Functions and Forms of Commercial and Banking Credit
Credit is a word that is often heard in financing. It is something that affects the funds and income of a company. But it is not only used by companies but also by the consumers, especially when purchasing something. Credit is the ability to borrow or purchase something with the delay of paying (Farlex, 2008). It is not a thing, it is not an objective, nor is it a material. It is just a process that delays payment. It is the same as debt although looked at a different point of view. For the one to whom the payment is to be made, it is a credit but for the person obliged to pay, it is a debt.
Credit is not always given to a person or to a firm. The ability of a person, business firm, or government unit to get credit depends on the trust that the potential creditor has for him. Generally, the potential creditor look at the three “C’s” in determining the credit applicant’s ability and willingness to pay. These three “C’s” are character, capital and ability to acquire income (Mueller, 1951). It is the objective of this work to find the forms of credit that are used today by companies, government, and individuals and the function of that credit plays.
It will try to determine the people involved in every transaction of credit and for what purpose are they using it. II. Forms of Credit The success of a company depends on the demand of the consumers for the products that it produces. As its sales increase, its profit and the value of its stock also increase. Sales defend on factors that are either uncontrollable or controllable by the company. These controllable factors are sales prices, product quality, advertising, and the firms credit policy. Therefore, the company should make credit policy carefully.
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The company must look at four factors in making credit policy. First is the company must make their credit policy with considering the length of time that the borrower will pay the amount borrowed. Second is the company must look at the financial strength of the borrower. It will be the basis of the company in determining the ability of the borrower to pay the amount borrowed. The company cannot give large credit to individuals or institutions that are less likely to earn the amount being borrowed.
This represents the credit standards. Third is the firm’s collection policy, which is the ability of the firm to follow up a slow-paying account. This is important in determining whether the borrower is paying on time or paying the agreed amount. Fourth is the discount given in early payment, including the discount amount and the discount period. This is important because discount changes the value of the amount of credit. Discount is usually given if the borrower is able to pay the credit earlier than the agreed length of time.
The length of time when the discount should be given to the borrower is agreed by both parties (Brigham, 1990). There are some qualitative measures that can be used by the credit department of the firm. These are average collection period, ratio of bad debts to credit sale, and the aging of accounts receivable. All of these can be used in collection policy (Block ? Hirt, 1994). There are many types of credit that can be classified on many bases. One basis is on the nature of debtor. In this basis, the classifications are the individual debt, business debt, and government debt.
On the basis of the nature of the creditor, there are the credit extended by individuals, commercial banks, financial businesses, non-financial businesses, and government. On the basis of the purpose for which the debt is created, we have credits that are made for consumption purposes and for productive purposes. Lastly, on the basis of the length of payment, there are four classifications. These classifications are short-term, which is paid in less than a year, intermediate term, which is paid in one to five years, long-term, which is paid in more than five years, and payable or demand (Chandler, 1959).