, CRfDN&COLL6CWON

3. A rna who occupies a very important position in the

structure economy.
A task of verifying as well as evaluation of the applicant
character, credit standing and integrity through th
process of data gathering of all essential facts.
5. It revolves around the presence and cooperation of a st
of trained, experienced and capable persormel whos LEARNING OUTCOPtES
task and responsibilities are delineated by the kind o
positions they hold. 1. Define credit information;
2. Know the different financial statement;
6. It contains the following information subject of appraisal
3. Identify the various bases of credit;
land identity, description of land, etc.
4. List down other bases;
7. It evolves from an unwritten set of standards, nebulou
5. Know the different bank's credit rating system; and
to more specific criteria covering the conditions nude
6. Prepare credit investigation report.
which loans are made.
8. A system of gathering and putting every informatio
about customers and applicants into a folder which i Everyone who grants credit has an important task and responsibility not
filed in proper order. ly to himself but to the economic society as well, i.e., only those entitled to the use
9. The terms or conditions under which the credit is granted., J credit should be conferred such privilege. For this reason, there is both a pressing
10. d compelling need to conduct a proper and thorough analysis and evaluation
The length of time within which the customer is I credit risks of applicants for credit. This is sine qua non to the determination of
expected to remit in part or in fulL rtiper credit rating.

Thus, among others, it is necessary and important that sources of

information c tapped to the fullest extent and placed under careful scrutiny and,
moreover, tudied thoroughly just as a physician examines very carefully the
specimen placed nder the microscope so as to ascertain what possibly is the cause
of the ailment of c patient. As may be noted, the physician does not stop there.
Rather he continues n his painstaking search, trying to find the unknown through
whatever means that re available at his command. For this reason, he tries to
acquaint himself with the. cdical history of the patient as well as the various
symptoms he observes frorñ is physical and medical examination of the patient.
Not infrequently, he consults
fellow physicians in order to arrive at a correct diagnosis.

Those who run the credit department cannot do otherwise. The credit
fniinager, for instance, must avail of the services ot the credit investigator, die
dppraisers, salesmen, and others who could be of help to him. He may even enlist
the services of private credit agencies in order to supplement the various
information he has already at hand. In the case of properties which are odered as
securities, the credit manager may hire the services of independent and expert
appraisers as to
- their correct market value and not rely solely upon the appraisal of his own men.

i24
‘ . - - » * . ----——- '“
CR£DC%COLLECMON *’ ’ CREDtT&COLLtCL0H *'

Scope of Credit Analysis 4. Analysis of debtof s financial statement

5. Audits or surveys of the business
Financial analysis for credit purposes is a complex process. Not only does i
involve a thorough study and iinderstanding of financial facts recorded in balanc . From internal sources
sheets, income statements, trial balances, and separate schedules but moreover
th economics of a'1ine of business, of a trade, or of industry. 1. Mercantile agencies
2. Trade references
Financial analysis is part of the complete process known as credit checkin 3. Banks
or credit granting. 4. Newspaper clippings
5. Court cases
from the credit man's point of view, credit analysis of a firm is generall 6. Reports from competitors of the borrower (in the case of a business firm).
undertaken to help determine liquidity. Through going analysis every known fa
regarding the affairs of a business concern will be taken into consideration wh
ersonal Interviews
examining the financial report. In actual practice, however, wide extremes are foun
in the scope and intensiveness of financial inspection and analysis. Depending on A personal interview is initially started when a prospective borrower
credit policies established by his firm and the scope of his activity, a credit grant pplies for a loan (or for the purchase of goods and/or services on credit in the
may be superficial in his analysis or he may be purely mathematical, or he ma use of a business firm). The most prudent credit extension is based upon
not be satisfied with nothing less than understanding of the conditions and tren complete vestigation and competent analysis. Each application for a loan requires
disclosed by his analysis. a different pe of Investigation.

It should be pointed out that comprehensive analysis requires that the tren Not orily does the personal interview result in a more accurate and detailed
of earnings and of economic conditions be compared with the experiences of formation, it likewise provides for a more complete information. This is so since
representative group of companies in the same line of industry. personal investigator can explain various perplexing questions in their different
ades of meaning and thus use a certain degree of salesmanship to persuade the
It should be noted, however, that the statement analysis is not the sole pplicant for credit, who is being interviewed, to reply accurately and more fully.
basi of the credit decision. It is only one part of larger process known as credit ten, too, in the personal interview, there is observed to be less likelihood for any
analysis. tim for facetious and deliberate misleading information than when information
sought merely from the standard to be accomplished by the applicant for credit.

