UNDERSTAND BUSINESS CREDIT AND RISK MANAGEMENT.

1

Essential Standard 5.00

UNDERSTAND CREDIT MANAGEMENT

2

Objective 5.01

Topics3

Main types of creditCommon advantages and disadvantages of

businesses using creditCost of creditMain factors examined for granting creditCredit documentsCredit regulationsCredit assistance

Consumer Credit Commercial Credit

Credit used by people for personal reasons.

Credit used by businesses.

4

Who uses credit:

Main Types of Credit5

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

Main Types of Credit continued6

Charge account is a contract between creditors and debtors. Charge accounts allow debtors (customers) to receive goods or services from suppliers (creditor) and pay for them at a later date. Deadbeats: People or businesses who

pay off the balance of their credit card bill every month with no interest expense.

You want to be a deadbeat!!!!!

Credit Cont.7

Charge Accounts – most common type of short- term or medium-term credit. Regular Charge Accounts

Require that you pay for purchases in full within a certain period of time. Example: A charge account with an electrician who re-wired a house

Revolving Charge Accounts Allows you to borrow or charge up to a certain amount

of money (credit limit) and pay back a part or the entire balance each month. Example: A charge account with Duke Power utility company

Budget Charge Accounts Allows you to pay for costly items in equal payments

spread out over a period of time (6 months same as cash). Example: Home equity credit line

Main Types of Credit continued8

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

Credit Examples cont.9

Single-Purpose Can only be used to buy goods or services at the

business that issued the card. Examples: JC Penney, Sears

Multipurpose Similar to a revolving charge account. May be used at several locations. Examples: Visa and Master Card

Travel and Entertainment Similar to regular charge accounts. Must be paid in full each month. Example: American Express

Main Types of Credit continued10

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

Credit11

Types: Student, mortgage, automobile, etc.

Secured vs. Unsecured Secured loans are backed by collateral (help

guarantee the repayment of a loan).Closed vs. Open Ended

Closed-end credit is used for a specific purpose and involves a definite amount of money.

Open-end credit gives you a certain limit on the amount of money you can borrow.

Cosigner Person responsible for the repayment of a loan if the

original party does not pay.

Business/Gov. forms of Credit12

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 Businesses13

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.

Definitions14

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

Definitions15

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

16Who Uses Credit?

Terms17

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.

Why Use Credit?18

Convenience

Immediate Possession

Emergencies

Advantages Disadvantages

Establishing favorable credit rating

Keeping business separate from personal expenses

Minimizing record-keeping and receipts

Keeping track of what employees are spending

Earning rewardsGrowth of the Economy

Buying goods will help the economy expand.

Experiencing theft of customer records/databases

Overbuying by employees

Overusing creditCredit Fees

Interest paid on balance

19

Common advantages and disadvantages of businesses using credit

Results of Overuse20

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.

How Credit Cards Are Made21

http://www.youtube.com/watch?v=gaduUHFrScI

The Credit Card Song by Old Man Piehttp://www.youtube.com/watch?v=2JwdIWjV

HaU&safety_mode=true&persist_safety_mode=1

Simpson’s Advertisementhttp://www.youtube.com/watch?v=jBaPx3sym

0I&feature=related

Tips for Using Your Credit Card22

YouTube Video Tips for Using Your Credit Card http://www.youtube.com/user/CreditMadeClearer

What is credit? Loans, Mortgages and Overdrafts http://www.youtube.com/watch?v=cjrG1QznxLY&safet

y_mode=true&persist_safety_mode=1

Obtaining Credit23

http://www.youtube.com/user/CreditMadeClearer#p/u/10/P0h_12RMWgk

Cost of Credit continued24

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

Cost of Credit continued25

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.

Business Credit Cont.26

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 creditService fees

MATH27

Calculate Maturity Date ActivityConverting Time and Percents ActivitySimple Interest ActivityInstallment Interest ActivityLevel loan payment schedule, Example

Main factors examined for granting credit

28

Creditors examine several factors about potential debtors when deciding whether to grant them credit, such as…….

The Four C’s of Credit CharacterCapitalCapacity Collateral

29

Main Factors Examined for Granting Credit

The 4 C’s of Credit30

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.

Capital is current available assets that could be used to repay debt if income was to become unavailable.

Collateral is security to help guarantee that the creditor will be repaid.

Credit Worthiness Terms31

Credit History Indicates the amount of debt you have and your

payment history. Capital

How much you have beyond what you owe. Credit Limit

Maximum amount you can borrow. Cosigner

Person responsible for a loan if you, the original debtor, do not pay.

Process of Obtaining Credit32

1. Credit Application2. Documentation3. Processing4. Underwriting5. Closing 6. Funding

Main Factors Examined for Granting Credit continued

33

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.

Main Factors Examined for Granting Credit continued

34

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

Main Factors Examined for Granting Credit continued

35

Information provided by Credit Bureaus Credit bureaus sell lenders credit information

about credit users such as debt records, payment history, and if any action has been taken to collect overdue bills.

Credit documents:36

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

Credit Documents37

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

Credit Documents continued38

Statement of account Comes once credit is granted and purchases are

made on credit. Comes monthly 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

Underwriting39

Reviewing loan for soundness.Consumer Reporting Agencies

Company that compiles and keeps records on consumer payment habits.

Used to evaluate creditworthiness. Examples: Equifax, Experian, and

TransUnion.

Closing a loan and funding40

REAL ESTATE Meeting with lending financial institution and

attorney to sign all documents Attorney files documents indicating a lien on the

property 3 Days after closing, funds are released

AUTO or PERSONAL Car dealership or lending financial institution will

process all documents indicating a lien on the property

Financial institution processes all documents

Credit regulations and assistance options

41

Credit Regulations: exist to protect rights of credit applicants and rights of credit users from fraudulent and unfair practices.

Credit Regulations 42

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.

Credit Regulations continued 43

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.

Credit Regulations continued 44

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.

Credit Regulations continued 45

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

Cost of Credit Terms46

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.

Terms Cont.47

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.

Credit Regulations continued 48

Some practices instituted by the CARD Act are: Inform customers of increase of cost of credit not less

than 45 days prior to effective date. Provides information about how long it would take to

pay off a loan if minimum payments are paid. Protects potential credit consumers under the age of

21, who must have a cosigner with a means to repay debt of the consumer.

Process of Obtaining Credit49

1. Credit Application2. Documentation3. Processing4. Underwriting5. Closing 6. Funding

Credit assistance50

is available to minimize or eliminate credit problems of credit users.

Credit assistance available includes: Debt repayment plan Credit counseling Bankruptcy

Credit Assistance continued51

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.

Types of Bankruptcy52

Chapter 7 (Liquidation) Draw up a petition listing assets and liabilities. Most of the debtor’s assets are sold to pay off

creditors. Cannot release debt on alimony, child support, taxes,

fines, educational loans, and court fees.Chapter 11 – (Reorganization) Businesses Only Chapter 11 bankruptcy reorganization: what is it and h

ow does it workChapter 13

Propose a plan for using future earnings and assets to eliminate debts over a period of time.

Effects of Bankruptcy53

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