is the inventory rotation fixed or determined;

- Nature and liquidity of inventories.

- Characteristics and nature of the product

- Market characteristics

- Distribution channels

- Analyze the evolution and trend

4.8 Analysis of fixed assets .

Description of the fixed assets one by one to have knowledge of the type of fixed assets that the company has and if it corresponds to its activity or item. The analysis of this account is linked:

- Existence of property

- Method of accounting for fixed assets

- Valuation, revaluation, depreciation, physical and moral wear

- Administration policy of fixed assets

- Technology and modernization

- Age of each of the assets

- Periodic maintenance carried out on each one of them

- Policies used for the good management of the company's assets

- What is the proportion of productive and unproductive assets that do not generate resources for the company

- It is necessary to separate the assets belonging to the partners of the company and the company this in order to have a more objective analysis

4.9 Bank Obligations .

- Analysis of the composition of bank obligations, long and short term.

- Considering the correct concentration of obligations in both current and non-current liabilities

- Analysis of the guarantees that support said credits and what the proportion of guarantees offered versus credits requested

- Analysis of the forms of amortization since this will depend on how the client can fulfill since not all activities have the same operating cycle (agricultural, trade, construction, services, etc.)

- Interest rates and terms at which each loan is agreed

- Analysis of the impact on the balance sheet of the obligation requested from the bank. This is important because it will determine the indebtedness of the company and what its structure of bank liabilities

4.10 Commercial Obligations .

- What is the policy of granting credit from suppliers to the company

- Payment methods, interest rates, commissions, discounts (which is the payment method; letters, guarantees, etc.)

- Financial indicators

- Liquidity ratio

- Acid test

- Accounts receivable rotation

- Inventory rotation

- Operational cycle

- Accounts payable rotation

- Leverage: Total Debt / Total Sales

- Return on assets

- Return on equity

- Sales / Total assets

- Sales / Fixed assets

- Gross profit / sales

- Operating result / sales

- Net profit / sales

- Limitations Of Financial Ratios

- Changing accounting methods

- Unrecognized liabilities

- Qualitative Aspects of the Analysis:

- Business analysis

- History of the company

- Owners

- Administration

- Business quality

- Organization

- Organization chart

- Management systems (administration techniques)

- Information systems

- Communication channels (vertical / horizontal)

- Objectives and goals

- Policies and procedures to meet the goals

- Human Resources

- Supply

- Production

- Sectorial analysis

- projections

CHAPTER V DOCUMENTARY CREDIT IN OPERATIONS OF

INTERNATIONAL TRADE

5.1 Background.-

Documentary credit is born from commercial practice. It is the same operators of international trade who realize the need for the figure of a commercial mediator among them.

At first, the deficiency was made up with the participation of agents or representatives of the seller in the country of the importer and vice versa, but as international trade became more dynamic, it was required to make a greater number of contracts more quickly and onerously.

It is that moment where the banks arise that required the buyer to open credit or money deposit contracts to be paid later to the seller, then began to demand that the seller prove for his part that he had met certain requirements that guarantee buyer satisfaction. This is how the figure of documentary credit was born, that although it can be used in operations within a country, it is in foreign trade operations where it achieves its development and attains great importance making international trade agile and operational.

The international chamber of commerce compiled the rules and current uses used for payment in international operations of purchase and sale of merchandise in an instrument called "Uniform Uses and Rules Relating to Documentary Credits"; which is currently used by the vast majority of banks that carry out foreign trade operations to stipulate the conditions of the contracts for opening documentary credits.

5.2 The Letter of Credit

The letter of credit is a contract by which the foreign buyer asks his bank to open a credit in favor of his supplier, payable upon delivery of certain documents (shipping, transportation, insurance, quality, etc.); required by it to take possession of what has been the subject of the transaction.

Under the letter of credit, a bank (issuing bank) undertakes, by order of its client (importer), to make available to a beneficiary (exporter), a certain amount of money, generally through another bank (notifier or confirming), upon delivery of the documents proving that the goods have been shipped.

In its simplest form documentary credit involves the participation of three parts:

The buyer or payer The bank AND the seller or beneficiary Procedures:

Firstly, there is a purchase-sale contract between the exporter and the importer, detailing all the conditions that both parties must meet. There the price, quantity, quality, delivery times, etc. will be determined. Once they have agreed on everything related to the sale and purchase, the buyer will order his bank (issuer) to open a credit in favor of the exporter who becomes the beneficiary.

For its part, the importer must guarantee solvency to cover the payment it will make. It is the payer who indicates the terms and modalities of the open credit (based on the provisions of the contract). The instructions from the payer to the bank must be complete and precise, avoiding including unnecessary details that generate confusion for the bank or the beneficiary.