CREDIT lNFORf4ATION Personal interviews may be conducted with or without the assistance of
nrefully-prepared questionnaire. In some instances, the interviewer may be armed
First things first. Sine qua non to any credit analysis is the gathering p ith acertain degree of authority with respect to how he should conduct the
all available information about the applicant. Owing to the complexity if not th interview
number of facts and data sought, the task of gathering credit information is far fro accordance with the type of information desired. An experienced inter ew ercan
an easy task. nsily detect whether the party being interviewed is sincere, straightforward or
vasive and untruthful.
The principal sources of credit information may be observed as follows:
cular Inspection
A. From internal sources
An interview with the seeker of credit may be followed by conducting an
1. Debtor's previous credit record with the business firm. cular inspection of the plant, equipment, and other assets which are offered as
2. Credit man's personal knowledge of debtor's character and reputation. ollateral security at the place of business of the applicant.
3. Personal contacts with debtor.
Moreover, title to property may be inspected to determine in whose name
• Through correspondence e property is registered as well as any annotations, if any, (as to past or present
• Through personal visits by credit man or his representatives. tirtgages), attachments, and notices of its pendens.
• Reports of salesmen

126
•CRED1T&COLLECTION

FINANCIAL STATES ENT is very important summary of past operations and a source of leads for
further investigation by the credit analyst.
While financial statement represents not only one source of credit
information nevertheless, its importance deserve utmost attention in respect to its Cost of goods manufactured, selling expenses, administrative expenses, and
study an analysis. other income and expense data summarized in the profit-and-loss statement.

Financial Statement, defined. A financial statement may be described as Explanatory text or footnotes by the auditor explaining any of the figures in the
presentation of financial data from accounting records.” This definition is a bit hnancial statement.
broad to permit an approach to the subject in its proper perspective. Financial
statemen of the, individual firm is the most important financial data. Varying Reliability
numbers o statements, schedules, and exhibits [Link] but three are
fundamental su The values of these statements supporting application of loans filed with
C‹immercia1 banks varies directly with the degree of confidence the loan officer can
liice in their accuracy. Statements prepared by outside accountants generally are
The balance sheet which depicts the financial condition of the business firm a given more credence than those prepared internally by the borrowed s own staff.
the end of a specified period.
merest of Commercial Banks
2. The profit-and-loss statement which summarizes the financial operations
over period of time; and Commercial banks are interested in the accuracy and reliability of the
various nancial statements. Occasionally, banks are presented with financial
The reconciliation of the capital accounts and summary changes. statements hat are not accurate and dependable because they have been
deliberately falsified, rcpared by those who do not follow acceptable accounting
In addition to showing the amount of net profit after income tax practice, or made by t›sé who are over-optimistic in valuing assets and
retained in the business and amount paid out in dividends, its importance underestimating liabilities. ecause of these factors,.commercia1banks insist that
anchored on pinpointing out changes resulting from revaluation of assets o financial statements, especially n large concerns, be prepared by disinterested
investment of additional funds. party, preferably by a certified iiblic accountant who follow accepted methods
and principles of accounting. onks sometimes insist that some applicants use
A number of other schedules, exhibits, footnotes, and textual materi financial statement forms prepared y them. Such a practice doubtless help
may be included in the more comprehensive financial statements. Among thosi facilitate the procuring of statements and it›reover results in standardization.
found within some degree of frequency are ones giving more details on.
The date of the statements in a factor that must be recognized. Balance
The auditor's opinion or statement of the scope of the audit. lac'ets, for example, that are prepared when the business is at its low point or
when ritlebtedness is not great will show a much different picture than if prepared
Individual items (suck as cash and investments) and liabilities (such as when inriebtedness is high and business activity is at its highest point.
note or bonds payable) given as a total in the balance sheet.
Since many financial statements such as balance sheets and statements of
Insurance coverage tn‹ ome, are historical in nature, it is highly desirable that the credit analyst has at
his
Sources and application of funds. This is one of the most useful of all tool ;ct›nvenience and reach financial statements for several periods if they are
available to the credit analyst..In it are summarized all the activities o1 th available. Abis will enable the credit analyst to make a comparison and thereby be
firm which increased or decreased its cash position. Sources of funds includ able to btain a good picture of what has occurred over a period of years.
net profits after payment of income taxes, non-cash consuming expense Obviously, a nnk credit analyst must have some knowledge of the applicant’s
such as depreciation and depletion, a decrease in working capital indicating business who is p[oplying for credit on the amount and quality of the data
a greater increase (or smaller decrease) in current liabilities than in available. In analyzing the fliaancial statement, the reliability of the audited
currerr assets, an increase in long-term debt, gains on the disposition of balance sheet is initially examined After which a summary of financial ratios and
assets, an sale of additional capital stock. Uses of funds include payment o1 statistics is subsequently prepared o ascertain the profitability, liquidity as well as
dividendsj an increase in working capital, reduction of long-term debt, solvency positions of the business enterprise under consideration.
losses in th disposition of assets, and acquisition of treasury stock. Tliis
statement, the
 ade References
Mcrcanti
Banks
Gathei-ing, As a standard practice, the credit-granting concern generally request the
Sales Ageits
Coliating, end Sources o/ ‹›on-applicant that it be furnished with a list of the bariks and business firms with
Sorting of Financial etat tt hich the applicant has business dealings at the moment as well as those with which
redit In Newspaper clippings
Credit Infor- Toriaaùon
t has dealt with in the past.
Court records
Trade firnis Basically, there are two major reasons which justify the need for
Interv'iews
references. "ii st, it is customary for all businessmen to satisfy themselves with
respect to the integrity, reputation, and financial standing of prospective
Investigation. customers. This holds with particular application to banks and banking
institutions inasmuch as checks In the hands of unscrupulous individuals could
Recording, become potent and dangerous weapons in that such individuals will not hesitate
aluntiop
Filing, to open current accounts with different banks and, with check forms in their
Appraisal and Indexing,
Credit Recoi œdations possession, they could fill them up in amounts far in excess of what they have in
Keeping credit their accounts and thus use them to tlufraud others, if not the banks themselves.
filca up to data
Second. Trade references showing established business connection during
the years past while not conclusive insofar as unblemished reputation and
financial ability to pay on the part of the applicant are concerned, nevertheless,
could serve us a good index regarding the experience of previous business firms
and trading companies with respect to transactions made by the financial
of each account managers of a business Its increase current assets and holds them in the form of
Billing cash or securities as are reasonably necessary under the circumstances. Such
jj „ ppt method confers upon the business firm the following advantages:
Crediü ng pnyin nts
Follow-ups Clasgifying debtors The business firm will be better situated to face unforeseen emergencies or
b Q@ habita unexpected business reverses.
COrt'espondence o'ith
Custoiners and othcra 2. Funds being readily available could be tapped and utilized for any attractive
business opportunities that may crop up in the future.
PIAJOR FUNCTIONS
DEPARTMENT AND RESPONSIBILI
TIES OF THE CREDI Purchases can be made in large economic lot sizes. As such, this will enable the
business firm to take advantage and obtain some discounts.
Profitability
From the point of view of sound business management, for a business firm
It is measured by the success of a business to be described correctly as solvent, it is necessary that it is able Io meet its liabilities
in owrier's equity. T e nature and amount
ofmô ifltaining and increasing the iis they mature.
trend are all significant in this appraisal.
earnings as well as their regularity ans
Perhaps, it may be correctly mentioned that if a thorough analysis is
Liquidity desired but the data are far from complete or not available, the financial analyst
must somehow act no different from a private detective. The same step should
apply in
It iS gauged through the ability return of cnses where some suspicion exists, as when the business firm is trying to hide or
due to insufficiency of funds. present a different financial picture from what actually it is. The financial analyst
checks
fact, the credit file Will give a good picture of
the true standing of applicant with
respect to previous borrowings, amounts should scout for the full facts and piece them together, as in a jigsaw puzzle, and
involved,
whether they were repaid on Ô me or and the time of payment, i.e., obtain the true picture of the firm which is the subject of study.
not.
 CREDIT & COLLECTION

