UNIT6:UNDERSTANDING LOAN / CREDIT POLICY
Key unit competence: To be able to explain the loan/credit procedures
Introductory activity:
Mr. Nkundurwanda is a business man operating his business in Rwanda in
small scale business. Apart of his main activity Mr. Nkundurwanda has family
responsibilities which require him more finances. The capital amount of his
business amounted to Frw 10,000,000, Due to the progress of his business
he is in need of Frw 10,000,000 more which will help his business to grow
and continue to expand and operate in different countries. In this process
there are many alternatives to deal with this issue and Mr. Nkundurwandaneeds to find the best one which will meet his needs.
Questions;
What is the activity of Mr. Nkundurwanda?
What are the challenges do you think that Mr. Nkundurwanda is facing?
What are the potential alternatives Mr. Nkundurwanda needs to think about
to overcome those challenges?
Among alternatives which one you can you advise Mr. Nkundurwanda to
take?What will be the importance of alternative chosen by Mr. Nkundurwanda?
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Learning Activity 6.1
Answer the following questions
1) What do you understand about this picture?
2) What is the role of the bank in this picture?3) What is the relationship between bank and borrower
6.1.1. Definition of concepts related to the credit
a. Credit
“By credit, we mean the power which one person has to induce another to put
economic goods at his deposal for a time on promise or future payment. Credit
is thus an attribute of power of the borrower.” Prof. Kinley.
“Credit is purchasing power not derived from income but created by financial
institutions either as on offset to idle income held by depositors in the bank oras an addition to the total amount or purchasing power.” Prof. Cole.
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“The term credit is now applied to that belief in a man’s probability and solvency
which will permit of his being entrusted with something of value belonging to
another whether that something consists, of money, goods, services or even
credit itself as and when one may entrust the use of his good name and
reputation.” Prof. Thomas.
On the basis of those definitions it can be said that credit is the exchange
function in which, creditor gives some goods or money to the debtor with a
belief that after sometime he will return it. In other words Trust ‟is the Credit‟.
b. Credit policy
A credit policy includes detailed guidelines for the size of the loan portfolio,
the maturity period of the loan, security against loan, the credit worthiness of
the borrower, the liquidation of loans, the limits of lending authority, the loan
territory, etc.
Credit policy provides some directions for the use of funds, to control the size
of loans and influences the credit decision of the bank. So, the loan policy is a
necessity for a bank.
In formulating the loan policies, the policy formulators must be very cautious
because the lending activity of the bank affects both the bank and the public
at large. All the influencing factors should be considered such as Size of loan
account; Credit for infrastructure; Types of loan portfolio; Acceptable security;
Maturity of the loan; Compensating balance; Lending criteria; Loan territory;
Limitations of lending authority.
c. Credit monitoring
A good lending is that the amount lent, should be repaid along with interest
within the stipulated time. To ensure that safety and repayment of the funds,
banker is necessary to follow-up the credit, supervise and monitor it. Credit
monitoring is an important integral part of a sound credit management. The
bank should always be careful for that fund properly utilized for what it has
been granted. Banker keeps in touch with the borrower during the life of the
loan. There are some steps from the banker’s point of view, to ensure the safety
of advance which are documentation, disbursement of advance, inspection,
submission of various statements, annual review and market information.
d. Credit services
It is the business of providing loans, other forms of credits and information aboutcredits to people and companies.
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e. Credit delivery
In credit delivery, the borrowers are allowed to draw funds from the account
to the extent of the value of inventories and receivables less stipulated margin
within the maximum permissible credit limit granted by the bank.
6.1.2 Types of credit
The credit assistance provided by a banker is mainly of two types, one is fund
based credit support and the other is non-fund based. The difference between
fund based and non-fund based credit assistance provided by a banker lies
mainly in the cash out flow. Banks generally allow fund based facilities to
customers in any of the following manners.
TRADITIONAL CREDIT PRODUCTS
• Cash credit
Cash credit is a credit that given in cash to business firms. It is an arrangement by
which, a bank allows its customers to borrow money up to a certain limit against
tangible securities or share of approved concern. Cash credits are generally
allowed against the hypothecation of goods/ book debts or personal security.
