Key Terms in Business Finance and Credit Management
**Credit Standards**
Credit standards refer to a firm’s minimum requirements for extending credit to a customer.
**5 C’s of Credit**
The 5 C’s of Credit are five key dimensions used to assess creditworthiness:
- Character
- Capacity
- Capital
- Collateral
- Conditions
**Credit Scoring**
Credit scoring is a credit selection method commonly used with high-volume credit requests.
**Aging Schedule**
An aging schedule is a credit monitoring technique that categorizes accounts receivable into groups based on their time of origin.
**Float**
Float refers to funds that have been sent by the payer but are not yet usable by the payee.
Mail float: The time delay between when a payment is placed in the mail and when it is received.
Clearing float: The time between the deposit of a payment and when spendable funds become available to the firm.
**Lockbox System**
A lockbox system is a collection procedure in which customers mail payments to a post office box that is emptied regularly by the firm’s bank.
**Controlled Disbursement**
Controlled disbursement is the strategic use of mailing points and bank accounts to lengthen mail float and clearing float, respectively.
**Cash Concentration**
Cash concentration is the process used by a firm to consolidate lockbox and other deposits into one bank, often called the concentration bank.
**Depository Transfer Check (DTC)**
A depository transfer check (DTC) is an unsigned check drawn on one of a firm’s bank accounts and deposited into another.
**Automated Clearinghouse (ACH) Transfer**
An ACH (automated clearinghouse) transfer is a preauthorized electronic withdrawal from the payer’s account, deposited into the payee’s account via a settlement among banks by the ACH.
**Wire Transfer**
A wire transfer is an electronic communication that, via bookkeeping entries, removes funds from the payer’s bank and deposits them into the payee’s bank.
**Spontaneous Liabilities**
Spontaneous liabilities are financing that arises from the normal course of business.
**Unsecured Short-Term Financing**
Unsecured short-term financing is short-term financing obtained without pledging specific assets as collateral.
**Cost of Giving Up a Cash Discount**
The cost of giving up a cash discount is the implied rate of interest paid to delay payment of an account payable for an additional number of days.
**Short-Term, Self-Liquidating Loan**
A short-term, self-liquidating loan is an unsecured short-term loan in which the use to which the borrowed money is put provides the mechanism through which the loan is repaid.
**Prime Rate of Interest**
The prime rate of interest is the lowest rate of interest charged by leading banks on business loans to their most important business borrowers.
**Discount Loans**
Discount loans are loans on which interest is paid in advance.
**Single-Payment Note**
A single-payment note is a loan obtained for a short period.
**Pledged Accounts Receivable**
Pledged accounts receivable is the use of a firm’s accounts receivable as security, or collateral, to obtain a short-term loan.
Lien: A publicly disclosed legal claim on loan collateral.
Non-notification basis: The basis on which a borrower, using accounts receivable as collateral, continues to collect the account payments without notifying the account customers.
Notification basis: The basis on which an account customer whose account has been pledged is notified to remit payment directly to the lender.
**Factoring Accounts Receivable**
Factoring accounts receivable is the outright sale of accounts receivable at a discount to a factor or other financial institution.
Factor: A financial institution that specializes in purchasing accounts receivable from businesses.
Non-recourse basis: The basis on which accounts receivable are sold to a factor with the understanding that the factor accepts all credit risks on the purchased accounts.
**Line of Credit**
A line of credit is an agreement between a commercial bank and a business, specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period.
Compensating balance: A required checking account balance equal to a certain percentage of the amount borrowed from a bank under a line of credit or revolving credit agreement.
Annual cleanup: A requirement that for a certain number of days during the year, borrowers under a line of credit carry a zero loan balance.
**Revolving Credit Agreement**
A revolving credit agreement is a line of credit guaranteed to a borrower by a commercial bank, regardless of the scarcity of money.
Commitment fee: The fee that is normally charged on a revolving credit agreement; it often applies to the average unused portion of the borrower’s credit line.
**Commercial Paper**
Commercial paper is a form of financing consisting of short-term, unsecured promissory notes issued by firms with a high credit standing.
**Commercial Finance Companies**
Commercial finance companies are lending institutions that make only secured loans to businesses.