Bank's Own Records

Salesmen as Sources of Credit Information
It is scarcely necessary to point out the fact that the bank always Leeps
records of whatever transactions it has with its Not infrequently, salesmen are good sources of credit information because
customers. they have direct contact with the buyers in the field of their operation.

From such records, through a proper study and analysis, the bank is able
to ascertain the average balance kept on deposit by the applicant as well as cases The salesman is in a favored position, if properly instructed, to collect an
involving subject applicant together with the degree of promptness of repayment' immense wealth of information about the applicant which perhaps is scarcely
am many others. available elsewhere. He can do this through conversation and questioning of the
applicant. Sometimes, even gossip could be of some help. As a keen observer, he
The following form letter is an example of a request for business reference: can evaluate the importance of the location of the business firm, the methods
employed (whether ethical or unethical) and its reputation in the community
where it operates.

In as much as it takes certain qualities of good judgment, training and

Re: Request for Business Reference experience to be able to gather the needed information, not every salesman can
furnish specific information that is desired by the company. To be of great value to
This customer of yours has given us your name as a reference. As. such, we would like to the company, the salesman must be thoroughly trained in the broader aspect of his
appeal to your kind cooperation for whatever valuable information you could furnish us company s selling policy — that “it is better not to make a sale than be able to sell
which- would be of help in the consideration of his application for credit. one for which no payment will ever be made by the buyer.” Moreover, the
salesman must also be made to understand and remember that “no policy could be
How long has the applicant been buying more detrimental to the interest of the business firm than to offer special
from you? concessions not in consonance with the terms of the selling concern.
2. How much credit do you allow him?
Narket Research Department
3. How promptly does he settle his obligations with your company?
While not many companies maintain its own market research department,
4. What is your opinion of the applicant as a credit risk? nevertheless, in cases where they do, such department could provide a good
source of credit information. This is due to the observation that research men
°i. Any remarks you might care to make. engaged in the collection of needed information enjoy a certain latitude of freedom
from any bias or prejudice. Indeed, they are trained to size up the merchant, his
store, his method of conducting business and others — with absolute impartiality.
In connection with our request, please be informed that we will treat it in absolute and On top of this, their reports enjoy the distinct advantage of being free from the
strict confidence. uncertainty and impersonality that oftentimes characterize most stereotyped credit
reports.
Your cooperation on the matter will be highly appreciated.
Market research does not only delve into the potentialities of a particular
With sincere thanks, product or the degree of market demand but, at the same time, it will provide
other information such as business houses that will handle the product — and, of
John Swift course, their business and financial standing.