The issuing bank proceeds according to the instructions given by its client to open a credit in favor of the exporter. Once this is opened, it communicates to the beneficiary by itself or through a correspondent bank. If you do it using a second bank, this can be a notifying bank, if you simply notify the beneficiary of the opening of the credit or confirmer if you not only notify if not that you are obliged to pay the amount established in the letter of credit against compliance of the conditions stipulated therein. In this second case, the confirming bank will repeat the payment against the issuing bank and this in turn against the client.

The beneficiary receiving receives the notification, examines if the conditions stipulated in the documentary credit correspond to those agreed in the original contract.

In this, the exporter must be very careful, since the letter of credit is a document other than the contract that originates it and is eminently formal, the issuing bank and the other intervening banks only respond in accordance with the literal wording of the letter of credit without exceptions arising from the fundamental contract that gave rise to the issue. If the exporter disagrees with some of the conditions imposed by the importer, he should contact the importer to modify them.

If there are no differences or if these have been exceeded, the exporter will proceed to dispatch the merchandise and deliver all the required documents that support the fulfillment of what has been agreed on their part (generally commercial invoice, clean bill of lading on board, insurance policy, certificate inspection (Quality certificate, certificate of origin or others, etc.); to the bank of your country, who will pay directly (if it is a confirming bank) or communicate so that the issuing bank pays (if it is a notified bank). It is important to know that banks do not assume any kind of responsibility for the form, sufficiency, correction, authenticity, falsification or value of any of the documents they receive; nor do they assume responsibility for: the quantity, description, weight, quality,packaging, delivery or value conditions of the merchandise covered by these.

The following page presents a flow chart of the documentary credit operation used in international trade operations.

DOCUMENTARY CREDIT FLOW CHART

5.4 Types of Letter of Credit:

a.- Revocable Letter of Credit.-

The irrevocable letter of credit can be modified or canceled by the issuing bank at any time and without further processing, unless it has been negotiated or agreed by the paying bank. Its use is not very common and even less recommended since it does not provide security particularly for the seller.

However, the issuing bank is obliged to:

Refund to the other bank, in which the revocable credit is available for demand payment, acceptance or negotiation of any payment, acceptance or negotiation against documents apparently in accordance with the terms and conditions of the credit made by such bank prior to receipt by your part of the notice of modification or cancellation.Refund to the other bank in which the credit is revocable is available for deferred payment, if such bank has taken documents in accordance with the terms and conditions of credit prior to receipt by you of the notification of modification or cancellation.

b.- Irrevocable Letter of Credit.-

This letter of credit is a secure means of payment, since it cannot be revoked or canceled by the payer without first having obtained the consent of all the parties involved (banks, beneficiaries, etc.). Through this mechanism, the importer's bank agrees to pay the exporter even when the importer is unable to do so. In turn, the irrevocable letter of credit can be confirmed or unconfirmed. It is not confirmed when it only has the payment commitment assumed by the issuing bank. In this case the negotiating bank does not assume any responsibility for the payment it only notifies.

It is confirmed when, apart from the obligation assumed by the issuing bank, the notifying bank also enters into the payment commitment through confirmation, assuming the risk of obtaining a refund of the amount paid from the issuing bank.

In the case of a confirmed irrevocable credit, the beneficiary has two independent acknowledgments of responsibility: one by the issuing bank and the other by the confirming bank.

The requirements to be met are:

The credit must be irrevocably issued. The correspondent bank must be instructed to add its confirmation. The credit must be available and payable to the confirming bank. The contents of the credit must not be ambiguous and must not contain any condition that allows the buyer to prevent the credit terms are met.

Depending on your payment method, letters of credit can be:

1.- At sight.- In sight letters of credit, the payment to the exporter occurs when the documents are presented according to the terms and conditions stipulated in the documentary credit. The seller gets the payment immediately after the merchandise is shipped.

2.- Acceptance.- In acceptance letters of credit, payment occurs at the expiration of the letters drawn according to the term established in the text of the documentary credit. The seller has a title that can be discounted, obtaining immediate liquidity.

3.- Deferred Term Payable.- Through it a credit is established from the seller to the buyer according to the term agreed between the parties. No letters are used.

5.5 Special Letters of Credit:

The most common letters of credit are:

5.5.1 Stand by Letter of Credit.-

It is a letter of guarantee used to support the fulfillment of works, bidding and merchandise supply contracts. The beneficiary can make it effective in case the counterparty does not fulfill the acquired commitment.

5.5.2 Revolving Credit.-

The revolving letter of credit; It is the one in which the issuing bank agrees to renew it automatically according to the original conditions, each time it is used within the stipulated period. It is mostly used when there is a contract between buyer and seller for the periodic supply of similar goods.

5.5.3 Red Clause.-

The letter of credit with a red clause is one that allows the beneficiary to obtain full or partial payment in advance (risk assumed by the issuing or confirming bank, if applicable); on behalf of the payer, against a written commitment that he will comply with the requirements of the documentary credit.

