Page 494 - Business Principles and Management

Chapter 18 • Credit and Insurance

18.2 Managing Credit

Goals Terms
• Identify the information on which • creditworthiness • conditions
decisions about credit applications • character • credit agency
is based and how that information • capacity • aging of accounts
is obtained.
• capital
• Describe the steps in collecting
unpaid accounts.

Determining Credit Standing

A business must have a policy and a system for approving credit for customers.
Creditworthiness is a measure of a person’s ability and willingness to repay a
loan. Two methods commonly used to check applicants’ creditworthiness are
(1) the four Cs of credit and (2) the point system.

THE FOUR CS OF CREDIT
To determine the creditworthiness of people or organizations, businesses gather
information as part of the credit application process. They then apply the “four
Cs” of credit to analyze the information: character, capacity, capital, and condi-
tions. A review of each factor helps to determine the answers to two important
questions about the applicant’s creditworthiness: (1) Can the customer pay? and
(2) Will the customer pay?
Character is a measure of a person’s sense of financial responsibility or per-
sonal belief in the obligation to pay debts. It includes honesty, integrity, and atti-
tude toward indebtedness. Credit-granting businesses check an applicant’s credit
reputation, payment habits, and job stability to judge the person’s character. The
applicant who is always late in making payments or who frequently changes
jobs will not likely be approved for credit. Credit references are frequently re-
quested to determine how others view the applicant.
Capacity is a measure of earning power and reflects the person’s potential to
pay, based on current income and other financial obligations. To judge capacity
for consumer credit, businesses look at the credit applicant’s employment his-
tory, income level, and number and amount of debts. For business credit, they
carefully examine the business’s financial performance and financial statements.
Capital, the third C, is a measure of the credit applicant’s current financial
worth or ability to pay based on assets. For an individual, “capital” means as-
sets such as savings, a car, or a home. For a business, “capital” means a healthy
balance sheet—far more assets than liabilities. Capital is especially important if
people lose their jobs or when businesses suffer losses or poor cash flow. With
adequate capital, individuals or businesses can still pay for credit purchases.
Creditors can also ask that assets be pledged as collateral for loans.
Conditions, the last of the four Cs of credit, is an assessment of the economic
environment, such as the economic health of a community or the nation and the

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