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AAT UNIT 15

EVALUATING CREDIT-WORTHINESS (OF CUSTOMER). 15.3 B Identify and use internal and external sources of information to evaluate the current credit status of customers and potential customers15.3 D Ensure the reasons for refusing credit are discussed with customers in a tactful manner. Evaluation. New

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AAT UNIT 15

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    1. AAT UNIT 15 EVALUATING CREDIT-WORTHINESS (OF CUSTOMER)

    2. EVALUATING CREDIT-WORTHINESS (OF CUSTOMER) 15.3 B Identify and use internal and external sources of information to evaluate the current credit status of customers and potential customers 15.3 D Ensure the reasons for refusing credit are discussed with customers in a tactful manner

    3. Evaluation New customer or additional credit for existing customer Internal information: Customers financial statements (minimum 3 years) Analysis of accounts Liquidity Profitability Gearing Cash flow Ownership and control Country of registration Country of operations Information from colleagues, minutes of meetings, correspondence

    4. Evaluation External information Bank references Be precise (eg. Do you consider X to be good for a trade credit up to 10,000, payable in 30 days) Trade (supplier) references Write to customer for details and authorisation (or use standard form) Unauthorised references may contravene Data Protection Act Check trade references for: Amount and period of credit provided Up to date Reliability of the reference Credit rating agencies (eg. Experian, Dun & Bradstreet) Companies House/Press/internet

    5. Bank reference As a rule of thumb, rate credit-worthiness as being a stage worse than suggested (diplomatically) by the bank Eg. Considered good for your figures = but not for anything beyond that! Should prove good for your figures = might not prove good

    6. Trade Reference A letter requesting a trade reference should include: Identify the authorisation to request the reference Questions: How much credit is provided What are the credit terms (weekly, monthly, etc) Is payment always received on schedule Have credit terms ever been withdrawn or reduced How long has the credit facility been in place Were satisfactory credit references obtained when the account was opened Request additional relevant information

    7. Analysis of Financial Statements Assess the financial position and performance of a business Examine ratios for: Liquidity Solvency Profitability

    8. Liquidity ratios Measure ability to pay short-term (current) liabilities from liquid (current) assets.

    9. Liquidity ratios Current ratio Acid test/liquid capital ratio Stock turnover or period of supply Debt collection period Creditor payment period

    10. Liquidity ratios Current ratio = Current assets Current liabilities Acid test = Current assets stock ratio Current liabilities (liquid capital)

    11. Liquidity ratios Stock turnover = Cost of goods sold in period (times per year) Average stock during period Period of = Average stock during period x 365 Supply Cost of good sold in period (days)

    12. Liquidity ratios Debt collection period =Trade debtors x 365 (days) Sales in period Creditor payment period = Trade creditors x 365 (days) Purchases in period

    13. Solvency Ability to pay liabilities in the medium-to-long term. Determined by the capital structure Companies with high borrowings are considered to be risky

    14. Solvency Ratios Gearing Interest cover

    15. Solvency Ratios Gearing = Long-term loans + preference shares x 100 Ordinary share capital + Long-term loans + reserves + preference shares Interest cover = Operating profit Interest payable

    16. Profitability Ratios Operating profit percentage Net profit percentage Return on capital employed (ROCE)

    17. Profitability Ratios Operating profit = Operating profit x 100 percentage Sales Net profit = Net profit before tax x 100 percentage Sales

    18. Profitability Ratios Return on capital = Operating profit x 100 Employed Capital employed (ROCE) Capital employed = Total assets current liabilities = Ordinary share capital + reserves + long-term loans + preference shares

    19. Credit decision Key questions: Are we likely to be paid? Are we likely to be paid on time? Problems to avoid: Default Late payment Based on Internal and external information Amount of information available (eg. start-up) Sales policy

    20. Credit decision Outcome Accept formal agreement Refuse for the time being (be tactful, suggest a review) Compromise (eg. 14 days credit, 50% credit, etc)

    21. Refusal letter A letter refusing credit should contain: Thanks for the application Explain that formal (objective) criteria were used to make the decision Regret the decision Suggest further application after a period of trade Offer to trade on a cash basis for the time being

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