Credit Management

Glen Bullivant

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317158103
• Edition: 6
• Topic: Business
• Subtopic: Management
• Index: Business

First Published in 2016. Credit Management provides a comprehensive, down-to-earth guide to every aspect of managing credit. The key message throughout is that cash flow and profits can be much improved by proper planning, motivation and control, without in the least jeopardising sales or alienating customers. All of the key credit control issues are covered including guidance on credit policy and management of the credit function; credit terms; risk assessment, management and modelling; debt collection; credit insurance; export credit; consumer credit; the commercial credit law; and credit services. For over thirty-five years, subsequent editions of this book have provided the best single-volume guide for anyone responsible for managing credit, risk and customers. Previously published as Credit Management Handbook, the new edition, with a new editor has been revised to reflect changes in practice and technology and is the set text for the Institute of Credit Management (ICM) examinations.

PART I
The Credit Management Function

1

Credit Past and Future

Glen Bullivant

• Origins • The role of credit and its importance in the economy • Capital and credit • The development of consumer and export credit • Secured and unsecured credit • Information Technology • External services • Credit management as a profession • Coping with change and the path forward •

Origins

It is easy to imagine that credit is a modern invention, like the DVD player or the mobile phone. The reality is that DVD and the mobile phone are little more than the development of previous methods of display and communication, in the same manner that the motorcar is an advancement on the horse and cart. Credit has been a part of human existence for a very long time – the levels of sophistication and progress in utilising and controlling credit continue to improve. Who would argue that today’s family hatchback is not a much more versatile and reliable form of transport than the 1920s ‘any colour you want so long as it is black’? From the earliest times, three principal factors became apparent as humans began to populate the planet and form themselves into groups or communities. From the beginning, some people, for whatever reason, would have more than others – today we recognise the word ‘surplus’ – and others would want some of it, but not have the means to pay. No change there then! If we add to that the seasonal agricultural factor, the roots of today’s credit cycle are even more obvious. Plant the seed, grow the crop, sell the crop, plant the seed can be illustrated by a twenty-first century flow chart, but remains as ancient a credit problem as ever – income is derived from selling the crop, but what pays for the seed in the first place? The buyer would want to see the product before paying for it, and if the source of supply was a long way from the source of demand, a period of time elapsed before payment would be made.

We are aware of credit being documented in the ancient civilizations of Egypt, Assyria and Babylon over 3000 years ago, but it is to the Middle Ages and Europe that we look to see real growth in credit trading as we recognise it today. Great trading fairs were held in Europe in the twelfth century, with merchants travelling from fair to fair, buying and selling on an ongoing basis. It became common for a trader in one place to buy out of the proceeds of sale in another place, and it was at this time in Italy that the trade agent came into being. The agent was created to handle all the buying, selling and settlement details on behalf of travelling clients. The ‘Cambium Contract’ was a powerful document which recorded multi-contracts, including those in different currencies, and instigated the transfer of funds from place to place.

For example, it is recorded that in 1253 a merchant of Genoa purchased English cloth in France from an Italian seller, agreeing to pay four months later with funds to be derived from the sale of his own spices elsewhere. The idea of discount for bulk purchase is not new either, nor is the practice of large discounts for cash in advance. Monasteries in medieval England, dependent on income from sales of wool from their sheep flocks, would give attractive discounts for large purchases by Italian and Flemish merchants for delivery in the next season. The ‘Bill of Exchange’, much as we know it today, was a product of fourteenth-century Italy on the sound basis then that gold and silver were available at all times to cover acceptance values. The creditworthiness of the issuer later replaced the gold coin as the basis for bill of exchange transactions. It was not until the seventeenth century that it became accepted practice for banks and nation states to issue paper at a greater face value than underlying deposits. Simply stated, receipts began to be issued for gold deposited, and notes were produced with a gold face value which could be exchanged for goods or services. The assumption was, and remained, that not everyone would ask for their gold back at the same time. ‘I promise to pay the bearer on demand the sum of …’ was an undertaking signed by the Chief Cashier of the Bank of England, appearing on every bank note produced for the Bank. This assumption became the foundation of the banking and fiscal systems, though today bank notes are not actually backed by gold deposits. It was the creation of the Bank of England in 1694 that was itself a catalyst for credit growth – the Bank remained privately owned, and therefore ostensibly independent, until it was nationalised in 1948. Though remaining publicly owned, the Bank’s independence of Government was restored in 1997.