5.5.4 Transferable.-

The letter of credit with a transferable clause allows the beneficiary to instruct the negotiating bank to transfer it partially or totally to other beneficiaries. It is mostly used when the seller acts as an intermediary, this being a guarantee of payment to your supplier. It can be transferred once, being possible to reduce its amount as well as shorten the terms established in it. The other conditions cannot be modified.

5.5.5 Backto Back.-

Based on a non-transferable letter of credit opened in favor of the exporter (intermediary), the latter requests your bank to issue a Backto Back letter of credit, in favor of another beneficiary. This is possible as long as it resolves its opening once the implicit risk conditions have been studied, since the pig letter itself does not constitute a guarantee.

5.6 Accounting treatment:

1.- For the opening of the Letter of Credit:

A commitment or contingency is acquired that gives rise to a legal relationship with the bank without increasing or decreasing the assets of the company, nor weighing on its results.

(See PDF)

2.- Execution of the Letter of Credit:

Accounting for example if it is an input import:

For the execution of the documentary credit according to the letter of credit.

CASE STUDY:

(See PDF)

Statement:

An importing company will carry out the acquisition of machinery from Italy for which it opens a letter of credit with a National Bank in the amount of $ 25,000, which is equivalent to S /. 87125.00. Bank charges amount to 5% of the total letter of credit.

Accounting by the Company:

a.- For the opening of the Credit letter:

At the time of signing the contract. The company acquires a commitment or contingency that gives rise to a legal relationship with the bank without increasing or decreasing the company's assets or weighing on its results. (Memo Accounts)

b.- For the execution of the letter of credit:

The National Bank proceeds to cancel the supplier from abroad once the shipment of the machinery has been confirmed.

c.- For Bank Expenses

d.- For the cancellation of the importing company to the National Bank

To finish the study: a practical case of Credit Policy Analysis

CASE STUDY:

The chemical company PERÚ SOL SA, was founded several years ago in the Barranco district and manufactures chemical products for the national industry. The company sells its products for S /. 320.00 the unit being its variable costs, per unit of S /. 260.00, in 2003 98000 products were sold, said sales were made on credit, having incurred a total average cost per unit of S /. 290.00, for said production and sales volume, the company has always had an average collection period of 30 days, but wishes to extend this credit period to 60 days. To achieve this objective e. CPC Financial Manager Roberto Calderón has held a coordination meeting with the Engineer Fernando López, Sales Manager of PERÚ SOL SA, which due to his vast experience,believes that with a more flexible credit policy, sales will increase by 60%. The minimum return that the company requires (or cut-off rate) for any investment is 25%.

REQUESTED

Calculate the marginal profit on sales Calculate the average accounts receivable calculate the average investment in accounts receivable calculate the marginal average investment in accounts receivable Calculate the cost of marginal doubtful collection accounts Calculate the minimum required return. Prepare a summary table of the evolution of the alternative credit policy (with the risk of doubtful collection).

(See PDF)

CONCLUSION

Being the deducted profit the doubtful collection accounts S /. 2'336,320 higher than the minimum required performance S /. 1,229,064 the new credit policy would be accepted since the company would benefit from the relaxation of its credit standards, because it would be obtaining a profit greater than the minimum required return.

REFERENCED BIBLIOGRAPHY

1.- J. Gitman Lawrence. Financial Administration, Eighth Abbreviated Edition-2000, Printed in Mexico, Editorial Mc Graw Hill, Mexico DF

2.- Pacifico Editores SA Directorate and Financial Management Volumes I and II, First Edition 2004, Lima-Peru.

3.- RW Jonson. RW Melicher. Financial Administration, Fourth Edition 1989, Printed in Mexico, Compañía Editorial Continental SA Mexico DF

4.- Carlos M. Jiménez. Management and Costs (Continuous Improvement), First Edition 2000, Printed in Buenos Aires -Argentina.

5.- Eugene F. Brigham and Fred Weston. Fundamentals of Financial Administration, Seventh Edition 1987, Printed in Mexico Editorial Mc Graw Hill, Mexico DF

6.- Pedro Bellido Sánchez. Financial Administration, First Edition 1989, Printed in Lima-Peru, Editorial Nueva Escuela.

7.- Joel G. Siegel. Joe K. Shim. Financial Accounting SCHAUM Series , Single Edition 1986, Printed in Bogota - Colombia, Editorial, Mc Graw Hill SA

8.- Steven E. Bolton. Financial Administration, First Edition 1981, Printed in Mexico, Compañía Editorial Limusa SA Mexico DF

Journals:

1.- El Asesor Magazine, July 1999.

2.- Caballero Bustamante, June 1996 to February 2005.

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To complement this document on administration, analysis and credit policies, we suggest the video-lessons below, in which Professor Gyna Montaño, from the Technical University of Loja, addresses the following topics: credit policies, the credit evaluation, the credit approval procedure and the portfolio recovery process, all in relation to financial institutions. (5 videos - 30 minutes)

Download the original file