CREDIT CONTROL IN THE OIL AND GAS INDUSTRY

1. CREDIT CONTROL IN THE OIL AND GAS INDUSTRY MDPI Oil & Gas Training

2. content

3. Introduction • Credit driven industry • Oil trading companies (OTCs)-90 days credit • Bulk distribution companies (BDCs) 45 days credit. • Oil marketing companies(OMCs) 21-30 days credit. • Service/filling stations (S/FS) 14-21 days

4. Value chain of down stream distribution

5. Credit sales and its implications • Credit sales–purchase made by a consumer that do not require a paymentmade in full at the time of purchase. • On the other hand it represents an extension of credit to customers allowing them a reasonable period of time in which to pay for the good or services received.

6. Why Sell on Credit? • Debtors are the current assets for a company and provide the liquidity for a company. • Secondly, most of the sales are on credit in every organization. Cash sales constitutes insignificant amount of the sales of firms in the oil and gas industry. • So to maintain the sales revenue, companies have to incur debts.

7. Why Sell on Credit? Cont. • It is important to reach the sales potential of a company in this growing market. So if the company does not give credit to the customers then it will be difficult to sell. • To optimize the return on investments on the assets. • To get a competitive advantage.

8. COLLECTION COST • Capital cost • Delinquency cost • Default cost

9. Debtors • Debtors are people or other firms who owe money to the firm. • If the firm has debts these are considered an asset, because when the debtors pay, the firm will have converted the debt into cash in the bank. • Because most debts are relatively short-term, they are considered current assets.

10. Ways to Manage Debtors • A sale is not considered a sale until the money is in your bank account. • When it comes to dealing with customers who seem unwilling to pay on time it can mean the difference between prosperity and failure • Having an effective credit policy and collection procedure in place is crucial for effective business management.

11. Credit Policy • Credit policy guides management about how to control debtors and how to strike a balance between liberal and strict credit policies. • Liberalcredit policy will increase the amount of sale and profitability. However, this will increase the risk exposure. • If we sell the products to those debtors who are not credit worthy, then it is possible that some bad debts will be incurred.

12. Credit policy cont. • A company may increase the time limit for debtors to pay. • On the other hand, if a company’s credit policy is strict, it will increase liquidity and security, but decrease the profitability. • Credit policy should be at optimum level where profitability and liquidity will be equal.

13. Credit policy cont. • Every Company should have a written policy that clearly sets out when, and under what circumstances, the organization offers credit. This should be distributed to all interested parties (especially the sales force).

14. Key Considerations of a Credit Policy The credit policy of a firm provides the framework to determine: • Eligibility of customer. • Amount of credit to be extended • Duration of credit • Whether or not to charge interest and if so at what rate

15. Key Considerations of a Credit Policy Cont. • Analyses the acceptable mode of security • Firms credit evaluation • What would be the net margin after credit outgo • Consider the performance of the party in past 5 years or so • Bank`s evaluating data of party`s performance

16. Key Credit policy cont. • Analyses the acceptable mode of security • Firms credit evaluation • What would be the net margin after credit outgo • Consider the performance of the party in past 5 years or so • Bank`s evaluating data of party`s performance

17. Dealing With Late Payments • The policy should appear on the credit application form, and • should clearly state the consequences of late payment. This may take the form of; - withholding goods, - not processing orders, - interest charges and in some cases, - legal action.

18. Credit Decisions • Credit decision is taken after debtor’s information have been collected and analyzed. • The company should fix the standard for providing goods on credit. • If a particular debtor is below the given standard, then his proposal to buy on credit should not be accepted.

19. Credit Application • To help you to decide which of your customers should be granted credit terms, it is important to have a credit application form/agreement. • This sets out all the conditions of credit, as well as the rights and obligations of both parties

20. Essential Requirements for Credit Application • Comprehensive details of all directors/partners/owners • at least three trade credit references • signature of the applicant to ensure that they have read and understood all the conditions and have agreed to abide by them. • A Deed of Indemnity and Guarantee for corporate clients is optional, however it is an excellent safeguard against insolvent clients.

21. Essential components of a credit application cont. • the final decision should be based on all the data collected, in particular the references, the length of time that the business has been operating and whether or not the guarantees have been signed.

22. Credit analysis • Two basic steps are involved in the credit investigation process • Obtaining Credit Information-The first step in credit analysis is obtaining the information which form the basis for the evaluation of customers.