However, one major drawback against a market research department is

the outlay that is involved not only in putting such department but its continuous
maintenance.

Credit Agencies

At least partial information about the credit standing of an applicant for

credit may be obtained from certain established credit agencies.
 CREDIT&COLLECLON
CREDO&COLLECMOM

' By definition, a credit agency may be described simply as that company Services Offered by CMAP
which gathers and distributes information about the credit position of individuals,
firms, and corporations. Generally speaking, two types of credit rating agencies CMAP offers the following services:
may be noted: (a) agencies that provide credit information with regard to
businessmen
and companies, and (b) agencies that provide credit information with regard to 134
individual 'purchasers.

Private credit agencies make a profit by collecting information and

publishing confidential reports for the benefit of their subscribers. Each subscriber
contributes to these reports by furnishing information and periodic ratings.
Additional information is gathered from local newspapers, notices of change in
address, death notices, and, court records.

The most important facts contained in the reports hirnished by credit

agencies, are those which pertain to the business histories of individuals as well a
those of business firms. This may be explained from the fact that such histories
could include all available information on bankruptcies, lawsuits, composition
settlemert with creditors, and other data, whether favorable or unfavorable.

Credit Management Association of the Philippines

The Association of Credit Men, Inc, came into being through the joint effort
of some 26 creditmen in 1931. Thirty years later, in 1961, the association becam
affiliated with the National Association of Credit Management, keeping this
position Ion the next ten years. The NACM has its headquarters inNew York and is
the pareri organization of state and local credit association throughout the United
States.

In 1967, it assumed its present name (Credit Management Association o

the Philippines) in consonance with the growing recognition and the increasin
demands and responsibilities of the credit profession. CMAP which stands for Credi
Management Association of the Philippines, for short, is composed of more th
200 members-companies from the banking, trading, manufacturing, financing an
insurance communities. Its overall philosophy revolves around three main theines:
(1) to inculcate credit consciousness in the public's mind; (2) to place fhe credit-
man in his proper place as a professional; and (3) to infuse credit discipline to the
greate mass of our people.

Broadly, its function consists of the collection of every bit of information vital
to the credit function which it disseminates to its members for their guidance. Thus
court cases involving dishonesty and immorality do not escape its attention. In th
main, most such cases are for estafa„ replevin, and others. Through its assistance, i
helps prevent the improper use and abuse of credit on the part of those who are no
entitled to such a privilege. Thus; such a safeguard represents service of far-
reachin significance considering the fact that in a developing country like the
Philippines there is utter need for the husbanding of all resources, including
capital; to mak the economy grow and prosper. And such an objective can only be
attained throng proper and wise allocation and utilization of financial resources.
1. Quarterly Survey of Credit and Collection Bureau. Member-companies are
surveyed by the association office every quarter of the year for their (a) individual
comparative experience on the collection situation between two succeeding
quarters, that is, whether collection has become easier, tighter or unchanged;
reasons which account for the situation; (b) the company's prevailing terms of
sale, equivalent days' billing of trade receivables, and ratio of bad debts to
gross credit sales for a period ending the particular quarter under review and
(c) aging of receivables.

2. Listing of Overdue Accounts. This is a periodic activity in which member-

companies provide the association with names of accounts overdue the
standardized terms of the reporting company. The accounts submitted are
consolidated.

3. Listing of Court Cases. This is a compiled listing of court cases in the

categories of sum of money replevin , and estafa filed in the different courts
within the cities and towns of Metro Manila.

4. Listing o1 Returned Checks. Any interested member-company may submit a

list of account names who have paid by checks and for one reason or another
cannot be negotiated or returned by the bank. All account names are
summarized.

s. Listing of Corporations and Partnerships. From available records, a periodic

listing of corporations and partnerships registered or dissolved is compiled.

6. Ledger Interchange. This is an exchange of notes for comparison on

experience and opinions extracted from the ledgers of members of accounts
selected from time to time for review only by interested and participating
member-companies.

Other services offered by CMAP consist of holding seminars/workshops,

publication of Credit Management Journal and others.

BASES OF CREDIT

The foundation upon which the system of credit rests has been indicated
earlier. Apropos to that, our attention is immediately drawn to the bases of credit
which are intertwined with credit analysis and evaluation.
CREDIT & COLLECTiON