Depending upon the nature of requirements of a borrower, bank specifies a
limit for the customer, up to which the customer is permitted to borrow against
the security of assets after submission of prescribed terms and conditions and
keeping prescribed margin against the security.
• Overdraft:
A customer having current account, is allowed by the banks to draw more
than his deposits in the account is called an overdraft facility. In this system,
customers are permitted to withdraw the amount over and above their balances
up to extent of the limit stipulated when the customer needs it and to repay it
by the means of deposits in account as and when it is convenient. Customer
of good standing is allowed this facility but customer has to pay interest on the
extra withdrawal amount.
• Demand loans
A demand loan has no stated maturity period and may be asked to be paid on
demand. Its silent feature is, the entire amount of the sanctioned loan is paid to
the debtor at one time. Interest is charged on the debit balance.
• Term loans
Term loan is an advance for a fixed period to a person engaged in industry,
business or trade for meeting his requirements like acquisition of fixed assetsetc. The maturity period depends upon the borrower’s future earnings. Next to
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cash credit, term loans are assumed of great importance in an advance portfolio
of the banking system of country.
• Bill purchased
Bankers may sometimes purchase bills instead of discounting them. But this
is generally done in the case of documentary bills and that from approved
customers only. Documentary bills are accompanied by documents of title to
goods such as bills of lading or lorry and railway receipts. In some cases, banker
advances money in the form of overdraft or cash credit against the security of
such bills.
• Bill discounted
Banker lends the funds by receiving a promissory note or bill payable at a future
date and deducting that from the interest on the amount of the instrument. The
main feature of this lending is that the interest is received by the banker in
advance. This form of lending is more or less a clean advance and banks rely
mainly on the creditworthiness of the parties.
INNOVATIVE CREDIT PRODUCTS
Since the liberalization period there have been drastic changes in the way loans
have been granted to individual customers and businessmen. The changing
pattern of banks from universal to branch banking after the liberalization period
also forced banks to adopt easy lending. Technology has supported the
development of financial service industry and reduced the cycle of money to the
shortest possible duration.
• Credit cards
Credit cards are alternative to cash. Banks allow the customers to buy goods
and services on credit. The card comprises different facilities and features
depending on the annual income of the card holder. Plastic money has played
an important role in promoting retail banking.
• Debit cards
Debit card can be used as the credit card for purchasing products and also for
drawing money from the ATMs. As soon as the debit card is swiped, money is
debited from the individual’s account.
• Housing loans
Various types of home loans are offered by the banks these days for purchasing
or renovating house. The amount of loan given to the customer depends on
the lending policies and repayment capacity of the customer. These loans areusually granted for a long period.
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• Auto loans
Auto loans are granted for the purchase of car, scooter and others. It may be
granted for purchasing vehicle.
• Personal loans
This is an excellent service provided by the banks. This loan is granted to the
individuals to satisfy their personal requirements without any substantial security.
Many banks follow simple procedure and grant the loan in a very short period
with minimum documents.
• Educational loans
This loan is granted to the student to pursue higher education. It is available for
the education within the country or outside the country.
• Loans against securities
These loans are provided against fixed deposits, shares in the market, bonds,
mutual funds and life insurance policy.
• Consumption loans for purchase of durables
Banks fulfill the dreams and aspirations by providing consumer durable loans.
These loans can be borrowed for purchasing television, refrigerator, laptop,mobile, etc.
6.1.3. Importance of loan
Credit plays an important role in the gross earnings and net profit of commercial
banks and promotes the economic development of the country. The basic
function of credit provided by banks is to enable an individual and business
enterprise to purchase goods or services ahead of their ability. Today, people
use a bank loan for personal reasons of every kind and business venture too.
The following are other importance of loan;
• Exchange of ownership
Credit system enables a debtor to use something which does not own completely.
• Employment encouragement
With the help of bank credit, people can be encouraged to do some creative
business work which helps increasing the volume of employment.
• Increase consumption
Credit increases the consumption of all types of goods. By that, large scaleproduction may be stimulated which leads to decrease cost of production. In
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turn also it lowers the price of product which in result rising standard of living.
