Chapter 7

CREDIT MANAGEMENT

The function of credit may be briefly summarized in the following words: To find profits in the
field of business activity which lies between the area of safe risks and those definitely poor.

For this very reason, the boundless effort of every business organization to increase its profits
by doing and carrying all the business it can on sound footing has given birth to the science of
credit management.

Importance of Credit Management. There is hardly any business concern today which is not
engaged in the grant of credit of one type or another. However, briefly pointed out, granting
credit is one thing and collection another. Thus, there is a need for a system which will insure
close collaboration between the grant of credit and its collection. While it is true that selling
goods and rendition of services only to customers who have shown and demonstrated their
willingness and ability to pay on the basis of their past records would doubtlessly reduce the
incidence of risks, nevertheless, such policy will evidently result in a reduction in sales volume
and ultimately work adversely against the interest of the firm.
On the other hand, precipitous and indiscriminate granting of credit to all types of customers,
while increasing sales volume, could undermine a firm and usher its collapse. Hence, the need
as well as the importance of a sound and efficient credit management.

The Credit Man in the Business World. For quite some time, the credit man was looked upon
no differently from a glorified clerk or bookkeeper whose job consisted mainly of keeping
records of the financial transactions of the firm's customers.

Efficiency of the Credit Man in His Work. It is exceedingly difficult to lay down specific criteria
for judging the effectiveness of the credit man in the performance of his task.

The Credit Department. The credit department does not grant or extend credits.

Its task and responsibility revolve around the gathering of all credit information about the
applicant and assembling them in such a way that they could be of help in properly guiding the
loan officers in their assessment and analysis for purposes of establishing correct credit rating.

The Credit Manager. The credit manager, paradoxical as it may seem, is a man who occupies a
very important position in the structure of a credit economy and yet is little known and least
talked about outside the world in which he lives. Upon his decision rests the success or failure
of a credit- granting organization. In small concerns, he is the credit investigator, credit
appraiser, credit supervisor, and credit manager (if not a loaning officer at the same time) all
rolled into one.
Credit Investigation and Appraisal
At this point, let us focus our attention on what a typical bank credit department does with
respect to credit investigation work. Like that of any financial institution that is engaged in the
grant of loans or extension of credits, sound bank management dictates that a thorough and
careful credit investigation of clients and appraisal of security(ies) as collateral be conducted
before any accommodations are made. This task is generally performed by the Credit
Investigation and Appraisal Section of the Credit Department. Doubtlessly, the quality of
information gathered is largely dependent on the ability and resourcefulness of the credit
investigators and appraisers.

Credit Investigation. This task is performed by the bank's credit investigator who has, as his
main objective, the verification as well as evaluation of the applicant's character, credit
standing and integrity through the process of data- gathering of all essential facts.

The request for Credit Investigation Report (CIS) may come from any officers/departments of
the bank for any of the following purposes:
a. On clients seeking loan accommodations or credit line with the Loans Administration
Department through Marketing Management Department;
b. On clients applying with the International Banking Department to secure availment in the
form of Letters of Credit, Import/Export Bills, Trust Receipts, and other forms of
accommodations;
c. On clients opening current/savings accounts with the Cash Administration for the first time
(which, of course, is no longer common nowadays in view of the competitive nature of the
banking business);
d. On clients transferring business with the Treasury Department through the money desk;
e. On co-makers and guarantors for credit;
f. On old clients for updating client information;
g. On insurance companies requesting accreditation or offering to act as surety;
h. On beneficiaries named in the Letter of Credit;
i. On prospective buyers of assets acquired by the bank;
j. On prospective suppliers of office equipment and supplies and contractors of services; and
k. Others, subject of special cases.

The Scope of Credit Investigation. The scope of credit investigation depends, to a large degree,
upon the following factors:
1. Purposes and types of investigation.
2. Company credit policy.
3. Client classification.
4. Amount involved.
5. Time and resource constraint.
Generally, the scope of credit investigation covers and includes the following:
I. Company's background/history.
This covers the complete business record, such as the date of incorporation, the type of
business organization, record of registration with the proper authorities, the names of
incorporators, and the summary of operating records. In the case of an individual, his personal
background, business, identity, and membership in organizations will be necessary together
with bank and trade references.

