Credit Management

Q1. Define Credit and discuss different classification of credit.

ANS:

Introduction:

The term credit has its roots set in the Latin word 'creditum' meaning "that

which is entrusted or loaned" which also came from 'credere' which means to "trust or entrust”. Credit
is a broad term that has many different meanings in the financial world. It is generally defined as a
contractual agreement in which a borrower receives something of value now and agrees to repay the
lender at a later date—generally with interest.

Definition:

“Credit is a contractual agreement in which a borrower receives something of value now and agrees to
repay the lender at some date in the future, generally with interest.”

Explanation:

Credit has been classified according to its consumer and needs:

Classification
of Credit

Private Credit Public Credit

Consumer Business
Credit Credit

Merchandise Service Commercial Financial

Credit Credit Cash Credit
Credit Credit

Single Medium
Open Charge Revolving Installment Open Charge Revolving Installment Revolving Installment Long Term Short Term
Payment Term

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 Classification of Credit
There are following types of credits:

A. Public Credit:

Public credit involves the credit activities of the federal state and
provincial government units.

B. Private Credit:

Private credit is concerned with credit of individual ultimate consumers

and with credit of private business concern.

Private Credit classification:

A. Consumer Credit
B. Business Credit

I. Consumer Credit:
This type of credit received importance after the beginning of
World War 2.This Credit is defined as a medium of exchange that an individual
consumer may offer to a seller of goods or services or to a lender of money.
In order to obtain a good or service at the moment with the promise to return the
debt in the future is called a consumer credit.
There are three major types of consumer credit:

 Merchandise Credit
 Service Credit
 Cash Credit

Merchandise Credit:

This type of credit means concerns with the selling of goods or services on a retail level to
the ultimate consumer.

This type of credit has following three forms:

I. Open Charge:

The retail open charge enables the consumer/customer to purchase

goods and to pay for them usually after 30 days without any carrying

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 charges. Any no. of purchases may be made provided it does not
exceed combined particular amount.

II. Revolving:
This type of credit is relatively new in the field of consumer credit. It has
the characteristics of both the open charge account and installment
account. Under this account a consumer is allowed to purchase goods
up to a pre determined amount and in return the customer agrees to
pay monthly installments with a service charge included in that monthly
payment. As long as the outstanding balance is below the limit of credit,
the customer is automatically eligible to make additional purchasing on
their revolving credit account.

III. Installment:

It is a form of credit in which an agreement is made between the

buyer and seller in which the payment of the goods are extending over
a considerate period of time. It generally involves the purchase of only
one item and the account is secured with a mortgage.

Service Credit:

This type of credit system has become routine method of conducting business between the
consumers and the service provider. Doctors, lawyers, dentists etc have become used to billing
their customers for the services rendered through this credit. Similarly the use of service credit
for the utilities such as Gas, water, Electricity is acceptable without any hesitation.

There are three arrangements for the service credit system given as:

I. Open charge
II. Revolving
III. Installments

Cash Credit

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 Cash credit not only facilitates the customers with the movement of the goods or services but
another facility provided by it is the loaning of money directly to the consumers. This money
may be lent under any one of the following three arrangements:

I. Single payment
II. Revolving
III. Installment

The development and expansion of this line of credit is based upon the definite needs of the
consumers.

II. Business Credit:

The second major classification is the business credit. It is defined as
“A medium of exchange, which a business concern may offer to the seller of goods
or services and to a lender of money to obtain goods at the present moment.”

There is always a promise involved between these parties to pay back in the future
time. Business credit is one of the most important tool for a business man if he
wants to avail every opportunity to carry on production activities. This line of credit
gives the business man the opportunity to successfully continue the business
peacefully without any interruptions.
The business credit can be categorized in following types:
 Commercial credit
 Financial credit

Commercial credit:

It is one of the most important forms of business credit according to the marketing
point of view. This type of credit allows the business to buy goods and services
concerned and repay for these items in the specified time in future. If a business
firm sells its goods on credit to both consumers and other business organizations.

The other business organization comes under the classification of commercial

credit.

Financial Credit:

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 Business man also needs funds which are to be repaid in the future time just like
consumers. The sole use of consumer credit would make the businessman short of
funds.

Most business uses their credit power to borrow cash to pay for current assets and
fixed assets. This borrowed amount can be repaid by the business by the following
three ways.

I. Long term Credit (over 5 years)

II. Intermediate or medium term Credit (between 1 to 5 years)
III. Short Term Credit (Less than 1 year)

The principle sources of financial credit are banks, Investment companies, insurance
companies etc.

Conclusion:

Credit management is the process to ensure that customers will pay for the products delivered or the
services rendered.

Credit management is of vital importance to your cash flow: you can be profitable, but if you lack the
cash to continue your business, you will either be bankrupt or taken-over by someone who knows how
to deal with cash.

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