Credit
Core concepts
Credit management covers the assessment, granting, monitoring, and collection of credit. Candidates must understand the 5 Cs of credit - character, capacity, capital, collateral, and conditions - and the credit appraisal process from application to disbursement. Know the tools of credit analysis: financial statement analysis, ratio analysis (liquidity, leverage, coverage), cash flow analysis, and credit scoring. Understand credit risk, default probability, exposure, and recovery. Study the credit policy variables: credit standards, credit terms, and collection effort, and how each affects sales, bad debts, and the cost of carrying receivables.
Common traps
Questions often confuse the cost of granting credit (financing receivables, bad debts, administration) with the benefit (incremental sales and contribution). Another trap is treating collateral as a substitute for capacity - collateral mitigates loss but does not create repayment ability. Watch for questions on the difference between a credit limit and an exposure limit, and between ageing analysis and collection policy.
Worked example / rule of thumb
A firm relaxes credit terms. Incremental sales of 2,000,000 carry a 30% contribution margin, giving 600,000. Extra receivables financed at 15% and additional bad debts of 40,000 cost 300,000 + 40,000 = 340,000. Net benefit = 600,000 − 340,000 = 260,000, so relax the policy. Rule of thumb: compare incremental contribution against the carrying cost of additional receivables plus expected bad debts.
Exam technique
Always state the decision and justify it with the net figure.