|
|
Credit Limits
A credit limit as "an approved level of credit allowable which ideally should be compatible with the anticipated turnover and the financial status of the customer".
One of the functions of the credit department is to ensure the proper control of an account, and the credit limit provides a means whereby one aspect of control may be achieved.
It is quite commonplace for suppliers to maintain control solely through the terms agreed, thereby eliminating the need to assess credit limits. It is however, more general in these cases for individual sanction to be given to each order that is placed, and delivery being suspended in respect of demands for amounts unpaid on a customer's account. It is best practice to assess the customer in a practical way, in an attempt to arrive at a credit limit which gives the customer some flexibility in his trading.
Although credit limits are flexible, unnecessary adjustments can be avoided by recognising that the most constant source of irritation to all concerned is the credit limit which is set too low and where this is a direct result of insufficient knowledge of the customer's future requirements and financial standing, rectification must be by reassessment, and whilst this is being carried out it could be considered necessary to suspend supplies. Naturally customer relations are going to be adversely effected, to avoid this it is essential that in the initial stages comprehensive information should be obtained thereby furthering protection of interests by the avoidance of bad debts without impairing the continuous need to develop sales.
Insufficient knowledge of a customer's requirements can also lead to the refusal of credit facilities.
Credit assessment is the correlation between status information and the value of goods or services sought. Before accurate credit assessment can be made it is necessary to know the total value of the order and the rate of delivery.
Credit Terms
When assessing a customer's worth it is essential to take account of the length of credit to be allowed. Under normal circumstances we refer to standard terms of trading of 30 days. However circumstances will arise apparently for commercial reasons where an unofficial offer of extended terms is made. Credit terms may also be restricted, providing a particularly useful method of enabling the customer who requires a greater credit limit than is deemed prudent on standard terms. For example, a customer whose credit worth has been assessed at £2000, terms 30 days, may wish to take advantage of £2000 total deliveries per month, terms 14 days. Not only have we accommodated the customer, turnover has been increased while the risk factor remains constant. However, it must be emphasised that this can only be achieved by ensuring that payment is made on the due date, and with the possible use of pro-forma invoices.
Effect of Extended Credit
Extended credit means that valuable capital is being frozen, the risk factor is increased and profit margins reduced. The product of these is a reduction in profitability to the credit granter which may result in the inability of a company to finance its day-to-day business. The situation, if unchecked, leads to a loss of confidence which in extreme cases causes the failure of the lenient credit granter.
Various reasons may lay behind the need for a company to take extended credit, and it is generally recognised that all suppliers experience this problem at some time or another.
Causes
Contra Accounts and Rights of Offset
A contra account is established when a customer supplies his supplier thereby creating an entry in both the sales and purchase ledgers.
Where this situation exists, it is quite common to find the initial seller not bothering to carry out any form of credit assessment when asked to supply goods nor of carrying out debt collection with any particular vigour. This is usually because there is an inbalance of trade and if the need arises it is always thought that payment can be obtained by offsetting the accounts, thereby a degree of security is fostered before adopting this philosophy, it is necessary to understand the legality of the rights of offset.
No right of offset is said to exist when accounts have been settled by an exchange of cheques. This mean that in the event of a liquidation any monies that have been appropriated by way of offsetting have to be handed over to the liquidator.
The right of offset will only be recognised when contra accounts are habitually settled by offsetting mounts due in the bought ledger against those owing in the sales ledger. Where this situation exists and debtor company goes into liquidation, then the monies owed by the creditor may be offset against the amount due without any fear of it being disgorged to a liquidator.