Financial Analysis LAP 2 Credit and Its Importance Give Credit Where Credit Is Due

Objectives: Credit and Its Importance Describe types of credit extended to businesses and consumers. Explain the reasons for extending credit. Give Credit Where Credit Is Due Financial Analysis LAP 2

Describe types of credit extended to businesses and consumers.

 Megan needs a car.  She doesn’t have enough cash on hand.

 Car dealer buys cars at auction.  He doesn’t always have enough cash on hand.  Car dealer buys cars at auction.  He doesn’t always have enough cash on hand.  Megan and the car dealer need credit!  Credit—buy now, pay later  Megan and the car dealer need credit!  Credit—buy now, pay later

Credit  Credit—the ability to buy something now and pay for it later  Businesses use to obtain products to sell.  Individuals use to buy products from businesses.  Credit—the ability to buy something now and pay for it later  Businesses use to obtain products to sell.  Individuals use to buy products from businesses.

Common Types of Credit  Revolving credit accounts  Installment credit accounts Credit limit set at time of opening. Finance charges apply to outstanding balance. Credit limit set at time of opening. Finance charges apply to outstanding balance. Apply to one total amount of credit Borrower makes down payment, then regular payments after that. Commonly used to purchase large, expensive items Lender has lien on item until all payments are made. Apply to one total amount of credit Borrower makes down payment, then regular payments after that. Commonly used to purchase large, expensive items Lender has lien on item until all payments are made.

Common Types of Credit  Regular credit accounts  Budget credit accounts Sometimes called open accounts Borrowers can buy anything during a certain time period (usually 30 days). May or may not have a credit limit Sometimes called open accounts Borrowers can buy anything during a certain time period (usually 30 days). May or may not have a credit limit Short-term No interest if payments are made on time Example: “90 days same as cash” Short-term No interest if payments are made on time Example: “90 days same as cash”

Common Types of Credit  Bank credit cards  Travel and entertainment cards Visa, MasterCard, Discover, American Express, etc. Can be obtained in many different ways Can be used almost anywhere, but charges are handled by banks Visa, MasterCard, Discover, American Express, etc. Can be obtained in many different ways Can be used almost anywhere, but charges are handled by banks Traditionally used in restaurants and hotels Must be paid in full every month Traditionally used in restaurants and hotels Must be paid in full every month

Common Types of Credit  Service credit  Secured loans—backed by collateral For utilities Utilities are consumed before they are paid for. For utilities Utilities are consumed before they are paid for.  Unsecured loans Borrower promises to repay. No collateral required Borrower promises to repay. No collateral required

Sources of Credit  Commercial banks  Savings and loan associations  Credit unions  Sales finance companies  Other businesses  Commercial banks  Savings and loan associations  Credit unions  Sales finance companies  Other businesses

Costs of Credit  Annual fees Apply to some credit cards Fees vary from card to card. Apply to some credit cards Fees vary from card to card.  Finance charges Interest on outstanding balances Expressed as APR—annual percentage rates Interest on outstanding balances Expressed as APR—annual percentage rates

Costs of Credit  Higher prices to cover expenses—operating systems and bank fees  Interest rates Fees on loans The amount of money being borrowed (principal), times the interest rate, times the length of time for which the loan is made Fees on loans The amount of money being borrowed (principal), times the interest rate, times the length of time for which the loan is made

Explain the reasons for extending credit.

Why Businesses Offer Credit  To be competitive Available credit may be customer’s deciding factor. Interest rates can also be used to compete. Available credit may be customer’s deciding factor. Interest rates can also be used to compete.  To gain new customers

Why Businesses Offer Credit  To encourage customers to buy They buy more freely when they don’t need cash on hand. They may buy larger quantities or more expensive models. They buy more freely when they don’t need cash on hand. They may buy larger quantities or more expensive models.  To foster customer loyalty Pre-sale notification Extend payment periods Pre-sale notification Extend payment periods Special discounts

Why Businesses Offer Credit  To use as a marketing-information tool Helps in planning promotions Helps in targeting specific markets Helps in planning product mix Helps in planning promotions Helps in targeting specific markets Helps in planning product mix

Benefits of Using Credit  Purchasing expensive items  Taking advantage of convenience Safer and easier than carrying large sums of cash Easy to order by phone or online Safer and easier than carrying large sums of cash Easy to order by phone or online  Purchasing emergency items

Benefits of Using Credit  Maintaining appropriate inventory levels— business can buy items to sell and sell them before credit payment is due  Having cash available for other purposes  Establishing a good credit rating  Saving money (special discounts, etc.)

Credit Regulations  State laws Vary from state to state Uniform Commercial Credit Code (UCCC)—gives states a model to follow Retail Installment Sales Acts (RISA)—regulate installment sales of personal property Vary from state to state Uniform Commercial Credit Code (UCCC)—gives states a model to follow Retail Installment Sales Acts (RISA)—regulate installment sales of personal property

 Federal laws Also called Consumer Credit Protection Act Makes it easier to compare credit terms Specifies what information credit providers must give borrowers Also called Consumer Credit Protection Act Makes it easier to compare credit terms Specifies what information credit providers must give borrowers Credit Regulations  Truth-In-Lending Act

 Federal laws Prohibits discrimination in granting credit Credit providers must provide written reasons for refusal. Prohibits discrimination in granting credit Credit providers must provide written reasons for refusal. Credit Regulations  Equal Credit Opportunity Act  Fair Credit Billing Act—companies must respond to billing errors promptly.  Fair Credit Reporting Act—consumers have the right to inspect their credit files.  Fair Credit Billing Act—companies must respond to billing errors promptly.  Fair Credit Reporting Act—consumers have the right to inspect their credit files.

 Federal laws Bans unfair interest rate increases Prevents unfair credit-card fees Ensures that contract terms are written in “plain language” Regulates credit-card companies’ marketing efforts toward young people and college students Bans unfair interest rate increases Prevents unfair credit-card fees Ensures that contract terms are written in “plain language” Regulates credit-card companies’ marketing efforts toward young people and college students Credit Regulations  Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (CARD)

Have you ever received an offer to open a credit account? From which credit provider did it come? Were you able to understand the terms that were offered to you? Did you open the account? Why or why not?

 Debt—a big problem for Americans Over 40 percent spend more than they earn each year. Average household—$8,000 in credit-card debt at any given time

 Some say credit-card companies’ unethical actions are to blame because they: Bombard people with offers for available credit Reel them in Keep them “on the hook” for years trying to pay off their debts  Others say that those who are in debt are to blame for not managing finances wisely.  What do you think?

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