Traditional C's of Credit It may be looked upon as representing the debtor's ability to conduct his
business efficiently and profitably. This is reflected by his business experience and
The major factors which must be considered and taken into account whiclr personal effort to succeed. Capacity, in this sense, briefly stated, involves
affect the decision as to whether credit should be granted or denied are generally business ability, reputation of product (in the case of a manufacturer or
termed as the traditional C's of credit. Such C's of credit are character, capacity,; producer), soundness of business methods as evidenced by profit-making
capital, and collateral. records.
Character 2. Capacity may be looked upon as the ability to enter into a valid contract. Age
and health of the debtor are two important factors to consider. Unléss the
The character of the borrower indicates his willingness to discharge his individual is of legal age, the contract may become invalid and unenforceable.
financial obligation, that is, to pay the loan as promised. While character does not, Çhus, a contract between a credit-granting concern and a minor is invalid.
in any way, in icate his probable ability to do so, nevertheless, one who possesse
good character will always endeavor to meet his obligations. On the other hand, health is likewise another factor that must be given
important consideration. For as is observed, uninterrupted earnings depend
Unblemished character makes for good reputation, which is of definite valu largely tipon one's good health. Conversely, ill-health may force the individual to
in credit analysis and evaluation. It goes without saying that honesty, integrity, Suffer horn a decrease in income which might impair his ability to pay.
willingness to meet obligations that have arisen out of past credit transactions a
well as willingness to cooperate are qualities that make the buyer a good risk.

Conversely, bad habits or tardiness in the discharge of obligations if not t The term capital has many meanings. For instance, for businessmen, money
say totally ignoring one's obligations, should immediately disqualify an applicarr is capital. From an economic sense, capital refers to capital goods, those goods
for credit. that iwe used in the further production of more goods.
On this subject, the eminent Bishop Fulton Sheen has this to say: As used in this book, capital represents the firm's property, like equipme !.
building and the like. Property which has a ready market, whether used directly
"Character is not revealed when life shows its best side but
when it shows its worst. The way to tell a print from a tapestry is to in the business or not, which is registered in the name of the prospective debtor
look at the seamy side. An inexperienced buyer never turns the chair constitutes the basis of the property risk.
upside down; an expert always does. The worth of a person, in like
manner, is to be judged by how he reacts to the obstacles, the limitations The risk factor increases with the length of loans, meaning to say, the longer
and the crosses of life. Life can be based on either of two assumptions. the term, the longer is also the risk. It is for this reason, that in many instances, if TlOt
One is that the obstacles, trials and sorrows are not a part of the pattern iilways, most long-term loans are secured by pledges of property.
of life. There must be all warp and no woof in the fabric of existence.
Hence, in the face of annoyances, one must either seek flight from Capital is considered by many as the most desirable and perhaps the most
existence through alcohol or barbiturates, or else blame all that happens important requisite for credit — this, notwithstanding the oft-repeated remark,
to others. From this flows discords, revolutions and wars."
ofJ.P. Morgan, a well-known financier during his time, who considered character
"The second assumption is that everythifig that happens to us aS the best collateral. However, it is not uncommon to observe that applicants who
must Öe changed and tra smuted by a Divine Vision to that, instead of possess bood character and integrity are unable to secure loans on the basis of their
defeating, it rather aids us to mount to higher levels of peace." character alone.

"However, a prospective user of credit should be more than a Collateral

good man equipped with the best intentions to be deserving of credit.
As one credit man aptly stated, “He should also have unquestioned ability Collateral refers to the compensating considerations purposely intende d to
to pay." shield the interests of the creditor from bad debts. With the use of collateral, the
incidence or risk of bad debt or default hecomes minimized. Thus, collateral iS Of
Capacity great value when the account is highly uncertain to be paid or the possibility of bad
debt or default on the part of the borrower looms large and seemingly forebodiftg.
As one of the bases of credit, capacity may be viewed from two senses:
 CREDF&CO

A collateral may be described as something of value which is easily convertible Preventing Frauds on Collaterals
into cash, deposited as a pledge with a lender to secure the repayment of the loan. Its
value is substantially very much greater than the amount of the loan, generally In order to prevent the commission of frauds, insofar as the use of
40% of its market value. Such a margin is intended to serve as a safety valve
over collateral is concerned, it is necessary that a central collateral register be provided
agains any unforeseen and sudden fluctuation in the value of the mortgaged
and maintained. This should provide complete and accurate descriptions of all
property. collateral pledged/deposited with the institution. Negotiable collateral should be
Generally spea g, if the borrower is unable to meet the loan obligation whe held under
it falls due, in accordance agreement between the parties, the creditor (lender) joint custody.
may sell the collateral and collect the debt from the proceeds of the sale. However,
in the case of real estate, the creditor does not acquire ownership on account of All collaterals, as taken from the collateral notes and records, should be
physically verified quarterly against the collaterals on hand by a person other
non- payment of the debt within the period agreed upon. But the creditor may
the court for the payment of debt or the sale of the real estate property. In than the collaterals' custodian. A designated employee/officer should inspect the
petitio collateral and all related documents. Collaterals should be appraised
this case, according to law, foreclosure and sale of mortgaged property shall apply.
conservatively t‹i avoid over-appraisal.
Collaterals which have been described as something of
several types, the most important of which are the following: value may partake
o
OTHER BASES
1. Real estate properties.
Within recent years, many economists and financial experts include other
2. Machinery and equipment. C's of credit apart from the traditional ones which were mentioned and discussed
in the foregoing paragraphs. They are: conditions and country.
3. Merchandise, crops, etc.
4. Corporate securities such as stocks and bonds. When business conditions start from bad to worse, sometimes it happens
that even those debtors who have shown exceptional business ability and the
5. Instruments or documents of ownership of commodities or manufactured reputation for discharging their obligations on time become delinquent, if not to
such as: bills of lading, warehouse receipts, and trust receipts. say, default in such obligations. That being the case, any prospective creditor
goods,
becomes wary in extending credit during slack periods. In fact, it may be
6. . Other forms like assignment of accounts receivable, etc. mentioned that, whenever credltors like banks and other financial institutions
observe certain red signals in the financial institutions observe certain red signals
In that case of pawnshops as sources of credit, the most common security i in the financial and economic horizon, like the onset of an impending depression,
jewelry, watches, household articles like refrigerators, freezers, washing not a few of their demand the immediate payment of obligations from their
machines and others like cameras, typewriters, etc., are becoming quite common. debtors on loans other than term-loans.
In passing, mention may be made that no applicant sh
because of a request on the part of the credit-granting concern ould feel insulte Conversely, during periods of business boom, if not to say, periods termed
to furnish it wi by economists as one of prosperity, creditors are quite liberal in the grant of loans
security. Such is a standard operating practice among creditors
and should npt b since most businessmen are making good in their businesses which insure their
interpreted as to mean that his integrity and financial ability are put to question.
ability to meet their financial obligations even before their due date.
fact, the applicant should have reason to feel that such request for
borrower as well. This is so since the applicant can borrow only thatsecurity is not only
amount whi
Country

