PRELIM REVIEWER known formal laws around 1800 B.C.
He established a ceiling or maximum
CREDIT AND COLLECTION
Lesson 1: History of Credit
Etymology
The term "credit"
• was first used in English in the 1520s.
• came "from Middle French crédit
(15c.)"belief, trust," from Italian
credito, from Latin creditum "a loan,
thing entrusted to another," from past
participle of credere" to trust, entrust,
believe".
The commercial meaning of "credit" "was
the original one in English (creditor is [from]
mid-15c.)" The derivative expression "credit
union" was first used in 1881 in American
English; the expression "credit rating" was
first used in 1958.
Definition of Credit
• is the trust which allows one party to
provide money or resources to
another party wherein the second
party does not reimburse the first
party immediately (thereby
generating a debt), but promises
either to repay or return those
resources (or other materials of equal
value) at a later date. (Wikipedia)
History of Credit
• Credit has existed from the very
dawn of civilization. Man has always
attempted to borrow from his
neighbor if not cold hard cash, then at
least a cup of sugar now and then
(Source: 3000 B.C. – 500 A.D. The
Ancient Economy | Armstrong
Economics)
• King Hammurabi of the first dynasty
of Babylon, authored the earliest
rate of interest at 33 1/3% per annum.
On loans of grain, maximum rate was
33 1/3%; for loans of silver, 20%.
(Source: 3000 B.C. – 500 A.D. The
Ancient Economy | Armstrong
Economics)
• Under the laws of Hammurabi, every
loan in Babylon had to be witnessed
by a public official and recorded in a
written contract.
• The penalty for charging more than
the legal rate through any means was
quite severe – the debt was simply
cancelled.
• Collateral could be pledged in the
form of land or some possession. A
debtor could also pledge his wife,
children or slaves.
• In extreme cases, the debtor could
even pledge his person but the law
forbids personal slavery of a debtor
beyond three years.
During the time of Hammurabi, unfair
practices also existed and were addressedby
the king. Among these were:
• Calling a loan to farmer before the
time of harvest.
• Crop failure may lead to cancellation
of the interest on the loan for the year.
• Due to scarcity of word, doors could
be used as collateral and are
considered separate from the house.
• Architects were held responsible for
construction defects and may be put
to death if the house or building
collapsed and killed the occupant.
Clay tablets as archaeological finds showed
aspects of man’s early social and economic
behavior several thousand years before
Christ. Among these were:
 • Loans took the form of bearer notes
or bills which the creditor could then
sell to another party.
• Some loans were subject to call.
• Other loans bore a fixed rate of
interest and a fixed maturity.
• International loans existed between
nations (like Babylonians, Assyrians,
Elamites, Hittites and Syrians)
A history of credit and interest reveals one
major trend that has been consistent through
all time.
• The stronger an economy the lower
the rate of interest.
• Interest rates are always at their
lowest level internationally when
capital reaches its point of maximum
concentration.
• This normally results in a strong
currency and high levels of
confidence in general.
Effect of Credit on the Economy and
Business
• The availability of credit can be
crucial to an organization, especially
in the early years or where the
organization is seeking to expand,
recruit or carry out important
research.
• Any reduction in the availability of
credit can adversely affect an
organization’s cashflow. The lack of
funds may prevent or deter a
business in carrying out
expansion plans.
• Money helps businesses hire staff,
produce product and rent facilities
for office space. Most companies
will seek financial support from an
investor or equity partner. Without a
financial backing, a business cannot
exist.
• Credit enables the individual or
business to “purchase ahead of
ability” or “desire to pay”. The
economic needs of agricultural,
commercial and industrial sector of
the economy are adequately met by
the bank credit.
The economic effects of a business credit
crunch
• An organization experiencing
difficulties with cashflow may
respond by cutting staff, or at least by
ceasing to recruit new staff.
• Unemployment rates then rise
dramatically.
• An organization may also choose to
address its financial difficulties by
freezing pay increases, or granting
increases that are well below
inflation.
Lesson 2: Nature and Functions of Credit
Basic Concepts of Credit
• The word “Credit” comes from Latin
“creditum” which means trust
• Ability to acquire something of value,
such as goods, services, securities or
money, at the present time in return
