Chapter 21.ppt
Transcript of Chapter 21.ppt
Chapter 21Fundamentals of
Corporate FinanceFourth Edition
Credit Management and
Bankruptcy
Presented by
D-r Evgeni Zografski
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Topics Covered
Terms of SaleCredit AgreementsCredit AnalysisThe Credit DecisionCollection PolicyBankruptcy
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Terms of Sale
Terms of Sale - Credit, discount, and payment terms offered on a sale.
Example - 5/10 net 30
5 - percent discount for early payment
10 - number of days that the discount is available
net 30 - number of days before payment is due
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Terms of Sale
A firm that buys on credit is in effect borrowing from its supplier. It saves cash today but will have to pay later. This, of course, is an implicit loan from the supplier.
We can calculate the implicit cost of this loan
( )Effective annual rate
1 + - 1discountdiscounted price
365 / extra days credit=
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Terms of Sale
Example - On a $100 sale, with terms 5/10 net 60, what is the implied interest rate on the credit given?
45.4%or .454,=1-+1
1-+1
rate annual Effective
365/50
955
credit days 365/extra
price discounteddiscount
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Credit Agreements
Terminologyopen accountpromissory notecommercial draftsight drafttime drafttrade acceptancebanker’s acceptance
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Credit Analysis
Credit Analysis - Procedure to determine the likelihood a customer will pay its bills.
Credit agencies, such as Dun & Bradstreet provide reports on the credit worthiness of a potential customer.
Financial ratios can be calculated to help determine a customer’s ability to pay its bills.
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Credit Analysis
Numerical Credit Scoring categoriesThe customer’s characterThe customer’s capacity to payThe customer’s capitalThe collateral provided by the customerThe condition of the customer’s business
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Credit Analysis
Multiple Discriminant Analysis - A technique used to develop a measurement of solvency, sometimes called a Z Score. Edward Altman developed a Z Score formula that was able to identify bankrupt firms approximately 95% of the time.
Altman Z Score formula
Z = 3.3EBIT
total assets+ 1.0
sales
total assets+.6
market value of equity
total book debt
+ 1.4retained earnings
total assets+ 1.2
working capital
total assets
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Credit Analysis
Example - If the Altman Z score cut off for a credit worthy business is 2.7 or higher, would we accept the following client?
9.debtbook
equitymarket
4.1assets total
sales
12.assets total
EBIT
retained earnings
total assets
working capital
total assets
=
=
.
.
4
12
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Credit Analysis
Example - If the Altman Z score cut off for a credit worthy business is 2.7 or higher, would we accept the following client?
A score above 2.7 indicates good credit.
Firm' s Z Score
( . . ) ( . . ) ( . . ) ( . . ) ( . . ) .3 3 12 1 0 1 4 6 9 1 4 4 1 2 12 3 04x x x x x+ + + + =
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Credit Analysis
Credit analysis is only worth while if the expected savings exceed the cost.Don’t undertake a full credit analysis unless the
order is big enough to justify it.Undertake a full credit analysis for the doubtful
orders only.
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The Credit Decision
Credit Policy - Standards set to determine the amount and nature of credit to extend to customers.
Credit Scoring – What your lender won’t tell tell you.
Extending credit gives you the probability of making a profit, not the guarantee. There is still a chance of default.
Denying credit guarantees neither profit or loss.
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The Credit Decision
The credit decision and its probable payoffs
Refuse credit
Offer credit
Payoff = Rev - Cost
Payoff = - Cost
Customer pays = p
Customer defaults = 1-p
Payoff = 0
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The Credit Decision
Based on the probability of payoffs, the expected profit can be expressed as:
p x PV(Rev - Cost) - (1 - p) x (PV(cost)
p =PV(Cost)
PV(Rev)
The break even probability of collection is:
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Collection Policy
Collection Policy - Procedures to collect and monitor receivables.
Aging Schedule - Classification of accounts receivable by time outstanding.
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Collection Policy
Sample aging schedule for accounts receivable
Customer' s
Name
Less than
1 month1 - 2 months 2 - 3 months
More than
3 monthsTotal Owed
A 10,000 0 0 0 10,000
B 8,000 3,000 0 0 11,000
* * * * * *
* * * * * *
* * * * * *
Z 5,000 4,000 6,000 15,000 30,000
Total $200,000 $40,000 $15,000 $43,000 $298,000
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Bankruptcy
Bankruptcy - The reorganization or liquidation of a firm that can not pay its debts.
Workout - Agreement between a company and its creditors establishing the steps the company must take to avoid bankruptcy.
Liquidation - Sale of bankrupt firm’s assets.
Reorganization - Restructuring of financial claims on failing firm to allow it to keep operating.
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Web Resourceswww.nacm.org
www.dnb.com
www.ny.frb.org/pihome/addpub/credit.html
www.creditworthy.com
http://bankrupt.com
http://finance.yahoo.com
www.myfico.com
www.jaxworks.com/zscore2.htm
www.kmv.com
www.abiworld.org
www.bankruptcydata.com
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