Credit and Collection for

the Small Entrepreneur

By: JOHN XAVIER S. CHAVEZ, MFM
 Entrepreneurship

It is the process of creating

incremental wealth. It involves
the following:

Initiative taking
Organizing and reorganizing of resources to put
them to practical account
Acceptance of risk or failure
 Why Entrepreneurship?

Increase Income Comfortable nest egg

Replace Earnings Money for retirement
Augment Family Income Prolong career

Your Your
Economic Retirement
Goals Goals

Freedom to do things your way

Chance to do things the right
way
Do work that you truly enjoy

Your
Personal
Goals
 So You Want To Be In Business?

Did you know that?

9 out of 10 start up businesses fail

within the year they were set-up.

8 out of 10 SME owners admitted

that they dont bother with the
financial figures of their business
The Traditional Entrepreneur

Enterprise founder

Entrepreneur as risk
taker

Entrepreneur as
innovator
 The Factors of Production

Land

Labor

Capital

Entrepreneur
 Entrepreneurial Roles

admin officer

HR officer

manager

money maker

money finder

accountant

finance officer
 Business and Risk-Taking

BUSINESS = RISK

Sources of Risk

Business
Financial
Liquidity
Capital
Credit/Settlement
Interest
Country
Foreign Exchange
The Need for Financial Literacy

The educational system does not prepare

students (the future entrepreneurs) for the real
world.

A new level of sophistication is needed in

teaching and advising children and even
adults in personal financial management.

The rules have changed Industrial Age vs.

Information Age
 Entrepreneurial Skills

Technical Skills Personal Entrepreneurial Skills

Writing Skills Disciplined

Oral Communication Risk Taker
Interpersonal Skills Innovative
Organizational Skills Change-oriented
Network Building Skills Persistent
Technological Skills Visionary
 Entrepreneurial Skills

Business Management

Planning Skills
Decision-making Skills
Marketing Skills
Financial/Accounting Skills
Negotiation Skills
 The Entrepreneurial Process

Identifying
Determining
and Developing Managing the
the
Evaluating the Business Resulting
Resources
the Plan Enterprise
Required
Opportunity
 Why Grant Credit?

To get a sale.

You are competing with many other businesses for

your customers and they offer credit. You want to
compete on an even basis or provide your business
with a competitive advantage.

It is a tool to get a new customer and keep a

customer.
The Credit-Granting Process for Small
Businesses

Set your credit policy

Credit standards and analysis
Credit term
Credit period
Cash discount
Typically includes the rate of cash discount,
cash discount period and the net credit policy.
Example: "2 10, net 30 The customer has
30 days (30) to pay the full amount (net) of
the bill, and if they pay in 10 days (10) they
would receive a 2 percent discount (2).
Collection policy and procedures
The Credit-Granting Process for Small
Businesses

Set application procedures (credit application)

Validate information and history
Credit information
Financial statements
Bank references
Trade references
Other sources
Know the legal requirements pertaining to credit
The Credit-Granting Process for Small
Businesses

Validate information and history

Credit investigation and analysis
Type of customer (new or existing, etc)
Customers business line, background and the
related trade risks
Nature of the product/service (perishable or
seasonal, etc.)
Size of customers order and expected further
volumes of business with him
Companys credit policies and practices
Others analysis of credit files, analysis of
financial ratios and analysis of business and its
management
The Credit-Granting Process for Small
Businesses

Validate information
and history
Credit limit

Know the legal

requirements
pertaining to credit
Credit Decision Criteria

The Classical 5 Cs of Credit

Character (integrity)
Capacity (sufficient cash flow to pay
the obligation)
Collateral (assets to secure the debt)
Capital (net worth)
Condition (of the borrower and the
overall economy)
The 6th C is Credit Record.
Small Business Collection Strategies

Set established payment guidelines

Put everything in writing

Prepare an aging report of receivables

Motivate and train your customer to pay on

time
Give incentives or rewards
Use follow-up calls and reminders of payment terms
(series of calls and reminders)
Small Business Collection Strategies

Organize your collection calls

Know the balance and the background

Prepare a past due log or call sheet
Document your conversation
Have a systematic follow-up procedure in
place
Send out statements on a regular basis
Make feel-good collection calls
Portray of positive customer service attitude
Use thank you cards
Small Business Collection Strategies

Evaluate the situation and present options (Be part

of the solution!)

