1. C HAPTER 10 C REDIT C ARD S ERVICES AND R ECEIVABLES M ANAGEMENT EBD-301 A CCOUNTING AND F INANCE FOR E NTREPRENEURS All Rights ReservedDr. David P Echevarria1

2. CREDIT CARD SERVICES  BUSINESSES PREFER TO SELL FOR CASH.  CONSUMERS INCREASINGLY PREFER TO USE CREDIT OR DEBIT CARDS TO PAY FOR GOODS AND SERVICES  STARTUPS CANNOT AFFORD TO GRANT CREDIT DIRECTLY FOR TWO REASONS. 1.GRANTING CREDIT REQUIRES SIGNIFICANT UPFRONT CAPITAL 2.RECEIVABLES MANAGEMENT IS COSTLY AND TIME CONSUMING All Rights Reserved Dr. David P Echevarria2

3. CREDIT CARD SERVICES FOUR PARTIES TO EACH CREDIT TRANSACTION 1.THE MERCHANT (SELLER) 2.THE CUSTOMER (BUYER) 3.THE ISSUING BANK (CARD ISSUER) 4.THE ACQUIRING BANK (TRANSACTION PROCESSOR) All Rights Reserved Dr. David P Echevarria3

4. CREDIT CARD SERVICES THE PROCESS BUYER SWIPES CARD AT THE POINT-OF-SALE READER TRANSACTION INFORMATION TRANSMITTED TO THE ACQUIRING BANK WHICH VERIFIES THE INFORMATION WITH ISSUING BANK AND SENDS BACK THE APPROVAL TO THE MERCHANT ACQUIRING BANK CREDITS MERCHANT ACCOUNT WITH PAYMENT LESS DISCOUNT FEE. ACQUIRING BANK RECEIVES FUNDS FROM ISSUER BANK LESS AN INTERCHANGE FEE. All Rights Reserved Dr. David P Echevarria4

5. CREDIT CARD SERVICES OTHER FEES MAY BE IMPOSED ONLINE AND PHONE TRANSACTIONS INCUR ADDITIONAL FEE TO COVER POSSIBLE CHARGEBACK COSTS CHARGEBACK: A CREDIT TO CUSTOMER’S ACCOUNT THERE IS ALWAYS THE POSSIBILITY THAT CHARGE IS INCORRECT OR FRAUDULENT – REASON FOR CVV CODE All Rights Reserved Dr. David P Echevarria5

6. CREDIT CARD SERVICE PROCESS ALL CREDIT TRANSACTIONS ARE CHANNELED THROUGH A PAYMENT GATEWAY PAYMENT GATEWAY VERIFIES CARDHOLDER INFORMATION AND AUTHORIZES PAYMENTS TO MERCHANT’S ACCOUNT SENDS DATA TO CARD HOLDER’S BANK WHICH THEN ACCEPTS OR REJECTS TRANSACTION IF ACCEPTED, PAYMENT TO MERCHANT FOLLOWS AND TRANSACTION IS COMPLETE. All Rights Reserved Dr. David P Echevarria6

7. SETTING UP CREDIT CARD SERVICES TWO STEPS REQUIRED 1.SETTING UP A GATEWAY ACCOUNT VERIFICATION AND PROCESSING OF CREDIT CARD TRANSACTIONS PROVIDE TRANSACTION SUMMARIES PROVIDE MEANS FOR MERCHANT-CUSTOMER COMMUNICATION 2.SETTING UP A MERCHANT ACCOUNT RECEIVE PAYMENTS – CREDIT TO MERCHANT ACCOUNT All Rights Reserved Dr. David P Echevarria7

8. SETTING UP CREDIT CARD SERVICES GATEWAY REQUIREMENTS 1.COMPLY WITH PAYMENT CARD INDUSTRY DATA SECURITY STANDARD (PCI DSS) 2.INCORPORATE A SECURE SOCKET LAYER (SSL) TO ENCRYPT AND PROTECT TRANSACTION INFORMATION 3.PROVIDE FULL ECOMMERCE CAPABILITIES  SHOPPING CART  EMAIL RECEIPT (TRANSACTION VERIFICATION RECORD)  SUPPORT RECURRING PAYMENTS All Rights Reserved Dr. David P Echevarria8

9. GATEWAY FEE SCHEDULES All Rights Reserved Dr. David P Echevarria9

10. CAVEATS INVESTIGATE BEFORE YOU SIGN A CONTRACT READ ALL THE FINE PRINT DOES THE PROVIDER IMPOSE ANY ADDITIONAL FEES? IS THERE AN AUTO-RENEWAL FEATURE? WHERE IS THEIR CALL CENTER LOCATED? HOW EASY IS IT TO CONTACT THEM TO RESOLVE PROBLEMS? All Rights Reserved Dr. David P Echevarria10

11. RECEIVABLES MANAGEMENT THE CASH CYCLE CASH TO INVENTORY TO SALES TO RECEIVABLES TO CASH RECEIVABLES A FUNCTION OF CREDIT POLICY RECEIVABLES MUST BE FINANCED UP FRONT PROFITABILITY AFFECTED BY COLLECTIONS EXPERIENCE COLLECTIONS EXPERIENCE REFLECTS CREDIT POLICY MORAL OF THE STORY: IN WCM, EVERYTHING AFFECTS EVERYTHING ELSE... All Rights Reserved Dr. David P Echevarria11

12. GRANTING TRADE CREDIT CREDIT RATING AGENCIES BUSINESS CUSTOMERS = DUN $ BRADSTREET CONSUMERS = EXPERIAN, TRANS UNION, EQUIFAX LARGE CORPORATIONS = STANDARD & POOR All Rights Reserved Dr. David P Echevarria12