The investigator also takes into account the requirements common in the following types of
business organization:
a. Single proprietorship.
b. Partnership.
The credit investigator should also take into account and consider the following characteristics
of a partnership, such as:
1. There must be a contract;
2. The partners must have legal capacity to enter into the contract;
3. There must be mutual contribution of money, property or industry for a common fund;
4. The purpose must be to obtain pecuniary profits and to share the same;
5. The purpose for which the partnership is formed must be lawful; and
6. Moreover, the Articles of Co-partnership must not be kept secret.
c. Corporation.

The legal existence of a corporation begins from the date of the issuance of the certificate of its
incorporation by the Securities and Exchange Commission. Important matters which a credit
investigator should carefully consider in the Articles of Incorporation are the following:

1. Name of the corporation.

2. Its purposes, objectives, nature, and powers.
3. The location or place of business.
4. The term of duration of corporate existence.
5. The names and residences of the incorporators.
6. Names of incorporating officers.
7. The capital stock and the number of shares into which it is divided.
8. The names and citizenship of the stockholders and the amount or number of shares they
have actually subscribed to and the amount paid on subscriptions.
9. The acknowledgment of the duly executed Articles of Incorporation before a notary public.

II. Financial Condition

Herein is represented in summary form a breakdown of the financial statement of the company
reflecting its latest financial condition and the results of operation for the past three or five
years.
Aside from the balance sheets and income statements, it may include schedules, explanations
or extraordinary items, breakdown of merchandise and receivables and full explanations of all
inter-company loans and merchandise transact- ions.

III. Dealings with Government lending agencies, etc.

a. With lending agencies of the government.
b. A multitude of facts that could be obtained from merchandise suppliers.
C. Other banking institutions. The investigator should focus his inquiries on such matters as the
following:
1. Nature of the credit accommodation granted.
2. Whether borrowings are on secured or on clean basis.
3. If secured, whether the security consists of real estate mortgage, shares of stock, warehouse
receipts, chattels, assigned receivables, discounted notes receivables, assignment of claims
under a government contract or some other form of security.

IV. Bank's experience with the subject

Has there been any previous relationship established in the past?

V. Court Cases
From the Credit Management Association of the Philip- pines data on court cases could be
gathered information about the subject's involvement in, not only collection and other civil
cases, but also criminal cases, as well, if any.
It is important as well as necessary to point out the fact that when a close study is being made,
it is essential to check with trade competitors on the subject (if it is a business concern). In such
"competitive checking", the following information must be sought:
a. The importance of the subject in its particular line of business, the general reputation, the
ability of the management and the quality of the products and/or services being offered.
b. The general outlook as to the conditions in the subject's line of business and whether the
operating methods used are considered sound.
c. Whether the subject resorts to unfair method of competition.
d. Names of other concerns to whom the subject may be known.

The Credit Work

The efficient performance of the credit work revolves around the presence and cooperation of
a staff of trained, experienced and capable personnel whose task and responsibilities are
delineated by the kind of positions they hold in the department, such as credit supervisor,
credit analyst, credit appraiser, and credit investigator.
The job description of each is presented in summary form in the following paragraphs.
A. Supervisor.
1. Handles the over-all supervision of his section or department.
2. Receives request for Credit Investigation Report/ Appraisal Report and assigns them to senior
credit investigators/appraisers for completion and submission on a certain date.
3. Reviews, edits and makes necessary corrections on the Credit Investigation Report/Appraisal
Report submitted by senior credit investigators/appraisers.
4. Answers credit inquiries from banks, trade firms. bank clients and other financial institutions.
5. Implements procedures and ascertains that all matters as well as inquiries of importance are
given top priority.
6. Undertakes to maintain or improve existing relations with other banking institutions and
other sources of credit information.
7. Supervises the preparation of monthly reports on output.
8. Performs other related functions from time to time, such as:
a. trains the new associates of the Section and counsels and guides them in the performance of
their jobs.
b. prepares a list of assignments for each analyst. This includes gathering of all data required.
c. recommends to the department head promotions or merit increase of staff within the
Section.
d. Recommends to the department head, acquisition of financial books, journals, magazines,
and periodicals relevant to the improvement of analysis preparation.

