1. Essential Standard 5.00 Understand business credit and risk management. 1

2. Objective 5.01 Understand credit management 2

3. 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 3

4. What is credit?  Credit – the privilege of using someone else's money for a period of time. Two parties are involved  Debtor – receives the loan  Creditor – makes the loan 4

5. Who uses credit: Consumer Credit  Credit used by people for personal reasons. Commercial or Trade Credit  Credit used by businesses. 5

6. 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 6

7. Main Types of Credit continued Charge account is a contract. Charge accounts allow debtors (customers) to receive goods or services from suppliers (creditor) and pay for them at a later date, usually at the end of the month. Example: Ace Hardware Doctors office Lawyers office 7

8. 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 8

9. Main Types of Credit continued Credit cards allow 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 9

10. 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 10

11. Main Types of Credit continued  Installment sales credit -when you borrow money and you make several partial payments instead of one large single payment. These payments are at specific times such as bi-weekly or monthly.  Example  Rooms To Go Furniture Store 11

12. Main Types of Credit continued  Consumer loans require 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  Promissory note – a written promise to repay  Collateral – Property that is used as security  Cosigner – The cosigner of the note is responsible to pay if you don’t. Usually a parent. 12

13. 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. 13

14. 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. 14

15. 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. 15

16. 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 16

17. 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 17

18. Who Uses Credit? 18

19. 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. 19

20. Why Use Credit?  Convenience  Immediate Possession  Emergencies 20

21. Common advantages and disadvantages of businesses using credit Advantages  Establishing favorable credit rating  Keeping business separate from personal expenses  Minimizing record-keeping and receipts  Keeping track of what employees are spending  Earning rewards  Growth of the Economy  Buying goods will help the economy expand. Disadvantages  Experiencing theft of customer records/databas es  Overbuying by employees  Overusing credit  Credit Fees  Interest paid on balance 21

22. 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. 22

23. How Credit Cards Are Made  http://www.youtube.com/watch?v=gaduUHFrScI 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 http://www.youtube.com/watch?v=2JwdIWjVHaU &safety_mode=true&persist_safety_mode=1  Simpson’s Advertisement  http://www.youtube.com/watch?v=jBaPx3sym0I&f eature=related http://www.youtube.com/watch?v=jBaPx3sym0I&f eature=related 23

24. Tips for Using Your Credit Card  YouTube Video  Tips for Using Your Credit Card  http://www.youtube.com/user/CreditMade Clearer http://www.youtube.com/user/CreditMade Clearer  What is credit? Loans, Mortgages and Overdrafts  http://www.youtube.com/watch?v=cjrG1Q znxLY&safety_mode=true&persist_safety_m ode=1 http://www.youtube.com/watch?v=cjrG1Q znxLY&safety_mode=true&persist_safety_m ode=1 24

25. Obtaining Credit  http://www.youtube.com/user/CreditMa deClearer#p/u/10/P0h_12RMWgk http://www.youtube.com/user/CreditMa deClearer#p/u/10/P0h_12RMWgk 25

26. 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 26

27.  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. 27

28. 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 28

29. MATH  Calculate Maturity Date Activity  Converting Time and Percents Activity  Simple Interest Activity  Installment Interest Activity  Level loan payment schedule, Example 29

30. Main factors examined for granting credit  Creditors examine several factors about potential debtors when deciding whether to grant them credit, such as……. 30

31. Main Factors Examined for Granting Credit The Three C’s of Credit  Character  Capital  Capacity 31

32. The 3 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. Debt that you can afford on what you earn.  Capital is current available assets that could be used to repay debt if income was to become unavailable. 32

33. Can you answer this Question? ZZack maintained the minimum (the cheapest) living expenses he could while working for the last three years. WWhich “C” of credit is he most likely to meet? CCapital CCapacity CCharacter 33

34. 1 more C!  Collateral is s ecurity to help guarantee that the creditor will be repaid.  Example: You own 10 acres of land. You want to buy a house. The bank requires collateral. You offer the 10 acres of land. If you don’t pay your house payment, the bank can take the 10 acres of land. 34

35. 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. 35

36. Process of Obtaining Credit 1. Credit Application 2. Documentation of Data 3. Credit Bureaus 36

37. Credit Application 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. 37

38. Documentation of Credit Data  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 38

39. Credit Bureaus  Information provided by Credit Bureaus  Credit Bureaus provide credit reports to other businesses (about your credit history)  Credit bureaus sell lenders credit information such as debt records, payment history, and if any action has been taken to collect overdue bills. 39

40. Can you answer this Question?  What do applicants of both business and personal (individual) credit have to provide?  Contact and credit information  Contact and employment history  Contact and business references 40

41. Credit Bureau Activity  Work with a partner to read and complete the Credit Bureau Activity Questions. 41

42. Can you answer this Question? WWendy’s reported that Samantha had worked at the Warsaw location for over two years. Which factor for granting credit related to documentation is this institution's action? CCredit application CCredit report CCredit data 42

43. Can you answer this question? PPage’s TV World obtained information about Timmy’s reputation for paying his bills. Which factor examined by creditors did the store receive? CCredit Application CCredit Report SStatement of Account 43

44. 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 44

45. 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 45

46. Credit Documents continued Statement of account  Comes once credit is granted and purchases are made on credit.  Come once a month 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 46

47. 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. 47

48. 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 48

49. Credit regulations and assistance options  Credit Regulations: exist to protect rights of credit applicants and rights of credit users from fraudulent and unfair practices. 49

50. 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 Act allows 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. 50

51. 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. 51

52. 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 Act prohibits deceptive, harassing, and unfair practices for collecting debt from debtors. 52

53. Credit Regulations continued Credit Card Accountability, Responsibility, and Disclosure Act is 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 53

54. 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. 54

55. 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. 55

56. 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. 56

57. Process of Obtaining Credit 1. Credit Application 2. Documentation 3. Processing 4. Underwriting 5. Closing 6. Funding 57

58. Credit assistance  is available to minimize or eliminate credit problems of credit users.  Credit assistance available includes:  Debt repayment plan  Credit counseling  Bankruptcy 58

59. Credit Assistance continued  Debt repayment plan  An agreement between a creditor and debtor that allows the debtor to pay off a debt with more manageable payment plan.  Credit counseling  Provides information on actions to take in order to manage debt.  Bankruptcy  May be used by debtors to reduce debt or amount owed to creditors. Legal process in which some or all of the assets of a debtor are distributed among the creditors because the debtor is unable to pay his or her debts. 59

60. Types of Bankruptcy  Chapter 7 (Liquidation)  Draw up a petition listing assets and liabilities.  Most of the debtor’s assets are sold to pay off creditors.  Cannot release debt on alimony, child support, taxes, fines, educational loans, and court fees.  Chapter 11 – (Reorganization) Businesses Only  Chapter 11 bankruptcy reorganization: what is it and how does it work Chapter 11 bankruptcy reorganization: what is it and how does it work  Chapter 13  Propose a plan for using future earnings and assets to eliminate debts over a period of time. 60

61. Effects of Bankruptcy  Kept on file with credit bureau for 10 years.  Affects credit rating, future extensions of credit, loss of jobs, etc.  YouTube - Credit Card reform too late for one Small Business Owner YouTube - Credit Card reform too late for one Small Business Owner  YouTube - Weekly Address: Health Insurance Reform, Small Business and Your Questions YouTube - Weekly Address: Health Insurance Reform, Small Business and Your Questions 61