Entrepreneurial Blog

Explain the four C’s of credit. Which is the most important and why?

Character – integrity is very important in determining the creditworthiness of an individual.  Past performance on other debts should be considered.  A credit score that determines credit worthiness by tracking late payments, over credit limit usage, past due accounts, total debt, and available credit.

Capacity – the debtor having sufficient cash flow to cover all their expenses and debt.  The ability to generate income to pay back the debt.

Capital – net worth of the individual.  Net worth is your current assets (assets convertible to cash within one year) less your current liabilities (liabilities due within one year).  Having sufficient capital to cover your debt is a major requirement to extending credit.

Collateral – assets to pledge for the debt.  Collateral is the assets or cash used to secure the debt.  If the credit extended goes  in default then the collateral will be forfeited to pay for the debt.

Collateral is the most important because is you have sufficient and the proper collateral to cover the debt and the debt goes into default then you can recover your losses by applying the collateral to your outstanding credit with the debtor.

Describe three kinds of credit accounts which a company can use to support its credit sales?

The three kinds of credit accounts which a company can use to support its credit sales are revolving agreement, charge agreement, and installment agreement.

Revolving Agreement:

In a revolving credit agreement you are charged interest on the amount of the balance that was not paid at the end of the period due.  If you pay for your purchases in full at the end of each period then you will not be charged any interest.  If you make a partial payment then the unpaid balance will be charged interest until paid in full.  If you make no payment then the unpaid balance will accrue interest until paid.

Charge Agreement:

In a charge credit agreement you agree to pay in full at the end of the period for all purchases.  Since there are no outstanding balances at end of the period there will be no finance charges.

Installment Agreement:

In a installment credit agreement you agree to pay a certain amount equally over a specific time with a fixed amount of interest.  Your periodic payment is applied to the interest accrued and pay down of principle balance until the total balance is zero.

Describe three methods for limiting the risk for a company that extends credit to its customer?

Three methods for limiting risks for a company that extends credit to its customers is to have each customer complete and update annually a credit application, check its customers credit worthiness with reference checks and credit score checks, and only offer small credit balances.

Credit Applications:

Each customer whom wishes to have credit with your business must complete a credit application to include: contact info, Federal Identification Numbers, personal guarantee of owners with social security numbers along with acceptance to check credit scores.  These credit applications must be kept on file and updated annually.

Check Credit Worthiness:

Each credit application should be reviewed for accuracy and credit worthiness should be checked.  Credit references should be obtained and updated annually.  Credit score should be obtained and received annually.

Keep Small Credit Balances:

Limit the amount of credit available to customers.  Keep balances small, if credit limit is not used reduce yearly or if needed increase.  Maintain a equilibrium with past performance.  Account receivable balances should be reviewed periodically and be kept within terms.  The minimum number of days in accounts receivable is preferable.

How does the extensive use of credit cards by their customers affect small businesses?

The extensive use of credit cards by their customers affect small businesses in the increased chances of fraud by the customer, the increased fees in credit card processing, and the increased chances of credit card theft.

Fraud by Customer:

If protocols are not in place to protect from credit card fraud then a small business can be a victim of fraud.  A fraudulent credit card could be used for purchases in a storefront or online store.  If used in a storefront then the product or service will have been given to the customer right away, if in a online store then the product would be shipped to the customer.  The small business owner might not discover the fraud until a month or two later, when the appropriate person opens their credit card statement to see the fraudulent charge.  Once victim of credit card theft disputes the charges then the credit card company takes the appropriate money from the small businesses account. The small business will lose the income from the sale as wells as have already lost the product or service with no way to recover the loss.

Increase Credit Card Processing Expense:

For a small business there are no fees involved when accepting cash for products or services.  If a small business accepts credit cards then there are fees involved.  These fees include monthly statement fees, percentage fees per dollar amount of transaction, and fee per transaction.  These fees are an added expense for the small business as well as reducing the profits of the small business.

Increase Chance of Credit Card Theft:

When taking credit cards from customers to process there is a chance that your customers could obtain those credit card numbers for fraudulent purposes thus exposing your small business to risk.

Explain the scope of fraud and why it impacts small businesses to a greater extent than large businesses. What should the owners or managers do to prevent fraud from occurring in the first place?

Fraud impacts a small business to a greater extent that large business in that there are not enough safe guards in place to protect the small business.

Cash Theft:

In a small business if there are many people handling the cash transactions then it could be easier for cash theft.  There should be oversights in place to check for cash theft loss.  Each cashier should have their own secure registers and at the end of the shift another person, either a supervisor or business owner should tally the receipts against the cash to see if there are any overage or shortages and problems should be immediately corrected.  A surveillance system with camera should be in place covering each cash register.

Credit Card Number Theft:

In a small business customers’ credit cards should be securely handled without keeping the full credit card number on receipts.  The customer’s credit card numbers should be x’ed out to prevent others from using the credit card for fraudulent purposes.  A surveillance system with camera should be in place covering each credit card transaction.

Credit Card Fraud:

A customer could use a fraudulent credit card to make transactions.  The small business should have safe guards in place to prevent this.  Checking identification so that it matches the credit card holder is one way to prevent fraud.  Keeping name, address, and phone numbers of customers can also help in preventing fraud.  Also a noticeable surveillance system with camera should be in place covering each transaction will also help to prevent fraud..

Inventory Theft:

Periodic planned and sporadic inventory reconciliation should be performed.  This will reduce the amount of inventory theft.  A surveillance system with camera should be in place covering all inventory locations.

Employee Time Abuse:

Employees in a small business may overstate their hours easier than in a larger firm.  An electronic time clock with individual personal employee codes could be used to minimize employees overstating their hours.  A surveillance system with camera should be in place covering all time clock locations.