‹my partSince, asworld

of the had been statedinvolves
on credit time and again,
risk, the sale
it follows of every
that goodsfactor
and services in
should be
he can support with collateral. This circumstance will prevent the possibility o carefully considered and scrutinized insofar as they affect credit risk.
haVing a millstone continually hanging around his neck especially
so if the
source ot income or means of repayment fails to materialize.
expecte
In the field of international trade, exporters who sell their goods on credit
are exposed to certain credit risk not-withstanding the fact that their importers
laave for years been very religious in the discharge of their obligations. A country
whoée government is continually threatened with insurrection and rebellion is far
from being a desirable place to sell goods on credit. For indeed, when a
government
CRRNTRCOLLELI ›' •
Perhaps, it is not uncommon to hear
One last word about bases of credit. credit, that is, the relationship between
topples down and a new administration takes over, that could signal a drastic ch
“connection” iS also another basis of
in policies among others. For instance, payments of international obligations may certain g vemment fin£tnCläl
reditor and the debtor. While this may be true in
stopped altogether. Hence, the exporter may be found holding an empty bag t Jciäl is always thinking in terms of “grease money” aS
tions, where a corrup
such time that payment restrictions are lifted. he grant Of lodft to another equally unscrupulous
tiinaryfactor that Willinfluencetconnection” hal nO COOL in established fifianCiäl
Cûrrency ttc individual, nevertheless, ”
lations marined by competent and morally upright OffiCfälS:
Not only is the stability of the country of importation an important facto
reckon with in the consideration of credit risk in international trade transactions
SYSTEf'g
b equally so is that which pertains to that of currency. The risk of exchange must NK'S CREDIT RATING
be taken into account. it rating system of one bM may differ
to expect that the cred
Where the currency of a country fluctuates quite markedly from time' It is logical their objectives
the others insofar its requirements are concerned. However,
as
time, such circumstance may prevent the grant of credit to the prospective buyer more or less the same, such aS:
importer of goods. For indeed, it could happen that at the time of payment of for credit analysis
obligations, the money paid to the exporter is not worth as much as it used to 'No define the aieas of credit and œrve as a medium
when the contract of sale was perfected. relevant und the of credit worthiness;
determination

Confidence s
a uniform yardstick for credit in evaluating all customer
’ro provide the bank
intending tO aVail of its services.
After having indicated and discussed the various bases of credit, one is led borrowers as well as rospective clients based on an
conclude that, in the ultimate analysis, credit is founded on confidence —which 4 o rank objectively scale and aCcordingty grade the bank’S investment
byf is the principal C of credit. For any credit transaction to take place, the established risk f àtlÛ worthiness; and
businessm whether he be a seller of goods or services on credit must have portfolio in accordance with various levels of credit
confidence.

• on the character of the buyer — whether he is trust-worthy and, as such, iepresen rating
a good moral risk; the steps and procedures to be followed in the credit
To standardize
‘ process.
• on the capacity of the buyer to enter into a valid contract and conduit his
Rating
busine Iternative Approaches to Credit
profitably;
In order to provide alternative approaches to credit rating and thus be
to fferentiate
di suflîciently the considerations fnvolved among varying typ •S
use of under the
• on the adequacy of the capitalpossessedby the debtor to support the transactio ble rfls, tWO basic
approaches are made
for which credit is required;

• on the fact that the collateral put up by the debtor is something of value and
not become subject to wide and violent fluctuations in the market;
l4o
• on the soundness of policies of the government of the country of importation’
the case of foreign trade; and of course

• on the stability of currency.

