Evaluating the Credit Applicant

Having established the terms of sale to be offered, the firm must evaluate individual credit applicants and consider the possibilities of a bad debt or slow payment. The credit evaluation procedure involves three related steps: obtaining information on the applicant, analyzing this information to determine the applicant's creditworthiness, and making the credit decision. The credit decision, in turn, establishes whether credit should be extended and what the maximum amount of credit should be.

SOURCES OF INFORMATION

A number of sources supply credit information, but for some accounts, especially small ones, the cost of collecting it may outweigh the potential profitability of the account. The firm extending credit may have to be satisfied with a limited amount of information on which to base a decision. In addition to cost, the firm must consider the time it takes to investigate a credit applicant. A shipment to a prospective customer cannot be delayed unnecessarily, pending an elaborate credit investigation. Thus the amount of information collected needs to be considered in relation to the time and expense required. Depending upon these considerations, the credit analyst may use one or more of the following sources of information.

Financial Statement. At the time of the prospective sale, the seller may request a financial statement, one of the most desirable sources of information for credit analysis. Frequently, there is a correlation between a company's refusal to provide a statement and its weak financial position. Audited statements are preferable; when possible, it is helpful to obtain interim statements in addition to year end figures, particularly for companies having seasonal patterns of sales.

Credit Ratings and Reports. In addition to financial statements, credit ratings are available from various mercantile agencies. Dun & Bradstreet, Inc., is perhaps the best known and most comprehensive of these agencies. It provides credit ratings to subscribers for a vast number of business firms throughout the nation. As we see, D & B ratings give the credit analyst an indication of the estimated size of net worth and a credit appraisal for companies of a particular size, ranging from "high" to "limited." D & B also indicates when the information available is insufficient to provide a rating for a given business. In addition to its rating service, D & B provides credit reports containing a brief history of a company and its principal officers, the nature of the business, certain financial information, and a trade checks of suppliers the length of their experience with the company and whether payments are discount, prompt, or past due. The quality of the D & B reports varies with the information available externally and the willingness of the company being checked to cooperate with the D & B reporter. The report itself can be accessed via a computer terminal if so desired.

TRW, Inc., in conjunction with the National Association of Credit Management, has developed a data base on some seven million businesses. Typically, the information is not as extensive as that of Dun & Bradstreet, but it is of considerable use in credit analysis. TRW information is computer based, so credit reports can be obtained through an automated retrieval system in a matter of minutes.

Bank Checking. Another source of information for the firm is a credit check through a bank. Many banks have large credit departments that undertake credit checks as a service for their customers. By calling or writing a bank in which the credit applicant has an account, a firm's bank is able to obtain information on the average cash balance carried, loan accommodations, experience, and sometimes financial information. Because banks generally are more willing to share information with other banks than with a direct inquirer, it usually is best for the firm to initiate the credit check through its own bank rather than to inquire directly.

Trade Checking. Credit information frequently is exchanged among companies selling to the same customer. Through various credit organizations, credit people in a particular area become a closely knit group. A company can ask other suppliers about their experiences with an account. Useful information includes the length of time they have had the account, the maximum credit extended, the amount of the line of credit, and whether payments are prompt or slow.

The Company's Own Experience. A study of the promptness of past payments, including any seasonal patterns, is very useful. Frequently, the credit department will make written assessments of the quality of the management of a company to whom credit may be extended. These assessments are very important, for they pertain to the first of the famous "four C's" of credit: character, collateral, capital, and capacity. The person who made the sale to a prospective customer frequently can offer useful impressions of the management and operations. Caution is necessary in interpreting this information, because a salesperson has a natural bias toward granting credit and making the sale.