B. Senior Credit Analyst.

a. Assumes responsibility of the supervisor in his/her absence.
b. Concentrates on evaluation of Cash Flow Projections based on the projected Income
Statement and Balance Sheet and Feasibility Studies of various companies.
c. Conducts an intensive research on the business prospects of industries for a more effective
financial and credit evaluation of Cash Flow Projections and feasibility study reports, submitted
to the bank.
d. Works continuously on the revision of present and future credit rating sheets of credit
evaluation reports to cope up with the changing economic/financial situations.
e. Assists supervisor in discharging his/her duty in time of heavy work load.

C. Junior Credit Analyst.

a. Assists senior credit analyst.
b. Studies financial statements and other documents submitted by the client and prepare the
following reports:
1. Credit Analysis and Rating.
2. Financial Analysis.
3. Cash Flow Evaluation.
4. Project Evaluation.
D. Senior Appraiser.
1. Receives and assigns requests for Appraisal Report to appraiser(s).
2. Edits Appraisal Reports prepared by appraiser(s).
3. Assists the appraiser(s) in carrying out their functions.
4. Conducts inquiries/surveys value of real and other properties acceptable to the bank as on
the current market collateral.
5. Performs such other functions as may be found necessary from time to time.

E. Appraiser.
1. Conducts ocular inspection of properties offered as collaterals.
2. Sketches the vicinity and location of the property under appraisal.
3. Verifies the authenticity of original/transfer certificates of titles with the Register of Deeds.
4. Summarizes in a report form findings on the ocular inspection made on the properties
offered as collateral.
5. Entertains inquiries/checkings of appraisers of other banks.
6. Conducts inquiries/surveys on the prevailing market values of real and other properties
acceptable to the bank as collaterals.
7. Performs other functions that may be assigned from time to time.

F. Senior Credit Investigator.

1. Receives and assigns requests for CIR to credit investigator and sets date of completion.
2. Initially reviews and edits CIR prepared by credit investigator.
3. Entertains credit inquiries from other banks and commercial houses.
4. Occasionally assists credit investigators in carrying out their functions.
5. Assists in the development of efficient and comprehensive credit files..
6. Gathers information concerning other banks' credit procedures.
7. Performs such other functions as may be assigned from time to time.

G. Credit Investigator.
1. Conducts checkings and evaluation of applicants for credit accommodations as well as of
existing clients.
2. Interviews co-makers and employers of applicants/clients to verify data gathered.
3. Undertakes bank, trade, government and court checkings regarding credit dealings of the
applicant/s.
4. Prepares Credit Investigation Report, memos, letters, and other correspondence.
5. Assists collection group in locating the whereabouts of clients with past-due obligations and
real estate properties registered in their names.
6. Conducts special investigations, surveys as per requests of other department heads.
7. Performs other functions as may be assigned to him from time to time.
Necessity for Close Supervision. The necessity for a considerable amount of supervision on the
part of the credit manager over his staff is quite apparent. Credit men operate during much of
the working time away from the home office removed from definite and direct executive
control. However, one method which could make the credit men do their job, as expected of
them, is to give them a "deadline" for the case they have under investigation and study.

Psychologists suggest three important appeals for use in attacking the problem of supervision,
such as:
a. Pride in accomplishment.
b. Monetary reward for a difficult job done, like col lection of a bill that is about to be written
off, and
c. Commendation and praises. This may be done through letters of commendation if not
through the awarding of plaque or certificate of merit.

Bank Appraisal Report. Generally speaking, a bank appraisal report contains, among others, the
following in- formation:
1. Subject of appraisal
a. Name of registered owner b. Location of the property

2. Land identity
a. TCT number
b. Technical description
c. Lot number
d. Block number
e. Land area

3. Description of land
a. Shape
b. Frontage

4. Neighborhood data
a. Commercial
b. Semi-commercial
c. Residential
d. Industrial
e. Raw land
f. Others

5. Public utilities
a. Electricity, water, telephone, gas, etc.
b. Kind of transportation facilities available
6. Improvements
a. Full description of improvements

7. Valuation
a. Market and appraisal values of land
b. Net value of improvements
c. Total appraised value
d. Recommended loan value

8. Encumbrances
a. Names of mortgages and amount
b. Others that might be annotated in the Original or Transfer Certificate of Title.

