Credit: Assessment, Monitoring and Control
Core concepts
Credit work rests on the 5 Cs: character, capacity, capital, collateral and conditions. Candidates must understand credit appraisal (financial statement analysis, cash-flow adequacy, debt-service coverage), credit scoring, security and covenants, and the monitoring of receivables through ageing analysis and collection ratios. Know the distinction between secured and unsecured lending, the purpose of a credit limit, and the treatment of provisions for doubtful debts under expected-credit-loss thinking.
Traps in questions
- Collateral is not repayment capacity. Security mitigates loss given default; it does not create cash flow.
- Ratios in isolation. A high current ratio may hide slow-moving inventory; examine receivables days and inventory days together.
- Gross vs net receivables. Ageing should be based on amounts actually owed, net of settlements.
- Credit terms arithmetic. A discount such as 2/10 net 30 has an implied annual cost of foregoing it; compute it rather than guess.
- Concentration risk. A single large debtor can dominate the ageing schedule; flag it.
Rule of thumb
Lend against capacity to repay from operating cash flow, secured where possible, monitored through ageing, and provided for as soon as recovery becomes doubtful.
Worked example
Terms 2/10 net 30: a customer who forgoes the discount keeps funds 20 extra days (30 − 10). Approximate annual cost = (0.02/0.98) × (365/20) ≈ 37.2%. If the firm's borrowing rate is 15%, taking the discount is cheaper.