Essential Standard 5.00 Understand business credit and risk management.
Objective 5.01 Understand credit management
Topics Main types of credit Common advantages and disadvantages of businesses using credit Cost of credit Main factors examined for granting credit Credit documents Credit regulations Credit assistance
How Credit Cards Are Made http://www.youtube.com/watch?v=gaduUHFrScI The Credit Card Song by Old Man Pie http://www.youtube.com/watch?v=2JwdIWjVHaU&safety_mode=true&persist_safety_mode=1 Simpson’s Advertisement http://www.youtube.com/watch?v=jBaPx3sym0I&feature=related
Tips for Using Your Credit Card • 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&safety_mode=true&persist_safety_mode=1
Obtaining Credit http://www.youtube.com/user/CreditMadeClearer#p/u/10/P0h_12RMWgk
Who uses credit: Consumer Credit Commercial Credit Credit used by people for personal reasons. Credit used by businesses.
Main Types of Credit • 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 continued 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. 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 continued Credit cardsallow 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. 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 continued • Installment sales creditis 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 loansrequire 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
Credit 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 Credit 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 Businesses • 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.
Definitions 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
Definitions 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
Terms • 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? • Convenience • Immediate Possession • Emergencies
Common advantages and disadvantages of businesses using credit Advantages Disadvantages • Establishing favorable credit rating • Keeping business separate from personal expenses • Minimizingrecord-keeping and receipts • Keeping track of what employees are spending • Earningrewards • Growth of the Economy • Buying goods will help the economy expand. • Experiencing theft of customer records/databases • Overbuying by employees • Overusing credit • Credit Fees • Interest paid on balance
Results of Overuse 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.
Cost of Credit continued • 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 continued • 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. • 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 credit Service fees
MATH Calculate Maturity Date Activity Converting Time and Percents Activity Simple Interest Activity Installment Interest Activity
Main factors examined for granting credit Creditors examine several factors about potential debtors when deciding whether to grant them credit, such as…….
Main Factors Examined for Granting Credit The Four C’s of Credit • Character • Capital • Capacity • Collateral
The 4 C’s of Credit • 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 wasto become unavailable. • Collateral is security to help guarantee that the creditor will be repaid.
Credit Worthiness Terms • 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 Credit • Credit Application • Documentation • Processing • Underwriting • Closing • Funding
Main Factors Examined for Granting Credit continued 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 • 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 • 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: • 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 Documents 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 continued 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
Underwriting • 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 funding • 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 Credit Regulations: exist to protect rights of credit applicants and rights of credit users from fraudulent and unfair practices.
Credit Regulations • 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 Actallows 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 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 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 Actprohibits deceptive, harassing, and unfair practices for collecting debt from debtors.
Credit Regulations continued Credit Card Accountability, Responsibility, and Disclosure Actis 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 Terms • 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. • 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 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 Credit • Credit Application • Documentation • Processing • Underwriting • Closing • Funding
Credit assistance • is available to minimize or eliminate credit problems of credit users. • Credit assistance available includes: • Debt repayment plan • Credit counseling • Bankruptcy