The following topics will be addressed in this post:
How does the extensive use of credit cards by their customers affect small businesses? Describe three methods for limiting the risk for a company that extends credit to its customer? Explain the four C’s of credit. Which is the most important and why?
“Cash is King” vs. “The World Takes Visa”
The first phrase has dominated business transactions throughout known experience. In most societies and across the globe, some form of hard currency has been the transaction medium for commerce. The second phrase, however, is becoming more prevalent. Indeed, the world now revolves on revolving credit.
As customers use credit cards more frequently, businesses must adapt to new situations. Among the new realities, businesses need modern equipment and services to process credit transactions that increase convenience as well as costs. Also, customers do not have to physically come to the business location, so out-of-state and international transactions are easier. Now, credit cards help the continuity of cash flows because the banks are extending consumer credit rather than the businesses. On the other hand, electronic crime increases so businesses must maintain secure databases as well as verify identities to prevent loss due to chargebacks. These are just of few of the many business considerations in the new age of credit cards.
People love lists and so credit analysis has a list of four items. Generally, sources agree on the first three – character, capacity, and conditions- but there is slight variance on the fourth as some people use collateral (mainly banks) and some people use capital (mainly business lenders). The credit analysis factors are:
- Character: credit ratings, past performance, current status (Dun and Bradstreet)
- Capacity: cash flows and financial assessments of the ability to repay the loan (About.com)
- Conditions: external factors surrounding the situation (Dun and Bradstreet)
- Collateral/Capital: tangible assets that can be used to secure the loan or that can be sold to pay the loan (Jourdan; Shultz).
Of these factors, character is the most important because past performance is the best indicator of future behavior (Santia).
Today, businesses of all sizes extend and need credit. Businesses that extend credit can mitigate their risks using various methods and three methods will be mentioned here. First, use credit rating agencies. In the past, credit bureaus were subscription services that tracked small geographic areas, but the modern credit rating agencies can provide credit reports on just about anyone for legitimate business reasons. Second, businesses should use legal instruments. Contracts, surety bonds, some forms of insurance, and other items help minimize loss should a debtor default on the promised payment. Third, firms should minimize credit outstanding. Firms can reduce risk by keeping outstanding balances small whether this means extending small credit lines, using incremental billing, or even requiring that debt be secured in some way.
As stated before, we are living in an age of increasing credit. Businesses large and small must acquire and extend credit, to customers, to contractors, to suppliers, and sometimes to staff. Used responsibly, credit improves business. Indeed, many small businesspeople create great improvements in the quality of life of their communities by extending credit. Credit use will not decline, so businesspeople must understand the ramifications of credit transactions and learn to use it to their advantage.
About.com. The 4 C’s of Credit for Business Loans. http://biztaxlaw.about.com/od/financingyourstartup/a/4csofcredit.htm
Dun and Bradstreet. The four C’s of business credit. http://smallbusiness.dnb.com/business-finance/business-loans-business-credit/12154-1.html
Jourdan, J. Do You Know The Four C’s Of Credit. http://ezinearticles.com/?Do-You-Know-The-Four-Cs-Of-Credit&id=1100092
Santia, B. (2010) The four C’s of credit- Which is the most important today? http://b2bchex.com/blog/2010/6/25/the-4-cs-of-credit-which-is-most-important-today.html
Schultz, R. (2008) It Isn’t Just The Four C’s of Credit Anymore. http://quotetocash.com/it-isn%e2%80%99t-just-the-four-c%e2%80%99s-of-credit-anymore/