CREDIT

FUNDAMENTALS
PROF: CAROLINE GRACE E. MELLA
Definition of CREDIT
is an arrangement to receive
cash, goods or services now and
pay for them later.
This is the easiest and simplest
definition.
(Personal Finance – Kapoor,
Dlabay, and Hughes, 2nd ed.)
Definition of CREDIT
In business, credit is viewed
differently. To a lender it connotes
trust on the borrower’s capacity
and willingness to pay.
To the borrower, it is the ability to
obtain goods or services in
exchange for a promise to pay.
Definition of CREDIT
 It is also defined as a transaction
involving the transfer of goods,
services, funds, property or rights,
thereby creating an obligation
on the part of those who receive
them, that must be complied in
the future.
 This definition indicates an exchange
between 2 parties:
 The first party providing the goods,
services, funds, property or a right and the
second party, who receives any of them,
will have the obligation to comply with this
obligation by promising to pay for them in
cash, in kind or to return the thing
borrowed.
 These parties, respectively, are generally
called the creditor and the debtor.
 The 5 items that are provided by the lender or creditor
are more or less, very commonly encountered by
ordinary individuals: (SCHEDULE)
 Items – Examples:
1. Goods – groceries, appliances, medicines, hardware
2. Services – Car repair, beauty parlor services, electrical
3. Funds – cash loan from a pawnshop, bank or friend
4. Property – a hammer temporary use by a neighbor, a
car for use in an errand (personal properties); a beach
house for use for a weekend (real property)
5. Rights – Possession or use of a commercial store space
bonds, stocks, loan on receivables
 For these items, the terms used for the providers of the
goods, services, funds, etc. and the users would certainly
vary.
1. For goods and services, a CREDITOR-DEBTOR
relationship is created. The provider of goods and
services is called the CREDITOR and the recipient or
user, the DEBTOR.
2. For funds, the terms used are LENDER AND BORROWER.
3. For rights, LESSOR (who owns commercial store for rent)
and the LESSEE (he who rents it)
4. For properties, where transactions are covered by
contracts, the owner of the personal or real property
being lent (by the owner or possessor) is called the
BAILOR and the borrower, the BAILEE.
CREDIT TRANSACTION
 Not all of the 5 types of transactions would
necessarily result in the creation of credit.
 Most of the credit transactions, however are almost
always SALE TRANSACTIONS and CASH LOANS.
 A transfer of goods without a sale is of course
possible.
 According to Article 1458 of the Civil Code, “by the
contract of sale one of the contracting parties
obligates himself to transfer the ownership of goods
or services and to deliver a determinate thing and
the other to pay therefore a price in money or its
equivalent.”
CREDIT TRANSACTION
 Not all of the 5 types of transactions would
necessarily result in the creation of credit.
 Most of the credit transactions, however are almost
always SALE TRANSACTIONS and CASH LOANS.
 A transfer of goods without a sale is of course
possible.
 According to Article 1458 of the Civil Code, “by the
contract of sale one of the contracting parties
obligates himself to transfer the ownership of goods
or services and to deliver a determinate thing and
the other to pay therefore a price in money or its
equivalent.”
CREDIT TRANSACTION
 In a sale, whether on a credit management or
not, it is the intention of the parties (the seller and
the buyer) that both the ownership and
possession of goods or services be transferred to
the buyer, who must pay for them.
 The transfer of ownership is evident in Art. 1458
“to transfer ownership of goods or services; the
transfer could be inferred from the Article: TO
DELIVER. Delivery refers to transfer of possession.
CREDIT TRANSACTION
 In a sale, the seller’s obligation is to deliver a
determinate thing, that of the buyer is to pay for
it – either now or in the future.
 If he pays now, the buyer’s obligation is FULLY
COMPLIED AND EXTINGUISHED, and there IS NO
CREDIT TRANSACTION.
 If he promises to pay in the future, the obligation
will remain outstanding until fully paid. By
promising to pay later, a CREDIT OBLIGATION
ARISES.
CREDIT TRANSACTION
 In rent transactions, credit would sometimes result.
 Since most rental contracts require advance
payment for the incoming month, credit is never
intended to be a result of a result of rental contract.
 When a lessee defaults or fails to pay on a rental
payment, credit is not actually created.
 A credit transaction is consummated by mutual
consent and the non-payment of rent on due date is
certainly not intended by the lessor or owner of the
rental property.
CREDIT TRANSACTION
 However, by virtue of a grace period (time
allowance to pay a rental beyond the due
date), usually included in most lease
contracts, a credit transaction is
AUTOMATICALLY CREATED ON A
TEMPORARY BASIS.
 When a lessee requests for an extension
beyond the grace period, and it is
approved by the lessor, a credit
transaction also results by musual consent.
Provisions of the Civil Code that govern a
particular type of Transaction:

 Sale - Civil Code Articles 1458 to 1637

 Contract for Services - Civil Code Articles 1689 to
1754
 Cash Loans - Civil Code Articles 1953 to 1961
 Property (commadatum) - Civil Code Articles 1935
to 1952
 Incorporeal Rights - Civil Code Articles 1624 to 1635
Credit Transactions that create a
Legal Dispute:
1. Goods delivered are spoiled or substandard.
2. Services provided such as car repair are
inadequate or technically defective.
3. When the prices, for either goods or services, were
not clearly understood by both parties (when price
is not considered certain in money or its
equivalent, there is no sale, and the transaction is
void – there being no mutual consent.
Credit problems resulting from transaction errors,
especially those that may lead to court action, will
certainly create difficulties such as:

1. High costs of litigation: lawyer’s fees, court

filing fees, company-paid salaries of
employees attending court hearings
2. Permanent loss of business customers – a
court case or even an arrogant or uncalled
for demand letter could certainly be a turn-
off for a good customer.
Credit problems resulting from transaction errors,
especially those that may lead to court action, will
certainly create difficulties such as:

3. Cash flow problems due to non-collection

(either payment delays or bad debts)
4. Tension to the employee who caused the
problem; employees under stress are not
efficient or productive employees.
5. The time and mental disposition of
managers are dissipated and disrupted.
Credit problems resulting from transaction errors,
especially those that may lead to court action, will
certainly create difficulties such as:

6. In situations where the company obtains

credit by factoring its receivables or using the
company’s receivables as collateral, and if
the promissory notes and other accessorial
documents are defective, its credit
application would be either delayed or
rejected, resulting in more cash flow
problems.
SYSTEMS APPROACH
 In a SYSTEMS APPROACH, problems
are looked at not on a single, incident
basis, but IN RELATION TO THE TOTAL
SYSTEM.
 It would be best to avoid problems by
handling transactions properly, from
the very beginning, with the use of
appropriate documents, free from
defects.
SYSTEMS APPROACH
 There are many large mature companies
whose credit and collection system has
been in place for a considerable period
of time.
 Their business philosophy, strategies,
organizational structures and procedures
have been tested over time.
 In this kind of situation, the best advice to
a manager is an American idiom: if it ain’t
broke, don’t fix it.”
SYSTEMS APPROACH
 Like in the other functional areas of an enterprise
(marketing, production), the systems approach is
always recommended, provided that it is feasible
primarily in terms of the company’s financial
resources and the adaptability and adjustability of its
employees to the recommended approach.
 A credit and collection system should be capable of
being handled with ease by the employees.
 A sophisticated, confusing set of procedures if not
completely understood, could cause more problems,
or might even cause inaction and partial paralysis in
the organization.
SYSTEMS APPROACH
 An example of using a systems approach, is the
EVALUATION OF THE CREDIT CRITERIA OF A
COMPANY.
 The manifested problem is LOW SALES, which is an
area of concern for another department (marketing).
 Are sales down because of the company’s product
deficiencies (low quality, no warranty when
competing products carry them), inappropriate
promotional efforts, or an un-appealing advertising
message?
 Or is there a continuing downtrend in sales because
of the strict credit requirements where many potential
credit applicants simply could not qualify?
SYSTEMS APPROACH
 Sales and credit are directly related, in
that, in most cases, stricter credit
criteria would always result in higher
sales.
 A good example of this are the stages
of the appliance industry where sales
and credit played a big role in the
growth of the industry.