23. Credit analysis cont. The sources of information may be internal such as the historical payment pattern of customers, or may be external such as : • Financial Statements • Bank References. • Trade References. • Credit Bureau

24. Credit analysis cont. Analysis of credit information • The information collected from different sources are analyzed to determine the credit worthiness of the applicant. • The analysis should cover two aspects: -Quantitative -Qualitative

25. Credit analysis cont. Quantitative • based on the factual information available from the financial statements, the past records of the firm’s and so on. Qualitative • The qualitative judgment would cover aspects relating to the quality of management.

26. Customers Evaluation-The 5 C’s • Character- Reputation, Track Record •  Capacity- Ability to repay( earning capacity) • Capital- Financial position of the company. • Collateral-The type and kind of assets pledged • Conditions- Economic conditions & competitive factors that may affect the profitability of the customer.

27. Collection Procedure • Contact the debtor and remind them of the debt. • If no barrier to payment exists, ask them to settle the debt by a specific date. • If there is a cash flow problem, try to arrange a payment plan that accommodate both parties.

28. Collection procedure cont. • If the problem is recurrent then it is a good idea to review the customer's credit terms. • A statement asking for payment should be sent. Some 'Reminder' or 'Final Notice‘ adhesive labels can be bought. • If the debt is not settled within the agreed timeframe, you may wish to take legal action

29. Mode of Payment by Customers • Customers must not be given any excuse not to pay on time. • Make sure all your paperwork is easy to read and understand. • Company should give their customers plenty of payment methods to use (i.e. cheque, MasterCard, Visa, mobile transfer etc).

30. Credit Management Strategies • Clearly stating terms and conditions in the credit contract ensuring all credit transactions are documented and signed • maintaining records accurately • keeping track of due and overdue payments • checking the credit rating of debtors before extending credit

31. Credit Management Strategies Cont. • checking the credit rating of the debtor on a regular basis after giving credit • collecting a deposit from the customer before delivering goods or services • collecting portions of the payment as a project progresses • reminding customers of payments through phone, letters or visits

32. Dealing With Delinquent Customers In spite of having an efficient credit management strategy, it is still possible to incur bad debts. All businesses will have some percentage of customers who delay payments or even avoid them. Some strategies of dealing with delinquent customers include:

33. Dealing With Delinquent Customers Cont. • Consultation: • The consultation can bring about an agreement between the creditor and debtor regarding the payment.

34. Dealing With Delinquent Customers Cont. • Demand letter: • A demand letter must clearly state the details of the debt, along with the total amount of debt involved and the date by which the debt must be settled. • The demand letter can also include a warning of legal action in case the debt is not paid by the specified date.

35. Dealing With Delinquent Customers Cont. • Statutory letter: • A statutory letter will also give details of the debt, total amount of debt and expected date of debt settlement. • Statutory letters are sent out like court documents and hold greater clout than demand letters. • The statutory letter warns the debtors of legal action, within 21 days of the specified date, if they fail to make the payment.

36. Dealing With Delinquent Customers Cont. • Litigation: • a business may have to file a lawsuit against the debtor to recover the debt. • All other debt recovery strategies, within legal boundaries, must be tried before reaching this stage. • Litigation is always the last option. Taking legal action is a time-consuming and costly business. • It is advisable to get some idea of the potential cost involved before proceeding with the litigation.

37. Benefits of Effective Accounts Receivable Management • It can cut and maintain your average collection delay • It can lessen your direct and indirect expenses • It can considerably reduce your bad debt

38. Benefits of Effective Accounts Receivable Management Cont. • It can tell you various ways to take advantage of your cash-flow • It can help you capitalize on your internal resources • It can maximize interventions on sales, service and market share

39. Cash Conversion Cycle: • The term "cash conversion cycle" refers to the  time span between a firm's disbursing and collecting cash. • In management accounting, the Cash Conversion Cycle (CCC) measures how long a firm will be deprived of cash if it increases its investment in resources in order to expand customer sales. • It is thus a measure of the liquidity risk entailed by growth. However, shortening the CCC creates its own risks

40. Cash Conversion Cycle • CCC = Days between disbursing cash and collecting cash in connection with undertaking a discrete unit of operations. = Inventory conversion period + Receivables conversion period – Payables conversion period

41. Cash Conversion Cycle • Avg. Inventory : COGS / 365 • Avg. Accounts Receivable :sales revenue / 365 • Avg. Accounts Payable : COGS / 365

42. Conclusion • Bad debts are an unavoidable side effect of extending credit. Though there are many avenues to collect debts, they are by no means easy and can cost the business a good amount of time and money. • Therefore, it is better to develop an effective credit management strategy to minimize bad debts. • Also, consider a partnership with a good collection agency that can take over the task of collection if your in-house resources and expertise is inadequate to resolve the situation