• Saving encouragement
Credit gives encouragement to the saving habit of the people because of the
attraction of interest and dividend.
• Capital formation
Credit helps in capital formation by the way that it makes available huge
funds to unable people to do something. Credit makes possible the balanced
development of different regions.
• Development of entrepreneurs
Credit helps in developing large scale enterprises and corporate business. It
has also helped the different entrepreneurs to fight against difficult periods of
financial crisis. Credit also helps the ordinary consumers to meet requirements
even in the inability of payment.
• Priority sector development
Credit helps in developing many priority sectors including agriculture. This
has greatly helped in rising agriculture productivity and income of the farmers.
Banks in developing countries are providing credit for development of SSI inrural areas and other priority sectors too.
6.1.4. Importance of liquidity management
Liquidity refers to the ability of an organization to pay its suppliers on time,
meet its obligation costs, such as wages and salaries and to pay longer-term
outstanding amounts such as loan repayment. Adequate liquidity is often a key
factor in contributing to the success of failure of a business. For example liquid
assets include cash, short term deposits, trade receivables and inventories.
Those are called Working capital of a business.
Cash is the most liquid of assets and it is part of working capital of the business.
However, the time taken to convert trade receivables into cash and the time
taken to pay creditors affect the liquidity position of the business.
Liquid assets are current asset items that will, or could soon, be converted into
cash, and cash itself. Two common definitions of liquid assets are all current
assets or all current assets with the exception of inventories.
The main source of liquid assets for a trading company is Sales. A company can
obtain cash from sources other than sales, such as the issue of shares for cash,a new loan or the sale of non current assets but company cannot rely on these
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and in general, obtaining the liquid funds depends on making sales and profits.
The management needs to carefully consider the level of investment in working
capital and to consider the impact that this is having on a company’s liquidity
position; an overview of this is given by the cash operating cycle/working capital
cycle.
Cash operating cycle/working capital cycle is the period of time between
the outflow of cash to pay the raw materials and the inflow of cash from
customers. The number of days credit taken by accounts receivable has a direct
effect on the amount of time money is tied up for in working capital. Therefore,
managing the period of credit customers take is vital to the management of the
organization’s liquidity.
6.1.5. Granting loan
Granting credit to customers is essential for many organizations and brings
many benefits to both organizations and the customers. However, the risks
associated with granting credit should be monitored and managed carefully.
a. Applicant profile
To make prudent credit decision, bank essentially should know well the borrower
well. Without these information bank cannot judge the loan application.
Creditworthiness of the applicants is evaluated to ensure that the borrower
conforms to the standards prescribed by the bank. It can be said that a loan
properly made is half-collected. So, a bank should make proper analysis before
making any credit decision. With increasing credit risks, banks have to ensure
that loans are sanctioned to „safe‟ and „profitable‟ projects. For this, they need
to fine tune their appraisal criteria.
b. Application form
It is a document on which the lender bases the decision to lend. A loan
application is neither a pledge by the applicant nor a commitment by the lender.
It contains essential financial and other borrower information. Detailed business
plan, projected income statements showing profit and loss, balance sheet, and
cash flow statement are required for a business loan. Loan amount and purpose,
period and means of repayment, and guaranties and/or collateral offered are
required of a company applying for a loan. Banks generally use standard forms
for the applicant to fill-in. It is also known as credit application.
c. Information required for granting credit
When assessing the credit status of either on established or a new customer
there are a range of sources of information that the credit controller can use.
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Some are external to the business and others are internal to the business.
The credit controller needs to consider the customer’s ability and willingness
to pay within the stated credit terms and also that the customer will remain
solvent. No single source of information can guarantee either of these but there
are varieties of sources which can be pooled for a final decision on credit status
to be made
External sources: Bank Reference, Trade reference, Credit reference agencies,
Office of Register General, Management accounts from the customer, Media
publication, Internet searches.
Internal sources: Staff knowledge communicated by conversations, emails,
meetings, customer visit, financial analysis of either external published financial
statements or internal management and previous trading history.