Be persistent in trying to collect

Be wary of warning signs of financial trouble like

bankruptcy

Be willing to sue (know when it is time to turn over

the account to a collection agency or lawyer)

Know when to quit

Educate yourself

Join credit and collection industry groups

 Financial Analysis in Credit and
Collection Decision-Making

Financial Analysis - the process of evaluating businesses, projects, budgets

and other finance-related entities to determine their suitability for investment;
used to analyze whether an entity is stable, solvent, liquid, or profitable
enough to be invested in.

Bases for Analysis:

Income statement
Balance sheet
Cash flow statement.

Past performance is used to predict future performance.

(www.investopedia.com)
 Balance Sheet

A balance sheet is a
It is also called a financial statement that
statement of summarizes the financial
financial position of a company on a
position. particular date.

23
 Income Statement

An income statement is a
financial statement that
summarizes the results of a
companys operations.

24
 Statement of Cash Flows

A statement of cash flows is a

financial statement that summarizes
the cash inflows and outflows of a
company for a period.

25
 Ratio Analysis

Liquidity Ratios

Profitability/Performance Ratios

Leverage/Financing Ratios

Measure the ability of a company to meets its long- and short-term

obligations
Provide a measure of the degree of protection provided to a
companys creditors

Turnover Ratios/Activity Ratio

 Leverage Ratios
Time Interest Earned Ratio

Uses the income statement to assess a

companys ability to service its debt

Income before taxes + Interest Expense

Interest Expense
 Leverage Ratios
Time Interest Earned Ratio

This is the most common 2003 2002

Income before
measure of a companys PHP900,000 PHP800,000
Income Tax
ability to provide protection
Add: Interest Expense PHP300,000 PHP250,000
for its long-term creditors. Amount Available
A ratio of less than 1.0 is PHP1,200,000 PHP1,050,000
for Interest
inadequate. Number of Times Earned 4.00 4.20

Earnings before Interest Use: To assess the risk

Times to debt-holders in
Expense and Income Taxes terms of number of
Interest =
Interest Expense times interest
Earned charges were
earned.
 Leverage Ratios
Debt Ratio

Measures the degree of protection afforded creditors in case of

insolvency

Reflects the percentage of assets financed by creditors

Total Liabilities
Total Assets
 Leverage Ratios
Debt Ratio

2003 2002
This ratio indicates the Total Liabilities PHP310,000 PHP443,000
relative proportions of debt Total Assets PHP1,139,500 PHP1,230,500
to assets on a companys Debt Ratio 0.27 0.36
balance sheet.

Total Liabilities Use: To indicate the

Debt
= Total Assets degree of
Ratio protection to
debtors.
 Leverage Ratios
Debt to Equity Ratio

Measures the amount of debt that is financed by

stockholders

Total Liabilities
Stockholders Equity
 Leverage Ratios
Debt to Equity Ratio

This ratio indicates the 2003 2002

Total Liabilities PHP310,000 PHP443,000
relative proportions of debt
Stockholders Equity PHP829,000 PHP737,500
to equity on a companys Debt to Equity Ratio 0.37 0.60
balance sheet. Stockholders
like a lot of debt if the
company can take
Debt Total Liabilities
advantage of positive
financial leverage. Ratio
= Stockholders Equity
Creditors prefer less debt
and more equity because
equity represents a buffer of Use: To indicate the
protection. margin of
safety to
creditors.
 Ratio Analysis