13. CREDIT INSTRUMENTS OPEN ACCOUNT LIMITS IMPOSE WHEN PAYMENTS DON’T ARRIVE. MOST COMMON FORM OF TRADE CREDIT ACCOUNT. BANKERS’ ACCEPTANCES BANKS GUARANTEE PAYMENT. GOODS ARE COLLATERAL AGAINST GUARANTEE. PROMISSORY NOTES DOCUMENTARY EVIDENCE OF AMOUNT OWED + TERMS All Rights Reserved Dr. David P Echevarria13

14. CREDIT POLICY VARIABLES MAXIMUM CREDIT PERIOD HOW LONG CAN FIRM CARRY RECEIVABLES AND STILL BE PROFITABLE? MINIMUM CREDIT STANDARD IS BEING WARM AND BREATHING ENOUGH? COLLECTION POLICY HOW DO WE DEAL WITH DEADBEATS? All Rights Reserved Dr. David P Echevarria14

15. CREDIT POLICY VARIABLES DISCOUNTS GRANTING DISCOUNTS TO ENCOURAGE EARLY PAYMENT ADVANTAGE - REDUCE CARRY TIME AND RELATED EXPENSE. DISADVANTAGE - REDUCES CASH INFLOW, SOME FIRMS PAY LATE AND STILL TAKE DISCOUNT! All Rights Reserved Dr. David P Echevarria15

16. DETERMINING CREDITWORTHINESS FIVE C’S OF CREDITWORTHINESS CHARACTER - PAST HISTORY CAPACITY - INCOME CAPITAL - WHAT THE OWN LESS WHAT THEY OWE COLLATERAL - REDUCING THE RISK OF LOSS CONDITIONS - EXPECTATIONS RELATIVE TO ECONOMY ASSIGNING RELATIVE WEIGHTS AND SETTING MINIMUMS All Rights Reserved Dr. David P Echevarria16

17. COLLECTION PERFORMANCE HOW WELL ARE WE MANAGING A/R? DAYS SALES OUTSTANDING (DSO); DSO =  DI / N ACP = A/R DIVIDED BY AVG. DAILY CREDIT SALES ACP = [1/ARTO] * 360 All Rights Reserved Dr. David P Echevarria17

18. ALTERNATIVE STRATEGIES WHAT CAN FIRMS DO IF CASH IS SLOW IN BEING RECEIVED? FACTORING - SELLING RECEIVABLES (AT A DISCOUNT) WITH RECOURSE WITHOUT RECOURSE FORFAITING - SELLING RECEIVABLES IN THE INTERNATIONAL MARKET All Rights Reserved Dr. David P Echevarria18

19. COST OF CARRYING RECEIVABLES FUNCTIONAL RELATIONSHIP CCR = DSO * ACSPD * VCR * K F WHERE:DSO = DAYS SALES OUTSTANDING ACSPD = AVERAGE CREDIT SALES PER DAY VCR = VARIABLE COST RATIO K F = COST OF FUNDS UTILIZED All Rights Reserved Dr. David P Echevarria19

20. INCREMENTAL ANALYSIS EVALUATING CHANGES IN CREDIT STANDARDS CCR O = DSO O * ACSPD O * VCR O * K F CCR N = DSO N * ACSPD N * VCR N * K F  CCR = CCR N - CCR O All Rights Reserved Dr. David P Echevarria20

21. INCREMENTAL ANALYSIS IDENTIFYING OPPORTUNITY COSTS WHAT HAPPENS WHEN WE RECEIVE CASH LATER? OC =  DSO *  ACSPD * (1 - VCR) * K F WHERE:  DSO = CHANGE IN DSO  ACSPD = CHANGE IN ACSPD (1 - VCR) = CONTRIBUTION MARGIN K F = OPPORTUNITY COST OF FUNDS All Rights Reserved Dr. David P Echevarria21

22. CREDIT STANDARD CHANGE IMPACT ON RECEIVABLES INVESTMENT (  I) ASSUMPTION : LOOSENING CREDIT STANDARDS WILL RESULT IN MORE SALES BUT SLOWER PAYMENT.  I =  DSO*ACSPD O + VCR*DSO N *  ACSPD ASSUMPTION : TIGHTENING CREDIT STANDARDS WILL RESULT IN LESS SALES BUT QUICKER PAYMENT.  I =  DS O *ACSPD N + VCR*DSO O *  ACSPD All Rights Reserved Dr. David P Echevarria22

23. CREDIT STANDARD CHANGE CHANGES IN PROFITABILITY  OP =  GP -  CCR -  BDE -  CD WHERE:  OP = CHANGES IN OPERATING PROFITS  GP = CHANGES IN GROSS PROFITS  CCR = CHANGES IN COST OF CARRYING A/R  BDE = CHANGES IN BAD DEBT EXPERIENCE  CD = CHANGES IN COST OF DISCOUNTS TAKEN All Rights Reserved Dr. David P Echevarria23

24. CREDIT STANDARD CHANGE ALTERNATIVE METHOD FOR CHANGE IN OP PROFITS  OP =  S*(1-VCR) - (K F *  I) - (B N S N - B O S O ) - (D N S N P N - D O S O P O ) WHERE: DS = CHANGE IN OPERATING PROFITS B O, N = BAD DEBT EXPENSE RATE (OLD, NEW) S O, N = SALES ACTIVITY P O, N = PERCENT OF CUSTOMERS TAKING DISCOUNT D O, N = DISCOUNT PERCENT All Rights Reserved Dr. David P Echevarria24