Briefly observed, then, confidence is the cornerstone of every credit

transaction — the prime mover of credit economy.
of industries and business fir
crcdit rating system, They are:
1. Inward A9 § àch
fïnancial performance and lts
This type of approach emphasizes a firm's
capacity.
date. The main t1St of this approach is on
position as of a specified nsset
the financial iequirements
This approach has value and is used whenever
way or the other, by
to be affected materially, one
e business film are not expected
t›utside factors or conditions.
 CREDN&COLLECMON ,.

2. Outward Approach Cash Flow Evaluation .

The use of outward approach lays emphasis on industry conditions, plans, Cash flow is the inflow and outflow of cash. But the term cash flOW iS tOO
forecasts and general outlook. Unlike the first approach, outward approach
assumes. that the financial requirements of a concern will be materially affected by ’ often used in a very broad sense and as such may or may not be held to apply
outside factor literally to the flow of cash. Cash flow may be another term for a flow of net
s and conditions. working capital or for a flow of the more liquid current liabilities. Cash is only
Under the rating system, the weight designs of the two approaches are as one of current assets and is part of the working capital. Hence, the changes in all
follows: Of
other current assets and in the current liabilities must be carefully analyzed.

Cash flow evaluation refers to the analysis of the projected sources and
onward Outward applications of funds to determine the available cish to meet future obligations
and contingencies of the subject business firm requesting loan or increase in its
Points "/» of Total Points
credit facility. The forecast to be made should contain at least the following
Character 75 15.0 75 15.0 important
Capital 75 15.0 75 15.0 information:
Collateral 50 10.0 50 10.0
Cash Flow 50 10.0 50 1 0.0 a. 5ources and uses of cash on a monthly basis or annual basis depending on the
Capacity 160 32.0 90 18.0 terms of credit accommodation requested;
Conditions 90 18.0 1 60 32.0
500 100.00 500 100.00 b. A repayment scheme on the accommodation applied for; and

c. A disclosure of all pertinent assumptions used in the forecast.

' As may be observed under both approaches, only two factor groups are
.', variable, such as capacity and conditions. Emphasis on capacity and conditions Other information included in the evaluñ tion are the nature of request,
! may be explained by the fact that they are both sensitive to changes. Capacity and. analysis of future cash receipts and disbursements, other related considerations
conditions represent the basic processes and factors which indicate performance. For and of course, the conclusion and recommendation, if any.
instance, capacity shows in effect, how the firm utilizes its reé ources, which may
be in terms of money (capital), people (character, attitude, and abilities) and Handling Credit Investigations
machines (fixed assets) against a background of predetermined goals and
objectives. In the case of banks as sources of loanable funds, it is scarcely necessary tO
state that they serve as the guardians of the capital and credit of the industrial
Conditions, on the other hand, will determine to a large extent, given past world. A bank is, in a very real sense of the world, no less than a public servant. It
performance, the resource level and plans as variables, how the firm will perform owes tO its depositors the assurance that their interests will be properly protected,
in the future and what these conditions may require in terms of ability and and cared for and that no unnecessary risks will be taken.
resources.
For a bank to protect its interest, it is highly essential that proper credit
In certain instances, where the major basis for the credit decision on loans
leans heavily on past performances and asset position, the analytical emphasis is
laid
on capacity. This is because under conditions where the industry outlook presents investigation of every prospective borrower be undertaken to determine the
no‘
tangible proof for material changes, the expectation is that future firm justification behind a loan. However, a good deal of objections has been raised by
performance will necessarily depend to a large degree on the firm's past some businessmen against the inquisitive methods resorted by some banks. It iS
performance, which is a manifestation of the ability of the managing business thus important that the banker in investigating a possible customer as well aS if1
team, operating efficiency and available resources. checking up an old borrower shall exercise much discretion and fact in order to
avoid offending the client.
Conversely, where the basis for credit decision is anchored on the expected
impact of future conditions or given firm's performance, the analytical . stress Robert Morris Associates, composed of bank credit men in the United States,
logically should be focused and concentrated on conditions. has adopted the following principles in handling credit investigations:
 CREDIT•

i
1. The first and cardinal [Link] credit of the a. Brief biographical sketch of the borrower, if an individual, Business hiSt0), *
replies, and any violation of this principle places the pale of business firm; •
consideration of the honest credit man.
b. A breakdown on the capitalization structure of the firm;
2. Every letter of inquiry should indicate in manner '
some the object of that inquiry. c. A presentation of the latest audited financial statements in a ° nd£ nsed form'

3. When more than one inquiry on the same subject, is sent to the d. A listing of the management principles of the business fi' i
banks in the same city, the fact should be plainly
0
e. A credit responsibility reported by other creditors, trade suppliers and R"

4. Individual consideration by the recipient of a credit inquiry of distinguishing banks; and

marks therein will increase the efficiency of the credit irivestigation.
f. Court cases and litigations per Credit Management Association of the Philf
eS

5. Indiscriminate revision of files regardless of the presence of the note in the records.
s,
market is unnecessary, wasteful and undesirable. of the subject, addres

