Credit decisions and line of credit

Credit–Scoring Systems

Quantitative approaches have been developed to estimate the ability of businesses to service credit granted to them; however, the final decision for most companies extending trade credit (credit granted from one business to another) rests on the credit analyst’s judgment in evaluating available information. Strictly numerical evaluation have been successful in determining the granting of credit to retail customers (consumer credit), where various characteristics of an individual are quantitatively rated and a credit decision is made on the basis of the total score. The plastic credit cards many of us hold are often given out on the basis of credit scoring system in which such things as occupation, duration of employment, home ownership, years of residence, and annual income are taken into account. Numerical rating systems are also being used by some companies extending trade credit. With the overall growth of trade credit, a number of companies are finding it worthwhile to use numerical credit scoring systems to identify clearly unacceptable and acceptable applicants. Credit analysts can then devote their energies to evaluating marginal applicants.

Credit Decision and Line of Credit

Once the credit analysts has marshaled the necessary evidence and analyzed it, a decision must be reached about the disposition of the account. In an initial sale, the first decision to be made is whether or not to ship the goods and extend credit. If repeat sales are likely, the company will probably want to establish procedures so that it does not have to fully evaluate the extension of credit each time an order is received. One means of streaming the procedure is to establish a line of credit for an account. A line of credit is a maximum limit on the amount the firm will permit to be owed at any time. In essence, it represents the maximum risk exposure that the firm will allow to undergo for an account. The establishment of a credit line streamlines the procedure for shipping goods, but the line must be reevaluated on a regular basis to keep abreast of developments in the account. What was a satisfactory risk exposure today may be more or less satisfactory a year from today. Despite comprehensive credit procedures there will always be special cases that must be dealt with individually. Here a firm can streamline the operation by defining responsibilities clearly.

Outsourcing Credit and Collections

The entire credit/collection function can be outsourced (i.e. subcontracted to an outside firm). A number of third-party companies offer complete or partial services to corporations. Credit scoring system, together with other information, are used in deciding whether credit will be granted. Ledger accounts are maintained, payments processed, and collection efforts on tardy accounts are initiated. As with the outsourcing of any business function, it often comes down to a question of core competence. Where such internal competency does not exist or is inefficient, the decision even for large companies may be to buy the service on the outside. For small and medium-sized companies, credit and collections may simply prove too costly to do on one’s own.