6.1.6. Evaluating credit worthiness
The purpose of analyzing the financial statements for credit control assessment
is to find the indicators of the customer’s performance and position in four main
areas as follow:
Profitability Indicators; Liquidity indicators; Debt indicators; Cash flow indicators
Profitability Ratios
When credit has been granted one major concern will be the profitability of the
customer. If the customer is not profitable in the long term then it will eventually
go out of the business and this may mean a loss, in the form of an irrecoverable
debt, if it has been granted credit.
Gross profit margin: Gross profit/Revenue*100% It shows how profitable the
trading activities of business are.
Net profit margin: PAT/Revenue*100%. It indicates the overall profitability of
the business
Return on capital employed (ROCE): Net profit/Capital employed*100%
Net asset turnover: Capital employed/Revenue. It measures the number of
times that revenue represents capital employed (or net assets).
Liquidity Ratios
The purpose of calculating liquidity ratio is to provide indicators of the shortterm and
medium-term stability and solvency of the business. It is also to assessif the business can pay its debts when they fall due. There are two overall ratios:
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Current ratio: Current assets /Current Liabilities. Ideal ratio is 2:1
Quick ratio or acid ratio: (Current assets-Inventory)/Current liabilities. Ideal ratio
is 1:1
Gearing Ratios
When assessing a customer’s credit status, the credit controller will also be
concerned with the longer-term stability of the business. One area of anxiety
here is the amount of debt in the business ‘ capital structure and its ability to
service this debt by paying periodic interest charges.
Main measures are:
Gearing ratio= Long term debt/ (Long term debt + Equity)*100%. Is a measure
of the proportion of interest-bearing debt to the total capital of the business.
Interest cover = Profit before interest and tax / Interest. It is calculated as the
number of times that the interest could have been paid, it represents the margin
of safety between the profits earned and the interest that must be paid to service
the debt capital.
Credit scoring
Credit scoring is a method of assessing the credit worthiness of an individual
or organization using statistical analysis and is used by the organizations such
as banks, utility companies, insurance companies and landlords to assess the
ability of an individual or organization to repay any loans or pay for services or
goods.
A credit score is a number ranging from 300-850 that depicts a consumer’s
creditworthiness. The higher the credit score, the more attractive is the borrower.
A credit score is based on credit history such as number of open accounts, total
levels of debt, and repayment history.
Lenders use credit scores to evaluate the probability that an individual will repay
loans in a timely manner.
Your credit score, a statistical analysis of your creditworthiness, directly affects
how much or how little you might pay for any lines of credit you take out.
Illustration
A company has share capital of Frw 200million, resources totaling Frw 188million
and a loan of Frw 100 million . The net profit for the year is Frw 45million, afterdeducting depreciation of Frw 12 million and interest of Frw 6million.
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Solution:
Opening a new customer account
Once a decision has been made to grant credit to a customer then a file and
account in the trade receivable ledger must be set up.
The following information will be required: Business name of the customer; the
contract name and title within the customer’s business; business address and
telephone number; the credit limit agreed upon; the payment terms agreed.
Refusal of credit
The credit controller may decide that it is not possible to trade with a new
potential customer on credit terms.
It is a big decision for the credit controller as the business will not wish to lose
this potential customer’s business but the credit controller will have taken a
view that the risk of non- payment is too high for credit terms to be granted.
It simply means that on the evidence available to the credit controller, the chance
of non-payment is too high for the company to take the risk.
The reasons are the following:
A non-committal or poor bank reference
Poor trade references
Concerns about the validity of any trade references submitted
Adverse press comment about the potential customer
Poor credit agency report
Indications of business weakness from analysis of financial statements
Lack of historical financial statements available
Information from a member of the business’s credit circle
The credit controller will consider all the evidence available about a potential
customer and the reason for the refusal of credit may be due to a single factor
noted above or a combination of factors.
Communication of changes or refusal
If a credit facility is to be changed or not granted to a potential customer thenthis must be communicated in a tactful and diplomatic manner. The reason for
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the change or refusal of credit must be politely explained and any future actions
required from potential customer should also be made quite clear.
Communication method
It is common to communicate the reasons for the refusal of credit in a letter
initially. In the letter the credit controller may suggest that a telephone call may
be appropriate in order to discuss the matter and any future actions.