Credit Policy
In most instances, a bank's credit policy evolves from an unwritten set of standards, sometimes
very nebulous, to more specific criteria covering the conditions under which loans are made
Where a bank is small, such policies are seldom found in writing. However, the policy although
not expressed is given meaning and substance through practice and implementation.

A policy has been described as a "decision in advance." Owing to the fact that the entire range
of loan function of a commercial bank is basically interwoven with the decision-making process,
it follows that any pre-made decision can but result in the elimination of flexibility and could
work against the interests of the bank.

How Bank Loan Policy is Formulated. Any loan policy that may be formulated by a bank reflects
but one phase of the over-all policy program of the institution. Such a policy must obtain the
stamp of imprimatur of the board of directors.

A statement of loan policy, among others, includes reference to types of loans and the basis
upon which loan applications may be considered. Such, however, are circumscribed by the
provisions of the General Banking Act which governs the operations of commercial banks.

Also, the kinds of securities that are considered acceptable by the credit-granting institution are
also the subject of loan policy. And, so with amounts involved. In fact, when a certain amount
involved in a loan application does not exceed a certain ceiling imposed by the board of
directors, it is subject to the approval of the loan committee. Beyond such ceiling, approval is
lodged as the exclusive prerogative of the board.

Briefly noted, in the formulation of a loan policy, the officers are guided by two primordial
considerations:
First, the protection of the depositors' funds.
Second, the production of a fair return for its lending and investment activities. The activities of
the credit department contribute a major portion of a bank's income.

Setting a Standard for Control Purposes. It goes without gainsaying that no policy achieves
maximum effectiveness unless it is accompanied by a periodic check-up to insure its proper
implementation and ascertain its weak spots, if any.

CREDITS AND COLLECTIONS

The loan policy should be stated in clear and unmistakable terms so that its implementation by
the officers of the bank charged with such function will be easy. Moreover, such loan policy
should provide specific guidelines for particular types of categories of bank credits, such as the
following:
1. Agricultural credits
2. Commercial loans
3. Industrial loans
4. Real estate loans
5. Consumer or personal loans
6. Term loans.

Dissemination of Loan Policy. The importance of effective communication to the success of any
undertaking has been stressed time and again. Its validity is not in any way diminished
regardless of whether the organization is small or considerably huge. Without it, the
organization would be engulfed in an ocean gap that would act as a monkey wrench that will
ruin the entire machinery of the business organization.

The Credit File

So important is the credit file to any firm extending credit that it behooves upon it to adopt a
system of gathering and putting every information about customers and applicants into a folder
which is filed in proper order. Hence, the term credit file.

As credit information is received by the credit man, he goes over it carefully to make sure it is as
complete as possible. Then he puts it into the credit folder (a large envelope) bearing the
customer's name and address. Necessarily, one folder is assigned to each customer or applicant
for credit.

In this manner, through the course of time, there is accumulated eventually a complete credit
history of each customer, to which immediate reference may be made at any time when the
need arises. Arranging the folders in alphabetical order enjoys the advantage of providing easy
location.
Experienced credit managers also keep a card record on which are noted the different kinds of
information. Two distinct advantages are obtained from this method. One, a card record could
be examined quickly without taking the time to go through the papers in the folder. Second, in
the event that some records are found missing from the folder for whatever reason or reasons,
the company will not be left in the dark, since it has another means which could help serve its
purpose.

It is important that credit files be kept up to date. In some banks, the responsibility for constant
revision of such file as needed by circumstances falls upon the credit department. Others place
it under the charge of the loaning officer.

Regardless of where the responsibility falls, it is a good policy to revise such files not more than
once a year unless unusual circumstances prevail. Since credit files tend to get big and bulky, it
is necessary that those with inactive status be transferred to other folders.

