Assignment 2

Credit & Collections Policies and Collection Flowchart

1. Different methods of setting Credit Limit/Lines/Terms

Through establishing credit limits for customers, a creditor holds discretion over
the credit granting. To put it simply, it places a ceiling on the amount of orders a
company can place and doesn’t promise to extend credit further. companies use
different criteria and experience patterns when establishing credit limits. National
Association of Credit Management (n.d.) enumerated a number of methods that firms
use:

• Payment Record – Refers to the customer’s reputation carried in the

marketplace, both of the business and its management. The customer’s debtor’s
positive debt paying capacity or ability to pay. In short, whether or not the credit
can be paid on time within the credit term and what amount, is the financial
approach of setting credit limit.
• Competition - The information that you have or can obtain from your customer
or other sources. A company determines the credit limit by matching the
amount, or average amount, granted by similar competitors. It uses outside
reports and other credit information sources to identify competitive limits.
• Payment Performance - This popular method adopts a conservative risk
management approach and rewards new customers as they continue to do
business with the company. It is often used when little payment history is
available. While limiting the company’s exposure, it does limit the speed at
which sales can grow.
• Secured or Unsecured – Refers to whether you are a “secured” or “unsecured”
creditor. If there are any lien rights that you can exercise.
• Period of Time - Purchases made over a specific period of time such as a week
or month cannot exceed the credit limit. This is useful in cases where many
shipments may be made to a customer from various company locations. Firms
can approve orders in a more routine manner using this method, as long as the
overall credit provided does not exceed the credit limit.
• Agency Rating - This method is similar to that used for new customers.
Companies that use it can set it up to operate routinely. It is fairly simple to
communicate credit limits to other departments.
• By Formula - Several calculations are made and averaged to determine the
credit limit assigned to the customer. Firms use key financial data such as net
worth, inventory, current assets and/or net working capital, assuming the
 customer accommodates the credit grantor’s request for information. These
data items are divided by the number creditors to determine the amount per
creditor. Amounts are then averaged to set the credit limit.
• Expectation of Use - Sometimes referred to as requirements, this method sets a
credit limit based on the expected dollar volume of credit sales over a period
such as a year. This figure is then divided by the number of orders expected
throughout the designated time to estimate the credit limit. This method, like
the formula method, is often used to obtain a preliminary estimate that can be
defined further by one or more of the other methods.
• Collection - The confidence that you have in your in-house “Collection” process
The following are the factors to consider in formulating credit and collection policies:
1. Capital – Up to what extent can the capital of the company services support
the receivables?
2. Competition – Up to what extent or period of payment does the competition
give to the market?

3. Product or Services – Does your product or services lead or lag in its market?
Does your product or services give you sufficient market leverages against
your competitions?

4. Kind of customers or target market – The class of customers (or the market
for your product or services whether belonging to the high-, middle- or low-
income group will do a large extent influence the collection policies in you will
adopt.

2. What are the advantages of setting credit limits?

Setting credit limits is the overall tool for the control of credit extension,
promotion of sound credit practices and the effective collection of the accounts. It
prevents misunderstanding and confusion within the sales operations and with the
customers, minimize wasted sales efforts, provide some degree of discretion for
automatic control over the accounts receivable.
It aids in reducing the cost credit and collection operations and contributes to
efficiency. Credit limits works as a check against imprudent, reckless buying of
customers and abate extravagance.
Imposing credit limits could be a service to buyers on credit since it could
prevent them from failing hopelessly into huge debts that they may not be able to pay
regardless of the means they employ to weed themselves out such a precarious
predicament.
Credit limits are essential. This is because credit is a motivation to an active and
profitable sales activity. It is inherent in the institution of credit as leverage in its
administration and control.

3. Find a Collection Flowchart and discuss each process.

1. Target Markets – This is where the lending unit identifies the client base and
credit facilities it will pursue.
2. Origins - The credit process begins with a thorough analysis of the borrower’s
creditworthiness, or capacity and willingness to repay the loan.
3. Evaluation - After the credit analysis is completed and borrower has been
determined to be an acceptable risk, the credit officer proposes a loan structure
for approval that preserves the strengths and protects against identified
weaknesses of the borrower.
4. Negotiation – Includes the credit officer’s assessment of the client’s optimal loan
structure, including loan amortization, covenants, reporting requirements – the
underwriting elements.
 5. Approval - Depending on the results from the underwriting process, an
application will be approved, denied, or sent back to the originator for
additional information. If certain criteria don’t match according to the rule
engine set in the system, there can be an automatic change in the parameters,
such as reduced loan amount or different interest rates.
6. Documentation - Since lending is highly regulated, the quality check stage of
the loan origination process is critical to lenders. The application is sent to the
quality control team, that analyze critical variables against internal and external
rules and regulations. This is the last look at the application before it goes to
funding.
7. Disbursement - Most consumer loans are disbursed once the loan documents
are signed. Business loan, line of credit and second mortgage loans may take
additional time for legal and compliance reasons. Lender issues a check or
demand draft, which the client can receive from the bank branch or is couriered
to their address.
8. Administration - If there are special payment plans, compare scheduled
payment dates to the dates on which payments are actually received, and
contact customers as soon as it appears that they will miss a scheduled payment
date. This level of monitoring is required to keep customers from delaying their
payments.
9. Workout Situation - Credit workout, or working with problem loans, should be
covered in detail in the bank’s credit policy. The process for dealing with
borrowers whose capacity to repay is in doubt or has become impaired is the
subject. When a loan is placed on the watch list, an action plan should be agreed
internally and with the borrower as soon as possible. The action plan should
include specific actions or goals to be achieved by the borrower and a specific
time frame for their achievement.
10. Repayment/Loss - If all collection techniques have failed, this includes
completing a credit memo approval form in the amount of the invoice(s) to be
written off.

4. Target Market Identification and its importance.

In its general definition, Target Market Identification refers to members who
share common needs and characteristics. These similarities are typically explained in
terms of their demographic information and the specific need the company hopes to
fill. Common target market characteristics identified include age, gender, income,
education, and location.
For the purposes of credit and collection procedures, identifying the target
market is important because doing so allows it to tailor its advertising, pricing and
promotions to appeal directly to the targeted audience. In contrast, a company that
does not define its target market narrowly could end up with promotions and products
that do not fully meet most customer’s needs. In line with this, a Credit Risk Manager’s
job also includes planning for target market credit allocation and credit risk portfolio
management within pre-defined limits and assessing suitability of credit risk appetite,
credit limits and target market allocation in line with the credit environment and
industry.