for a promise to pay at some future
time.
• Two parties involved:
• Creditor - the one who provides the
thing borrowed
• Debtor – the one who receives the
thing and assumes an obligation to
pay.
• Credit transaction uses money as the
medium for the value of the goods
 and the corresponding amount of
obligation to be paid.
• Credit Instrument – the paper which
contains in writing the obligation of
the debtor and the right of the creditor
• Credit System – includes credit,
credit instruments, credit institutions,
laws and customs on credit lending
and collection.
• Credit System – includes credit,
credit instruments, credit institutions,
laws and customs on credit lending
and collection.
Elements of Credit
Trust – the creditor or banker has faith in the
ability and willingness of the debtor to fulfill
his obligations, be it an individual,
corporation or government.
Time of payment – the borrower has the
obligation to pay his debt in a definite time or
date.
Bases of Credit (5 C’s of Credit)
Risk – the borrower’s ability to pay may be
affected by circumstances beyond his
control.
Character – the personal integrity of the
borrower. His determination to pay can be
judged by his past business record, such as
his reputation for honest dealings or his
business losses. Information may be
obtained from credit card companies and
other financial institutions.
Capacity – measured by the managerial
ability of the borrower such as his
responsibility, maturity and business
competence.
• Capacity measures the borrower's
ability to repay a loan by comparing
income against recurring debts and
assessing the borrower's debt-to-
income (DTI) ratio.
• Lenders calculate DTI by adding a
borrower's total monthly debt
payments and dividing that by the
borrower's gross monthly income.
Capital – the resources owned by the
borrower, such as properties.
Collateral – property of the borrower
used as security for the loan.
Condition - other factors which affect the
ability of the borrower to pay their
financial obligation such as geographical
location, the enterprise and the general
economy.
Credit Management
Credit Scoring
• a method of credit selection used
by firms with high-volume/ small-
dollar credit requests.
• applies statistically derived
weights to a credit applicant’s
scores on key financial and credit
characteristics to predict whether
the applicant will pay the
requested credit in a timely
fashion.
• results in a score that measures
the applicant’s overall credit
which is used to make
accept/reject decision for
granting the applicant credit.
Credit Standards
• The guidelines a company follows to
determine whether a credit applicant
is creditworthy.
• The set of standards that a company
or bank uses to determine whether to
extend a loan or line of credit to an
applicant. Credit standards may
 include having a certain software-
calculated score, recent good credit
history, and a certain income.
Changing Credit Standards
• Firm may consider changing credit
standards to improve its returns and
create greater value for the firm’s
owners.
• The effect of relaxation of credit
standards:
Types of Credit
Trade Credit
• A business to business agreement in
which a customer can purchase
goods without paying cash up front
and paying the supplier at a later
scheduled date.
Consumer Credit
• Short-term loans to individuals for
purchasing goods and services for
personal and household use.
• Credit card debt, vehicle leases, and
installment loans are examples of
consumer credit.
Bank Credit
• A loan given for business
requirements or personal needs to its
customers, with or without a
guarantee or collateral, with an
expectation of earning periodic
interest on the loan amount.
• The principal amount is refunded at
the end of loan tenure, duly agreed
upon, and mentioned in the loan
covenant.
Revolving Credit
• An agreement permitting an account
holder to borrow money repeatedly
up to a set limit while repaying in
installments.
Open-Ended Credit
• An agreement to lend the borrower
an amount up to a stated limit and to
allow borrowing up to that limit again,
whenever the balance falls below the
limit. (e.g. Credit Card Accounts)
• Borrower usually has a choice of
repaying the entire balance within 30
days or repaying it over a number of
months/years.
• Can be used again and again as long
as the balance owed does not
exceed the limit
Types
• Open 30-day Accounts
Installment Credit
• Installment Sales Credit is a contract
issued by the seller that requires
intermittent payments at specified
times such as bi-weekly or monthly.
• Customers are required to make a
down payment which is a portion of
the entire purchase.
• Most often used for furniture and
household appliances.
Examples
• Room to Go Furniture
• Aaron’s
Lesson 3: Sources of Credit Convenient source