The Industrial Revolution, born in the north-west of England at the end of the eighteenth century, gathered pace throughout the nineteenth century and made hitherto unprecedented demands on the credit culture. The UK underwent a momentous transformation in only a few short years from an agricultural economy to one dominated by manufacturing industry. All manner of new products were now being made and sold to new markets and to more and more customers all over the world, increasing risk and unknown exposure. New and varied credit and financing methods were introduced, not least of which was the raising of money via share issues from a greedy, gullible and inexperienced public. Again, nothing really changes! Venture capitalists (as we now know them) are not new. The wealthy and the adventurous have always been called upon to back expeditions and adventures into new and exciting areas. Good Queen Bess and her spirited servants, Drake and Raleigh, had illustrated the practice in the sixteenth century. What was new, however, was the deliberate raising of capital from the public via share issues, with the promise of riches beyond imagination. The scandal of the South Sea Bubble led to the Bubble Act of 1720, which banned the raising of public capital and the use of limited liability by firms, which remained in place until 1862, during which time partners in businesses and anyone investing for profit were personally liable for the debts of the businesses. In spite of limited liability, it is not difficult to see similarities between the gullibility and inexperience of the South Sea Company investors of the eighteenth century, the railway mania of the nineteenth century and the dotcom frenzy of the late twentieth century.

Throughout the Industrial Revolution, trade expansion was assisted by loans from local banks to local businesses, and the growth in diverse products and markets saw an expansion of trade credit as a significant source of financing businesses. Because interest rates were low (typically 2 per cent per annum) bank loans were cheap, and this bred something of a tolerance to late payment. Indeed, because rates above 5 per cent were banned by law until 1832, the cost of late payment was not recognised as having any material impact on profits, and extensive payment terms were both given and taken. It was only when bank loans were renewed after 12 months that firms noticed any cost element associated with customers who had not paid and the interest burden of unpaid bills became apparent. The legacy of extended terms remained, however, and has survived into more recent times. In the printing trade, for example, it was common for the payment chain through publisher, printer, printer supplier and author to be totally dependent on the book being sold to the customer, and extended terms in that trade still linger today. It is something of an irony that the financial meltdown of 2008 and 2009 brought with it a return to near zero interest rates and brought into sharp focus the need to collect accounts when due – the tolerance of delinquent payment habits was severely eroded.

Methods of payment progressed to keep pace with developments. Until around 1875, cheques were a rarity, debts being usually settled about one-third by cash and two-thirds by bill of exchange. The growth of banks with an increasing number of branches – the beginnings of what we now recognise as ‘high street’ banks – produced rapid expansion in the use of cheques for payment, as it became relatively simple to transfer funds between businesses a long distance apart. Local branches of banks made credit more accessible to all, which lessened the need for extended trade credit and brought about a general reduction in credit terms to what we now accept as normal or monthly terms. The expansion of trade, the proliferation of customers in far-flung places and in a variety of shapes and sizes, brought an appreciation, later rather than sooner, that giving credit was an aspect of the trading activity which required the same degree of management and discipline which applied to other aspects of day-today business operations. In other words, allowing time to pay and then getting paid needed some skilled effort to make it worthwhile. That which has been labelled the ‘UK disease’ of late payment has always been closely linked to the unwillingness of suppliers to ask customers for money. As long ago as 1689, a Lancashire merchant recorded ‘it being a year since I began to trade, I have been too forward in trusting and too backward in calling’. In 1780, a bookseller wrote: ‘I resolved to give no person whatsoever any credit, having observed that when credit was given, most bills were not paid within six months, some not for a twelve month and some not in two years. The losses sustained of interest in long credits and by those bills not paid at all; the inconvenience of not having ready money to lay out to trade to advantage; together with the great loss of time in keeping accounts and collecting debts … [but] I might as well attempt to rebuild the Tower of Babel as to run a large business without giving credit.’

The Role of Credit and its Importance in the Economy

Credit has been described as the oil of commerce, and it has been an accepted feature, since the early part of the twentieth century, that businesses allow customers time to pay. In normal trading, not to give credit would restrict sales, reduce volumes and increase unit costs. It is not true of every business, at least on the face of it. Many businesses selling direct to consumers do so on a cash basis (usually) – supermarkets, fast food shops, cafés, for example, B2B sales, however, would consider cash trading impracticable, and it would be a barrier to sales growth in most cases.

