Essential Standard 5.00 Understand business credit and risk management. 1
Objective 5.01 Understand credit management 2
3 Topics Main types of credit Common advantages and disadvantages of businesses using credit Cost of credit Main factors examined for granting credit Credit documents Credit regulations Credit assistance
4 What is credit? Credit the privilege of using someone else's money for a period of time. Two parties are involved Debtor receives the loan Creditor makes the loan
5 Who uses credit: Consumer Credit Credit used by people for personal reasons. Commercial or Trade Credit Credit used by businesses.
6 Main Types of Credit What is credit? Credit is an agreement to obtain money, goods or services now in exchange for a promise to pay in the future. Main types of credit Charge Accounts Credit Cards Installment Credit Consumer Loans
7 Main Types of Credit continued Charge account is a contract. Charge accounts allow debtors (customers) to receive goods or services from suppliers (creditor) and pay for them at a later date, usually at the end of the month. Example: Ace Hardware Doctors office Lawyers office
Main Types of Credit continued Credit cards allow debtors (customers) to receive goods and services from suppliers (creditor) and pay for them later. Types and examples: Bank MasterCard and VISA Travel and entertainment American Express and Diner s Club Oil company BP Oil and Exxon Retail store Belk and American Eagle 9
11 Main Types of Credit continued Installment sales credit is a contract issued by the seller that requires intermittent payments at specified times such as bi-weekly or monthly. Example Rooms To Go Furniture Store Consumer loans require debtors to make monthly payments of a specified amount for a period of time. Example Borrowing $1,000 from a BANK and agreeing to make $100 payments for ten months
13 Business/Gov. forms of Credit Bonds written promise to repay a loan with interest on a specific date. The buyer of the bond is considered the creditor. Corporate Bonds Usually used to finance buildings and equipment. Municipal Bonds State and local governments use these to finance projects. Savings Bonds Sold by federal government.
Other Sources of Credit for Businesses Small Business Administration Offers a number of financial, technical, and management programs to help businesses. Credit Bureau An agency that collects information on how promptly people and businesses pay their bills. Information retrieved from banks, finance companies, stores, credit card companies, and other lenders. 14
15 Definitions Trade credit: a company receives goods from a supplier and pays for them later Loan credit: borrowing money for a specific purpose Sales credit: Charge a purchase at the time you buy a good or service Finance charge: Total $$ cost of credit including interest and all charges Down payment: payment of part of the purchase price usually made at the time of purchase
16 Definitions Installment loan: borrower agrees to make monthly payments in specific amounts over a period of time Promissory note: a written promise to repay based on a debtor s excellent credit history Collateral: aka security; property that is used as security for a loan; the lender has the right to sell the property to get back the amount of the loan if you default or don t repay it Cosigner: person responsible for payment of the note if the signer doesn t pay as promised
Who Uses Credit? 17
18 Terms Review what is Credit : Privilege of using someone else s money for a period of time. Creditor One who sells on credit or makes a loan. Debtor Anyone who buys on credit or receives a loan. Obligated to pay back the loan. Usury Laws :Restricts the amount of interest that can be charged.
19 Why Use Credit? Convenience Immediate Possession Emergencies
Common advantages and disadvantages of businesses using credit 20 Advantages Establishing favorable credit rating Keeping business separate from personal expenses Minimizing record-keeping and receipts Keeping track of what employees are spending Earning rewards Growth of the Economy Buying goods will help the economy expand. Disadvantages Experiencing theft of customer records/databas es Overbuying by employees Overusing credit Credit Fees Interest paid on balance
21 Results of Overuse Repossession = Loss of property because of failure to repay loan. Bankruptcy = Legal procedure for liquidating a business (or property owned by an individual) which cannot fully pay its debts out of its current assets.
25 Cost of Credit continued Using someone else s money has a cost. Interest is the cost of using someone else s money. Factors for computing interest include: Principal, P = Amount of the loan Interest Rate, R = Percent of interest charged or earned. Time, T = Length of time for which interest will be charged, usually expressed in years or parts of a year. Formula for computing simple interest: I = P x R x T = 500 x 7% x 3 months
26 How is time determined for a loan for each of the following lengths? Years =multiply by the number of years Months=multiply by the portion of the year. Such as 2 months =2/12 Days=portion of the year such as 30/360 How is the maturity date calculated? Months-the maturity date is the same day of the month that the loan was made. Days-Determine the day the loan was made, and then count the exact number of days of maturity.
27 Business Credit Cont. How is a decreasing loan payment calculated? Interest is calculated on the amount of the loan that is unpaid. What is disclosed in Annual Percentage Rate (APR)? Percentage cost of credit Service fees
28 MATH Calculate Maturity Date Activity Converting Time and Percents Activity Simple Interest Activity Installment Interest Activity Level loan payment schedule, Example
29 Main factors examined for granting credit Creditors examine several factors about potential debtors when deciding whether to grant them credit, such as.