• People and business entities already

have depository accounts with the
Credit is an arrangement between two
banks.
parties wherein one party receives a certain
sum of money or an item of value from Expensive
another.
• High interest rate
• A contract or agreement • Other bank charges (bank fees,
• the lender provides the money and processing fees, documentation,
charges interest for the use of the etc.)
money
• the borrower promises to repay the
amount after a certain period of time Financial Institutions
Dedicated credit companies that work just for
Business needs: disbursing credit. Unlike commercial banks,
FI’s do notaccept deposits and provide safety
• Initial capital contributions fall short of lockers.
funding requirements.
Provide
• Fixed capital expenditures.
• Working capital needs. • Medium to long-term credit of
• Expansion substantial amounts for capital
expenditure requirements of large
Individual needs:
businesses.
• Daily expenditures • Financial and technical advice to
• Emergencies borrowers (also consultancy
• Long-term needs: education, services)
acquisition of fixed assets. Expensive

• High interest rate

• Other bank charges (bank fees,
processing fees, documentation,
Commercial Banks etc.)
Considered as the first and best funding Advantages:
source worldwide.
• Effective in providing substantial
Provides credit to amount for the long-term.
• Businesses for trade and Disadvantages:
manufacturing
• Service providers • Very rigid credit granting criteria.
• Individuals (for personal loans, • Right to appoint FI’s representative in
student loans, automobile loans, borrowing company’s Board of
home financing,etc.) Directors.
 • Right to monitor activities of
borrowing company – may become
too restrictive.
Trade Credit
A source of credit that comes along with the
day to day operations of a business. A form
of short-term credit given on the basis of
goodwill and market reputation of the buyer
(the one granted credit).
Amount of credit affected by (among others):
• Past business frequency and amount
• Payment pattern
• Degree of competition
How trade credit arises:
• A business buys goods or services on
credit from a supplier
• Agreement between 2 parties for
payment to be made after a certain
period of time
Advantages:
• Main advantage – INTEREST FREE.
• Readily available without any
formalities and lengthy
documentation.
• For a running and growing business,
may become a permanent source of
interest-free credit for the business
owners.
• Amount of credit may grow as time
passes (assuming that rapport and
relationship of business and supplier
remains cordial).
Disadvantages:
• Depends on the will of the supplier of
goods or services.
• Limited short-term arrangement (not
a permanent source of credit).
Credit Cards
A common source of credit
How credit is granted:
• Cardholder is given a credit limit
based on requirements / standards of
card issuing bank or company (e.g.
monthly gross or net take home pay)
• Credit cardholder buys goods or
services on credit
• Uses credit card as payment for
goods or services purchased.
• The card issuing bank or company
pays the seller of the goods/ services
on behalf of the buyer (the
cardholder).
• The cardholder pays the card issuing
company within a specific period of
time.
Public Deposits
• A source of credit directly from the
public.
• A company may obtain a certain sum
of money from the public for a specific
time period against the payment of
interest.
• Interest rates on public deposits are
comparatively higher than interest
paid on government and bank
deposits (to compete with these
types of deposits).
• Cost of borrowing from public
deposits is usually lower than bank
borrowings.
• The depositors do not get control of
the company and don’t get any
preferential or voting rights. The
depositors’ status remain as
unsecured creditors.
Advantages:
• Cost of borrowing is lower than bank
borrowing.
• Since it is unsecured debt, no charge
or lien is made on company assets.
Disadvantages:
• Only companies with good track
record and goodwill are able to
garner funds from the general public.
• Source of credit is unreliable. Funds
may not be obtained on time to meet
emergencies or other urgent needs.
• Short-term source of credit with
deposit period ranging 1-3 years.
• Depositor has the right to ask for
premature withdrawal.
Lesson 4: Classes & Kinds of Credit
Consumer Credit
• Also called Consumption Credit
• Extended to consumers in order to
facilitate the process of consumption.
• Lenders usually ask the borrower to
issue a promissory note.
• Promissory note – a written promise
that the amount borrowed will be paid
on a certain date.
Retail Credit
Replevin
• A typical example of Consumer
Credit
• Obtained through Charge Account
and Installment Credit
Use of the Credit Card
• a payment card issued to users
(cardholders) to enable the
cardholder to pay a merchant for
goods and services based on the
cardholder's accrued debt (i.e.,
promise to the card issuer to pay
them for the amounts plus the other
agreed charges).
• The card issuer (usually a bank or
credit union) creates a revolving
account and grants a line of credit to
the cardholder, from which the
cardholder can borrow money for
payment to a merchant or as a cash
advance.
• Two credit card groups: consumer
credit cards and business credit
cards.
• Most cards are plastic, but some are
metal cards (stainless steel, gold,
palladium, titanium) and a few
gemstone-encrusted metal cards.
• Allows the cardholder to obtain goods
or services from an affiliate
establishment of credit companies.
• Affiliate establishments include
restaurants, department stores,
hotels, etc.
• The establishments bill the credit
card companies which promptly pay
and in turn collects from the customer
on a specified date.
• An article is sold under an installment
contract.
• The buyer later fails to live up to his
contract (defaults on payments)
• Seller has the right to repossess the
article from the defaulting buyer.
• The legal action necessary is referred
to as REPLEVIN. (French word
replevin meaning warrant
Advantages of Charge Account
• Buyer is not bothered with having to
pay small sums of money at time of