6. The continued observance of high ethical principles in the conduct of the credit The report also contains information as to the name
Ji¡cer/
departments of banks and banking institutions insures the best, results and date the report is prepared, purpose of the report and the requesting
department of the bank.
cooperation in safeguarding banking credits. d
The report is reviewed by the Supervisor of the Credit Investigation
7. It is not permissible nor the part of good faith in soliciting accounts from a Appraisal Section and copies are usually distributed as follOWS-
competitor to seek information from the competitor without frankly stating the
object, of the inquiry. I. Original — requesting department

8. In answering, the source of iriformation should not be disclosed without II. Duplicate — Loans Administration Department.
permission and letters written in answer to inquiries should be held inviolable
by the recipients. III. Triplicate — Credit, Research, and Information Department file.

9. In seeking information, the name o1 the inquirer in whose behalf the reference
is made should not be disclosed without permission.

10. In answering inquiries it is advisable to disclose all material facts bearing on the
credit, of the borrower to the end that the paper offered in the open market be
of the same description as that held by the borrower's owrt bank. (Quoted from
Shaw Banking Serious on Credits and Collections).

CREDIT INVESTIGATION REPORT

All essential facts gathered by the credit investigator regarding a particular

or business entity are summarized in a formal report known as the Credit
Investigation Report. This report, prepared in two to four copies depending on the
nature of the request, usually contains the following information:

i44 ’
tREDlT&COdECTIOW

Name.- Date:
Year J Section: Score:

Define credit information and discuss its importance.

Explain what a financial statement is and give an example.

 Narrre: Date:
Year / Section: Score:

Test I. TRUE OR FALSE. Write T on the blank space proYided if the statement is
correct and F if the statement is incorrect.

Statement analysis is the sole basis of credit decision.

2. Personal intérviews may be conducted with or without assistance of
carefully prepared questionnaiie.
4. Define other bases of credit. Cite an example. [Link] prepared by outside accfiuñ tants generally are given
more credence than those prepared intemñ lly by the borrower's
own staff.
4. A business firm is solvent if it is able to meet its liabilities as they
mature.
5. It is scarcely necessary to point out that the bank always keeps
records of whatever transactions it has with its customers.
6. The salesman is in favored position, to collect an immense wealth
of information about the applicant which perhaps is scarcely
available elsewhere.
7. Credit rating system of one bank are synonymous from the others.
8. For a bank to protect its interest, it is highly essential that proper
credit investigation of every prospective borrower be undertaken to
determine the justification behind a loan.
9. Credit is founded on confidence which is the principal C of Credit.
5. Discuss the different bank's credit rating system. 10. During periods of business boom, creditors are quite liberal in the
grant of loans.

Test II. Fill in the bIa”nk with the correct answer.

1. This approach emphasizes a firm's financial

performance and its assets position as of a specified
date.
2. Returns to the compensating considerations purposely
intended to shield the interest of the creditor from bad
debts.
W
 CREDIT&COLLICMON CREDTRCOLlAŒ

3. Refers to money for the businessmen.

4. Borrower's W 8ness to discharge his finanC*6l
obligation as promised.
5. Company < gathers and distributes information
about the credit position of individuals, firms 6f£d
corporation.
6. Any presentation t ancial data from accounting LEARNING OUTCOf ES
records.
1. Explain financial analysis;
7. It is measured by the success of a business in
2. Know interpretation of ratios;
maintaining and licensing the owner's equity. 3. List the different sources of data;
8. When the credit rating concem generally request 4. Define cash flow statement; and
the loan applicant that it be furnished with a list of the 5. Know the non-cash transactions.
banks and business gon with which the applicants had
business dealings at the moment.
Apart from the tradiÔonal bases of credit, equally-important is the fînanC3äÎ
9. The ability of return of checks due to insufficiency of statement.
funds.
10. Its functioD COflSÎsts of the collection of every bit This is generally required of business enterprises applying for loans hfld
of information vital to the credit function which Ît. credits. Financial statements such as the balance sheet, the profit and loss statement
',' disseminates to ito member for their guidance. and the source and application of funds statement, are constructed to present useful
over-all summaries of the financial data accumulated by a business enterprise. A
proper analysis of these statements provides valuable insight into the financial
condition and operatîons of a business. Such analysis is important tö all who have
an interest in the functioning of the business.

Among those who are most directly concerned with the various tools of
analysis, who use them most and are keenly aware of their need and importance,
are business executives, bankers, investors and credit managers.

Financial Analysis

The amount of time and effort devoted to analysis of a particular situation

varies with the objectives of the analyst. Banks considering a large loan to a customer
for the first time, obviously, will devote a great deal more time and care to their
analyses than will the trade creditor in his apnual review of the data on a small,
satisfactory customer.

The nature of the analysis and the degree oI conclusiveness of the results
depend much on the amount and quality of the data available. For a meaning<*
study and interpretation of financial statements prior to the evaluation of the credft
worthiness of a given business enterprise, it is important that all the required
financial and other data be organized properly. For this purpose, the following
standard forms have been designed:

lso