A major problem common among credit-granting institutions pertains to keeping track of credit
folders when they are removed from the credit file - especially so when time is of the essence
and there is immediate need for a particular credit folder.

A very practical method, if not to say the best method, to solve such problem and thus serve
the interest of the company is by inserting a board the same size as the credit folder in its place
with the following information: name of the folder, date it was removed from the file, and the
person who has the folder.

Maintenance of credit files with utmost confidentiality should be the over-riding concern of the
officials charged with this responsibility. Because of the confidential nature of the information
contained in the credit files, folders can only be withdrawn upon prior authority granted by the
responsible official.

Credit files give historical account of transactions and are generally observed subdivided into a
number of sections. For instance, the first section is used for statements. As may thus be logical
to expect, the latest financial statement of the company is found with the bank's comparative
statement form. The second section contains a compilation of reports on interviews conducted
by the loaning officer of the bank and his staff. Correspondence and other related matters with
banks and business firms are contained in the third section.

The fourth section contains an up to date file record of borrowers as well as prospective ones.
In the case of the former, also their latest balance is included. The fifth section contains reports
from credit agencies whose services and assistance have been sought by the bank.

Credit Policies of Commercial Houses

To say that a credit department is essential in every organization engaged in the grant of credit
is to elaborate on the obvious. On the part of small concerns, a credit department may exist
merely as a section. Or it may seem not to exist at all. At any rate, even in the absence of any,
credit functions are discharged by a responsible official in the organization. In fact, in the
particular case of sari-sari store which sells goods on credit, owing to its size and the close
contact between the owner and his customers, the existence of a credit department appears
superfluous. However, the owner himself performs the credit investigation and evaluation of
his customers.

Credit policies may vary from one business enterprise to another. One relates to the type of
customers who are to be granted credit. One firm may be primarily interested in in- creasing
the volume of sales. It therefore grants credit to all applicants and runs the risk of some losses.
Others take extraordinary precautions in granting credit that could reduce their sales volume.

It could be stated categorically that there is no single yardstick or criterion that could be used to
guide the business enterprises in the formulation of their respective credit policies. Be that as it
may, certain fundamental principles could prove helpful when taken into account and applied
accordingly. Their observance operates as an instrument of control.

Scope of Credit Policy. After adopting a credit policy, the business enterprise must decide just
what are its credit terms and what credit period it will adopt as well as its credit limits.

By credit terms is meant the terms or conditions under which the credit is granted. It includes
the time when payments must be made and the discounts, if any, that will be allowed for
prompt payment. In other words, credit terms pertain to the period when credit obligations will
remain subsisting; for instance, payment shall be made one week after delivery, or 30 days as
the case may be in accordance with company policy. In many instances though, this is not
strictly enforced thus resulting in considerable delay in payment of credit obligations.

Purpose and Advantages of Credit Limits. As aptly pointed out by Theodore N. Beckman and
Ronald S. Foster in "Credits and Collections," although limits are sometimes used as absolute
maxima of credit, nevertheless their general use is in the nature of danger signals, just like the
warnings posted at approaches to railroad crossings.

Principles of Controlled Credit. The following fundamental credit principles could serve as the
cornerstone of a controlled credit policy. They are:
1. Only after a thorough investigation of the credit worthiness of the customer seeking credit
may credit be granted.
2. Each new customer should be made acquainted with the terms and conditions as
promulgated and implemented by the business firm with respect to terms of payment; dis-
counts, if any; credit period; and credit limit.
3. It is necessary that the first reminder be sent immediately, i.e., the next day after bills
become past due.
4. Continued use of the credit privilege should be suspended in respect to slow paying
customers. Such privilege may be given back to them only after they have paid their existing
indebtedness.
5. Decisions and actions should be characterized by firmness but short of being rude and
arrogant.
6. When it becomes absolutely necessary, the services of collection agencies must be sought or
legal services enlisted as the case may be.

The Problem of Credit Extension. Few merchants ever escape the problem involving the
extension of credit to customers.

Granting Credit
Aptly observed, granting credit to the individual is one thing and to a business firm is entirely a
different matter.