Liquidity Ratios

Leverage/Financing Ratios

Profitability/Performance Ratios

Turnover Ratios/Activity Ratios

Measure the ability of a company to convert

different accounts into cash or sales
 Turnover/Activity Ratios
Accounts Receivable Turnover

Measures how long it takes the company to turn its receivables

into cash

Net Sales
Average Accounts Receivable
 Accounts Receivable Turnover

Beginning Ending
Average
Receivables + Receivables
Accounts =
Receivable 2
 Accounts Receivable Turnover

2003 2002
This ratio measures how many Net Sales on Account PHP1,498,000 PHP1,200,000
times a company converts its Accounts Receivable (net)
receivables into cash each year. Beginning Balance PHP120,000 PHP140,000
Ending Balance 115,500 120,000
Total 235,500 260,000
It measures how quickly credit
Average Accounts Receivable PHP117,750 PHP130,000
sales are converted to cash Accounts Receivable Turnover 12.72 9.23

Accounts Use: To assess the

Net Sales
Receivable = efficiency in
Average Accounts collecting
Turnover receivables and in
Receivable
the management of
credit.
 Days Sales in Receivable

Measures the number of days on average

that it takes for customers to pay their
account

Days in a Year
Accounts Receivable Turnover Ratio
 Days Sales in Receivable

This ratio measures, on average, 2003 2002

how many days it takes to Days in a Year 365 365
collect an account receivable. Accounts Receivable Turnover 12.7 9.2

It should be interpreted relative Accounts Receivable

28.7 39.5
to the credit terms offered to in Days
customers

Average 365 Days Use: To assess the

efficiency in
Collection = Accounts collecting
Period Receivable receivables and in
Turnover the management of
credit.
 Inventory Turnover

Measures how many times the average inventory turns over

(sold) during the year

Cost of Goods Sold

Average Inventory
 Inventory Turnover

This ratio measures how many

times a companys inventory has
been sold and replaced during 2003 2002
the year. Cost of Goods Sold PHP1,043,000 PHP820,000
Inventories
If a companys inventory Beginning Balance PHP283,000 PHP311,000
turnover is less than its industry Ending Balance 264,000 283,000
Total 547,000 594,000
average, it either has excessive Average Inventory PHP273,500 PHP297,000
inventory or the wrong sorts of Inventory Turnover 3.8 2.8
inventory.

Use: To assess the

Inventory Cost of Goods Sold
= efficiency in the
Turnover Average Inventory management of
inventory.
 Days Inventory

Measures the average length of time in days it takes the

inventory to turn over. As with inventory turnover, fewer days
mean that inventory is being sold more quickly.

Days in a year
Inventory Turnover Ratio
 Days Inventory

2003 2002
This ratio measures the number Days in a Year 365 365
of days being taken, on average, Inventory Turnover 3.8 2.8
to sell the entire inventory one Average Sales
time. 96.05 130.36
Period

Average Use: This ratio

365 Days
Collection = measures how
Accounts Receivable many days, on
Period
Turnover average, it takes
to sell the
inventory.
 Cash Operating Cycle

Time between the purchase of merchandise and

the collection of the receivables from the sale

Number of Days Number of Days

+
Sales in Inventory Sales in Receivables
Accounts Payable Turnover Ratio

Measures to quantify the rate at which a company pays off

its suppliers

Purchases
Average Accounts Payable
 Cash Conversion Cycle

Measures the amount of time it takes the company to

convert resource inputs into cash flows. This metric
looks at the amount of time needed to sell the
inventory, the time to collect receivables and the length
of time the company is afforded to pay its bills without
incurring penalties.

Number of
Number of Number of
Days Sales
days Sales Days
in
in Inventory Payables
Receivables
 Thank you!

Entrepreneurs
Accounting If I owe you a pound, I have a
Academy problem; but if I owe you a million,
the problem is yours.

www.eaa.edu.ph
(02)310-3857 - John Maynard Keynes