It is also not sufficient in this modern age to artificially restrict the granting of credit to business customers – only to allow credit to existing well-known and established customers. It is true that, up to the end of the first quarter of the twentieth century, companies with established and protected markets could afford to be particular and only give credit to those that they knew and trusted. The combination of increased competition and the need for business growth pushed businesses beyond the ‘tried and trusted’ and led them into the hitherto unknown. Vast ongoing volumes of goods and services, which provide employment for millions, became possible only on the basis of ‘buy now – pay later’. That growth in business, both domestically and worldwide, made it all the more important for the seller to know about the customer, judge the amount of credit it was feasible to advance, and correctly calculate the length of time it could afford to let that credit period be. Equally, businesses needed to recognise the worth of ensuring that the amount granted was actually paid on time, so collection processes needed to be in place. Credit, therefore, has become very much an essential part of the whole marketing cycle, but it has also to be recognised that there is a cost involved.

Credit has become an integral part of modern industrialised economies. In manufacturing, the more that is made and sold, the less the unit production cost of each item – this is known as economies of scale. Allowing for inflation, the true cost of manufactured goods in general falls year on year as both production techniques improve and markets for the finished product grow, though increasing scarcity of raw materials can have a negative impact on price reductions. The reduction in ultimate selling price is acutely visible in consumer goods and in consumer services, ranging from washing machines to airline tickets – the more you sell, the cheaper they can become. The credit cycle can begin with importing raw materials, through the manufacturing and distribution process, through to the sale of the finished product and ultimate payment. In all stages of the cycle, there is an element of credit granted and taken, and the contribution made by credit is basic to the success of the whole. There are drawbacks, however, to both seller and buyer in the credit environment. For the seller, there is the risk of late or non-payment, which will have a negative impact on both profits and liquidity. There are many examples of companies with full order books finding survival threatened by delinquent customers. The seller also has to set up costly procedures to control credit granting, the administration of which is a constant feature of modern trading. The buyer can face increased prices for credit-related supplies, without the advantages of discounts for full cash purchases. In addition, the buyer has to protect a reputation in respect of payment, which can suffer if payments are delayed, and which can in turn lead to difficulties in obtaining continuity of supplies.

Capital and Credit

The relationship between capital and credit lies at the heart of understanding the growth of, and the need for, credit. Over the millennia of human development, there remains a fundamental truth, which is that some have and some do not have. Put another way, the granting of credit rests in the hands of those who have, and the need for credit and its use is with those who do not have. It is also a fundamental truth that the value of assets will diminish in time, if those assets are not utilised for profit. It may be argued that the fixed asset value of a house will inevitably rise over time (notwithstanding the spectre of an overheated housing market as experienced in the UK in the 1990s and 2007/8), but it is the exception that proves the rule. A machine for producing plastic toy ducks will only retain any value if it actually makes plastic toy ducks for profit, and to maintain profit margins requires new investment in new machines. New investment comes from earning profits.

Ownership of capital has changed over the centuries. Whatever the political climate, capital ownership has spread more widely in more recent times. Capital was always in the hands of the Crown, State, Church and ruling classes. Governments remain prime sources of capital, and in some regimes, virtually the only source of capital. The Industrial Revolution saw the beginnings of the accumulation of capital by industrialists, and many of the large national and multinational corporations of today have their origins in the nineteenth century. The growth of industry and commerce saw the spread of capital ownership, and the development of that capital itself was encouraged by the use of credit and its wider provision. There is therefore a relationship between those who have capital and those who have not, which is the foundation of sales and credit.

The Development of Consumer and Export Credit

CONSUMER CREDIT

The aim of all production is consumption, and the ultimate beneficiary, and mainstay of the whole credit cycle, is the consumer. In times past, apart from the wealthy few whose buying power allowed them to insist on credit terms from generally poor tradespeople, most of the population had to find cash to buy their needs. Moneylenders and pawnbrokers, rather than banks, were the only source of borrowing for the man in the street, and, with the exception of the ‘slate’ at the local corner shop, credit was not available.

There was another exception, however. The eighteenth century saw the growth of the ‘tallymen’, itinerant traders who sold clothing at people’s front doors in return for small weekly payments. Their frequent contact with customers, to collect instalments, allowed them access to ...

Table of contents

• Cover Page
• Half Title page
• Title Page
• Copyright Page
• Contents
• List of Figures
• Foreword
• Introduction
• Part I The Credit Management Function
• Part II Credit Terms and Conditions of Sale
• Part III Assessing Credit Risk
• Part IV Sales Ledger
• Part V Cash Collection
• Part VI Credit Insurance
• Part VII Export Credit and Finance
• Part VIII Consumer Credit
• Part IX Commercial Credit Law
• X Credit Services
• Appendix
• Index