Three major considerations immediately come into the picture all of which merit attention.
•The first relates to the size of the order.
• The second refers to the identity of the applicant for credit and his references.
• Third is the customer's rating appears in the register of some mercantile agencies.

Wholesale and Retail Credit. Essentially, a big difference lies between wholesale and retail
credit. Wholesale customers usually buy for resale to others while retail customers buy for their
own consumption.

The Principal Objectives of Credit Management. As pointed out in earlier discussions, credit is
not only very important but moreover a scarce resource. This fact under- scores the need for
this judicious and wise use. Hence, credit management becomes very compelling indeed. Aptly
said, credit management is not unlike the management of any major business function which
seeks the attainment of its laudable objectives, such as;

1. Maximizing sales.

b. Controlling the amount of receivables.

Toward the achievement of these ends, it is necessary to develop, interpret and maintain
effective controls and standards which will assist all concerned to:
(1) project desired results more accurately;
(2) identify and forecast major trends that effect significant credit activities;
(3) determine the need for changes in policies and/or practices;
(4) detect credit problems, insofar as possible, in time to take corrective action before they
become critical; and conserve time and effort on the part of all concerned.

2. A primary problem of establishing effective controls in the credit department is to determine

what is significant.

c. Controlling costs of credit and collection. Every company incurs expenses in the extension of
credit and in the collection of accounts receivables.
These expenses include
(1) bad debt losses;
(2) wages and salaries of employees charged with credit and collection functions;
(3) cost of funds tied up in receivables;
(4) cost of fees and dues for credit information;
(5) charges incurred for outside assistance in making collections;
(6) rent or space occupied by credit and collection personnel. And, of course, depreciation of
credit and collection equipment and fixtures.

3. Control of credit and collection expenses does not necessarily, however, mean minimizing
expenses.

Importance of Credit Limits. It cannot be stressed too strongly, that one pressing problem
which taxes the minds of credit managers is not only the decision when to extend credit but a
complementary problem of how much credit must be extended.

Types of Credit Limits. In studying credit management, two types of credit limits may be noted:
quantitative credit limits and temporal credit limits. Both have their importance in granting
credit.
By quantitative credit limits is meant the maximum amount of credit which may be permitted
to remain outstanding on account. The amount is determined by a proper analysis of the C's of
credit which is not be exceeded.
On the other hand, instead of imposing a maximum ceiling on the amount of credit which a
debtor may be able to obtain and use, temporal credit limits impose certain requirements
which a borrower or prospective debtor must comply before he could be granted credit. This
temporal credit limits may be defined as simply "that type of credit which does not indicate the
maximum amount that an individual or business firm can obtain from the creditor-granting
company as long as the debtor is able to fully comply with conditions set.

SOUND CREDIT MANAGEMENT

Sound credit management principles revolve around three E's, such as:
1. Estimation.
a. All available sources of credit information must be tapped and utilized so that a pro- per
estimation of the credit risk can be obtained.
b. For individuals who buy for consumption, character and their ability to pay serve as
important bases of credit; for business concerns, it is the net worth and condition of the
business as well as reputation for paying their bills.
c. All credit information gathered and received must be kept in strict confidence. Only those
who are authorized must have access to it.

2. Enforcement
a. Granting credit is but one phase of the credit function, collection is another. Collection of
accounts should start from the moment they become due. There should be no room for
vacillation insofar as collection is concerned.
b. The task and responsibility of every collection department is to get the money due the
company. If the money can be collected without offending the customer, doubtless, this should
be done.
C. Collection records must be kept and main- tained and should indicate when notices were
sent; dates when calls were made by collectors; payments made; balances due; and action
taken, if any.

3. Evaluation.
a. Sound credit management principles dictate that results must be evaluated against company
policies and procedures.
b. If a situation should arise in the future which preclude good-paying customers to discharge
their obligations on time, policies and procedures may be modified without losing sight of
company goals and objectives.
c. Records must be periodically reviewed and kept up to date.

Credit Frauds
If only all individuals are honest, then no credit manager would develop wrinkles or grow gray
hairs prematurely. But that is perhaps wishful thinking. While it is true that most credit
manager's relations are those with business firms and individuals who operate above board,
nevertheless, there are a few who do not.