There are number of methods that can be adopted to assess the credit-worthiness of a potential credit customer. Describe and comment upon two such methods that Fenton could adopt to help reduce the current level of bad debts. (5 marks)
There are a number of ways in which Fenton Security Plc could ensure that customers are subjected to tighter credit appraisal checks before goods are supplied. The list below is indicative but not exhaustive, and includes significant more detail than would be expected of examination candidates:
Bank and Trade References
It is customary to request a customer to give permission for a banker's reference to be sought, and also to name two to three current suppliers who may be willing to provide trade references. The difficulty associated with both of these types of reference is that they cannot be relied upon as confirmation that a customer is creditworthy. A Bank is unlikely to give a customer a bad reference, and the customer is not going to name trade suppliers with which they have a bad payment record.
Trade Sources of Information
Within, for example, the credit card industry, it is not uncommon for information on an individual's credit rating to be shared. In similar vein, within the industrial sector, companies may share data on key customers in relation to their credit worthiness and debt records. Asking competitors if they are willing to share knowledge about a potential customer can help in establishing credit limits.
Credit Reference Agencies
A number of organisations e.g Dun & Bradstreet and Standard & Poor provide credit scores and ratings for companies. These may take the form of a simple rating from AAA to CCC, or a more detailed report.
If Fenton Security already has extensive sales records, it may be possible to use those records to compile a credit scoring system. Credit scoring system works by specifying the characteristics known to be associated with good/bad debts, and...
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