purchase.
• Buyer can make use of the goods
even before he has a chance to pay
for them.
• Buyer finds it easier to return
unsatisfactory merchandise and
obtain necessary adjustments.
Disadvantages of Charge Account
• Some buyers who use charge
account are induced to be careless in
the selection of merchandise.
• Encourages people to become
wasteful and extravagant.
• Purchase made on charge account
cost more than a cash purchase.
Advantages of Installment Buying
• Buyer is able to use the goods even
before he is able to save the full
amount for the purchase price of the
goods.
• Individual is able to acquire
expensive items or goods than they
could if installment plan is not
available.
• People with limited purchasing power
can obtain what they need through
installment buying.
• Goods purchased on installment may
pay for themselves. Example: In lieu
of payment for rental, installment
payment would confer ownership to
the buyer after all payments have
been made.
• Installment buying allows families to
spread out “expenditures’.
Disadvantages of Installment Buying
• Installment purchases cost more than
cash purchases.
• People who do not know what they
need to buy and buy impulsively may
become overburdened with financial
obligations.
• Individuals may be encourage to buy
what they don’t actually need and
may make it difficult for them to
purchase their real necessities.
Mercantile Credit
• Also called Commercial Credit.
• Type of credit which one
businessman may extend to another
when selling goods on time for resale
or commercial use.
• Parties to a transaction involving use
of mercantile credit include merchant
distributors (e.g. wholesalers,
jobbers) and producers or
manufacturers.
• Essential characteristic of mercantile
credit is the exchange of goods for
the purpose of sale.
• Mercantile credit is required only for
the length of time it takes the buyer to
process and resell the goods.
• Differs from Consumer Credit as to
the purpose of the purchase;
mercantile credit is for transfer of
goods for business purposes while
consumer credit is for consumption.
Commercial Bank Credit
• Credit given by commercial banks to
businessmen to assist the latter in the
operation of their business. Short-
term credit granted by banks in the
form of loans are used for a number
of purposes (e.g. production, storage
 and transportation of raw materials,
etc.)
Comparison of Mercantile Credit and
Bank Credit
Revolving Credit
• A combination of the charge account
and the installment plan.
• Developed out of the popular 91-day
charge account.
• Service charge is added for the
unpaid balance at the end of each
month.
• A fixed limit is placed on the account
provided the balance does not
exceed the stipulated ceiling.
• Credit investigation is made once.
• Upon credit approval, buyer can take
advantage of facilities offered by the
firm (seller) as long as he maintains
his good credit standing (paying his
obligations every month as agreed).
Investment Credit
• Businesses use this type of credit for
the purchase of fixed assets or to
carry minimum business operations.
• Funds obtained are generally
intended to be spent on equipment
which the borrower expects to use
continuously until it is worn out, or
suffers from obsolescence.
• Repayment covers a long period of
time.
• Evidences of credit may be in the
form of negotiable bonds or long-term
notes. In some instances, these may
be real estate mortgages.
• Sources of investment credit – funds
of individual investors, trustees of
funds of individuals and estates,
insurance companies, banking
institutions and business concerns.
Merchandise Credit
• Brought about by mass marketing of
many items/ goods on installment
plan.
• The items have become necessities
on the part of the buyer.
Borrowing Money
• Brought about by the need for money
by consumers to make cash
purchases instead of installment.
According to Purpose:
• Agricultural Credit
• Export Credit
• Industrial Credit
• Commercial Credit
• Real Estate Credit
Agricultural Credit
• intended for the acquisition of
fertilizers, pesticides, seedlings, and
any instruments, machinery and
other movable equipment used in the
production, processing,
transformation, handling or
 transportation of agricultural Commercial Credit
products.
• Also known as Mercantile Credit.
• Those loans intended to finance
• Transfer of goods for business
agricultural production as well as for
purposes.
the purpose of marketing the
products are included in the term
agriculture credit. Real Estate Credit
• Used for construction, acquisition,
expansion, or improvement of real
Commodity Loans estate properties.
• A type of agricultural credit. Short-term Credit
• Rationale: Agricultural products are
• Payable within one year of
produced annually and are marketed
acquisition.
within the span of transportation, • Usually covers purchase of
storage, financing, and marketing. consumer goods.
• Warehouse receipts are readily
accepted for collateral purposes.
• A warehouse receipt is a type of Medium or Intermediate-term Credit
documentation used in the futures • Ranges from one to five years in
markets to guarantee the quantity maturity.
and quality of a particular commodity • Given to finance improvements of a
being stored within an approved firm or industry.
facility.
Long-term Credit
• Generally, a warehouse receipt is
considered a document of title. • Ranges from five years up in maturity.
• Intended for investment purposes.
Export Credit

• Extended to the buyer before the

buyer takes possession of the goods
• Export sales can be done on the
basis of payment when the goods are
shipped through cash deposit by the
buyer or bank guarantees or by
letters of credit and the use of drafts.
Industrial Credit
Government or Public Credit
• Also subject to rules and principles
that govern the use of all credit.
• Means the pledging of the good faith
and the resources of the nation for
the repayment of the debt on behalf
of the people.
• Would emerge when certain definite
development has occurred.

• Finance the needs of industries like

logging, fishing, manufacturing, etc.
and involves big amounts of money.
• Usually long-term in repayment.