30 Main Factors Examined for Granting Credit The Three C s of Credit Character Capital Capacity
31 The 3 C s of Credit Character is Honesty to pay a debt when it is due. How past debt obligations were handled. Capacity refers to how much debt can comfortably be handled. Debt that you can afford on what you earn. Capital is current available assets that could be used to repay debt if income was to become unavailable.
32 Can you answer this Question? Zack maintained the minimum (the cheapest) living expenses he could while working for the last three years. Which C of credit is he most likely to meet? Capital Capacity Character
33 1 more C! Collateral is security to help guarantee that the creditor will be repaid. Example: You own 10 acres of land. You want to buy a house. The bank requires collateral. You offer the 10 acres of land. If you don t pay your house payment, the bank can take the 10 acres of land.
35 Process of Obtaining Credit 1. Credit Application 2. Documentation of Data 3. Credit Bureaus
36 Credit Application Credit Application: A form used by lenders to obtain information from applicants in order to make a decision about granting credit. Should be filled out completely, accurately and honestly. Requires signature of applicant, which indicates provided information is true.
37 Documentation of Credit Data Credit data make up the information that applicants provide on credit applications. Documentation of credit data may be verified by: Employers (former and current) Type of data: Employment dates and salary Financial institutions Type of data: Saving or checking account information Personal references Type of data: Manner how personal business is conducted
38 Credit Bureaus Information provided by Credit Bureaus Credit Bureaus provide credit reports to other businesses (about your credit history) Credit bureaus sell lenders credit information such as debt records, payment history, and if any action has been taken to collect overdue bills.
39 Credit Bureau Activity Work with a partner to read and complete the Credit Bureau Activity Questions.
40 Can you answer this Question? Wendy s reported that Samantha had worked at the Warsaw location for over two years. Which factor for granting credit related to documentation is this institution's action? Credit application Credit report Credit data
41 Can you answer this question? Page s TV World obtained information about Timmy s reputation for paying his bills. Which factor examined by creditors did the store receive? Credit Application Credit Report Statement of Account
42 Credit documents: Checking loan features and credit activities for errors minimize potential credit problems. Two commonly used credit documents that assist with minimizing credit problems are: Credit Contract Statement of Account
43 Credit Documents Credit contract Credit contracts are legal binding documents that allow debtors to use credit to obtain goods and services. Debtors should know the content of the credit contract before signing such as: Amount of finance charges Repairs covered Add-on features Reduction of finance charge if contract paid in full prior to ending date Receive the copy of the contract Repossession conditions
44 Credit Documents continued Statement of account Comes once credit is granted and purchases are made on credit. Come once a month and includes summary of transactions completed during the billing period. What kind of information may be found on the statement of account? Balance due Amounts charged or credited during the billing period Current balance Minimum amount of next payment
Credit regulations and assistance options 47 Credit Regulations: exist to protect rights of credit applicants and rights of credit users from fraudulent and unfair practices.
Credit Regulations Truth in Lending Law requires lenders to reveal the cost of credit (APR and finance charge) and terms before signing an application or contract. Equal Credit Opportunity Act allows credit applications be judged on financial responsibility of credit applicants. The three areas of responsibilities are low income, large debts, and a poor payment record. 48
Credit Regulations continued 49 Fair Credit Billing Act requires creditors to correct billing mistakes promptly. Fair Credit Reporting Act allows individuals to scrutinize any information shared by credit reporting agencies with potential creditors and employers. Individuals also may correct any incorrect credit information.
50 Credit Regulations continued Consumer Credit Reporting Reform Act requires that the credit reporting agency must be able to prove that credit information they provide is accurate. Fair Debt Collections Act prohibits deceptive, harassing, and unfair practices for collecting debt from debtors.
51 Credit Regulations continued Credit Card Accountability, Responsibility, and Disclosure Act is an amendment to the Truth in Lending Act. The act institutes fair and transparent practices of providing credit. FTC: Federal Trade Commission enforces laws on credit
52 Cost of Credit Terms Interest Rates Percentage that is applied to debt. Principal Amount of money borrowed. Time Factor Length of time for which interest will be charged. Maturity Date Date on which a loan must be repaid.
53 Terms Cont. Finance Charge or Fees Cost of credit stated in a dollar figure Annual Percentage Rate (APR) Indicates how much credit costs on a yearly basis. Grace Period Time period during which no finance charges will be added to an account. Cash Advance Borrow money on a credit card.
56 Credit assistance is available to minimize or eliminate credit problems of credit users. Credit assistance available includes: Debt repayment plan Credit counseling Bankruptcy
Credit Assistance continued Debt repayment plan An agreement between a creditor and debtor that allows the debtor to pay off a debt with more manageable payment plan. Credit counseling Provides information on actions to take in order to manage debt. Bankruptcy May be used by debtors to reduce debt or amount owed to creditors. Legal process in which some or all of the assets of a debtor are distributed among the creditors because the debtor is unable to pay his or her debts. 57
59 Effects of Bankruptcy Kept on file with credit bureau for 10 years. Affects credit rating, future extensions of credit, loss of jobs, etc. YouTube - Credit Card reform too late for one Small Business Owner YouTube - Weekly Address: Health Insurance Reform, Small Business and Your Questions