Subject: FIMA 30063

Credit and Collection

Prof. Myrna C. Cacho

1st. Sem. 2020-2021
 LECTURE 1 – OVERVIEW OF CREDIT
HISTORY OF CREDIT

 Barter – exchange of goods or services without the use of money, or trade one
thing with another with equal value
• Modernization has allowed credits to transpire, since it has allowed free flow of
heavy volumes of transactions (international borders)
DEFINITION OF CREDIT

Credit 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.
 Credit also refers to the creditworthiness or credit history of an individual or
company. It also refers to an accounting entry that either decreases assets or
increases liabilities and equity on a company's balance sheet.
 Items that are being lend/credit

 • Goods – groceries, appliances,, medicine, hardware (creditor/debtor)

 • Services – car repair, beauty parlors, electricity (creditor/debtor)
 • Funds – cash loans from pawnshops, banks, lending institutions, friend
(lender/borrower) • Property – car(rent a car), beach house(real property) =
(bailor/bailee)
 • Rights – possessions e.g. stocks, bonds, commercial paper, loan recievables
 Credit – happens when a credit transaction is consummated or consented
mutually
 • Ownership – confers legal title to a property or right
 • Sale – a transfer of goods and services
When credit turn sour:

 Goods delivered are spoiled or substandard

• Services provided such as car repair are inadequate or technically
defective
• When 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
NATURE OF CREDIT

 To give credit is to accept another's promise to pay in exchange for a

valuable consideration. To say that a firm gets a "line of credit" at a bank or
with another business house means that it has the right to borrow or to get
goods up to a certain amount by agreeing to pay sometime in the future.
IMPORTANCE OF CREDIT

 Credit is part of your financial power. It helps you to get the things you need
now, like a loan for a car or a credit card, based on your promise to pay later.
Working to improve your credit helps ensure you'll qualify for loans when
you need them.
 FUNCTIONS OF CREDIT

 The main function of credit is to relieve the constraint imposed by balanced

budgets on economic agents, that is, to meet the financial requirements of
investors who have to spend more on trade and investment than their own
savings.
What are the Five Cs of Credit?

 The five Cs of credit is a system used by lenders to gauge

the creditworthiness of potential borrowers, consisting of a quintet of
characteristics.
 1. Character—reflected by the applicant's credit history.
 2. Capacity—the applicant's debt-to-income ratio.
 3. Capital—the amount of money an applicant has.
 4. Collateral—n asset that can back or act as security for the loan.
 5. Conditions—the purpose of the loan, the amount involved, and prevailing
interest rates.
The Basics of the Five Cs of Credit

 The five-Cs-of-credit method of evaluating a borrower incorporates both

qualitative and quantitative measures. Lenders may look at a borrower's
credit reports, credit scores, income statements, and other documents
relevant to the borrower's financial situation. They also consider information
about the loan itself.
 The Five Cs of Credit

1. Character
 Although it's called character, the first C more specifically refers to credit history: a
borrower's reputation or track record for repaying debts.
2. Capacity
 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.
3. Capital
Lenders also consider any capital the borrower puts toward a potential investment. A
large contribution by the borrower decreases the chance of default.
4. Collateral
Collateral can help a borrower secure loans. It gives the lender the assurance that if the
borrower defaults on the loan, the lender can get something back by repossessing the
collateral.
 5. Condition
 The conditions of the loan, such as its interest rate and amount of principal,
influence the lender's desire to finance the borrower. Conditions can refer to how a
borrower intends to use the money.
The 6 C’s of Bad Credit

According to Phil Love

1. Complacency - It stems from the attitude, “I don’t need to watch this
borrower; they have always paid on time.”  This blinds lenders from seeing the
need to monitor the company which may end up with a nasty surprise when the
default comes.  Complacency can come from an overreliance on past
performance of the company, guarantors, or the economy.  Some may also look
at the net worth of the sponsors of the credit and think there is no need to
monitor the credit. 
2. Carelessness - One of the most popular forms of carelessness is sloppy, unorganized
loan files with inadequate documentation.  In some cases, collateral is not properly
perfected, resulting in the lender’s collateral position being compromised. 
Another popular form of carelessness is a failure to establish thoughtful, adequate
covenants to monitor the company’s performance through the life of the loan. 
3. Communication - A Communication breakdown may be a simple problem, or it
can bring down an entire institution.  The first breakdown may be between the officer
and the borrower.
All communication should be clear, concise, and yet comprehensive to include all
pertinent information.
4. Contingencies - Lenders have one of the hardest jobs as they need to be correct
99.5% of the time.  Once your losses begin to creep up over that ½% level, it could
begin to impair your capital.  Truly, commercial lending has one of the smallest
margins of error of any profession.  Imagine what would happen in baseball if you had
to get a hit that often to be successful! 
5. Competition - Competition causes lenders to do strange things.  Too often, credit
decisions are based upon what the institution down the street is doing rather than
concentrating on the merits and risks of the loan in front of them. 
A competitive euphoria is a sickness that may cause the institution to lower the price or
seek a reduced covenant or collateral position just to get the deal. 
6. Cluelessness - Cluelessness is the final factor.  What is most scary is when either a
borrower or worse, the lender does not even know what they do not know.  This can
come from inexperienced staff taking on lending functions in a vacuum, without
additional outside support. 
Types of Credit

 There are three types of credit accounts:

 revolving,
 installment and
 open.
 One of the most common types of credit accounts is revolving credit – a
line of credit that you can borrow from freely but that has a cap, known as a
credit limit, on how much can be used at any given time.
What is a Loan Consideration?

 "Consideration" is the benefit or the detriment to one or both parties that

separates an enforceable contract from a mere casual agreement. ...
Generally, the consideration is the giving of the loan to a borrower where
it the loan will benefit the guarantor.