6.1.7. Terms and conditions associated with Overdraft and
loan
Most of us are familiar with the concept of an overdraft, which is a form of
short-term borrowing from the bank, available to both business and personal
customers. The overdraft allows the account holder to continue withdrawing
money even when the account has no funds in it or has insufficient funds to cover
the amount of withdrawal. If a bank is approached for an overdraft, then it will
normally agree an overdraft facility. This is the amount by which the business’s
account is allowed to be overdrawn. It is then up to the customer to determine
how much of this overdraft facility is to be used by having an actual overdraft.
And loan is credit facility under which a bank allows funds withdrawn to exceed
fund deposited in accordance with specified terms and conditions
Among the terms and conditions associated with overdraft and loan application,
it should be disposed within a reasonable period of time and state specific time
period from the date of acknowledgement, within which the decision on loan
request will be conveyed to the borrower.
In case of rejection, specific reasons should be conveyed in writing. Credit limits
which may be sanctioned may be mutually settled.
Terms and conditions governing credit facilities such as margin security should
be based on due diligence and creditworthiness of borrower.
Lender should ensure timely disbursement of loans sanctioned.
Lender should give notice of any change in the terms and conditions including
interest rates and service charges.
6.1.8. Types of investments, risks and their terms and conditions
There are five major factors to be considered when any investor choosesinvestments
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a. certificate of deposit (CD)
A certificate of deposit is a document issued by a bank or building society
which certifies that a certain sum, has been deposited with it, to be repaid on a
specific date. The term can range from seven days to five years but is usually for
six months. CDs are negotiable instruments which means, they can be bought
and sold. Therefore, if the holder does not want to wait until the maturity date,
the CD can be sold in the money market. CDs offer a good rate of interest, are
highly marketable and can be liquidated at any time at the current market rate.
The market in CDs is large and active; therefore they are an ideal method for
investing large cash surpluses.
b. Government securities
• Bills of exchange
A bill of exchange can be defined as an unconditional order in writing from
one person to another, requiring the person to whom it is addressed to pay a
specified sum of money, either on demand (a sight bill) or at some future date (a
term bill). A cheque is a special example of a type of bill of exchange.
• Trading in bills of exchange
Most bills of exchange are term bills with a duration or maturity of between two
weeks and six months and can be in any currency. If one company draws a bill
on another company, this is known as a trade bill. However, the market in these
is small. Most bills are bank bills, which are bills of exchange drawn and payable
by a bank, the most common of these is known as a banker’s acceptance. There
is an active market in such bills and a company with surplus cash could buy a
bill of exchange at a discount and either hold it to maturity or sell it in the market
before maturity again at a discount. The difference between the price at which
the bill is purchased and the price at which it is sold or it matures is the returnto the investor. Commodities (Gold) are physical products such as gold. They
arQuestions:
What do you observe on the above picture?
Explain the function of each image found in this picture
After watching careful this picture is there any relationship between the
images in the picture?e traded on commodity exchanges where standard contracts are bought and
sold.
c. Shares Equity
An Equity investment is generally the purchase of shares in another company.
Often this takes place through a stock market. Income is from dividend payments
and capital gains on the increase in the share value.
Investments in companies that are traded on a stock exchange are very easily
sold, so these are a relatively liquid form of investment. However, unless
the investment is a speculative one, in anticipation of a rapid increase in the
company’svalue, investments in equity are normally held for longer periods.
Property and land
Investing in property and land is generally a very safe investment. However,
the costs of maintaining and generating an income from property and land are
higher than for other forms of investment.
These are generally long-term investments due to the costs and time associated
with purchasing and selling land and property.
Diversification and types of investment
A business should aim to create a diversified portfolio of investments, with
a spread of risk and return. Marketable securities can be ranked in order of
increasing risk and increasing expected return.
Government securities Low risk
Other ‘public’ corporation stocks
Company loan stocks
Other secured loans
Unsecured loans
Convertible loan stocksPreference shares
Equities High risk
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Government stock
The risk of default is negligible and hence, this tends to form the base level for
returns in the market. The only uncertainty concerns the movement of interest
rates overtime, and hence, longer dated stocks will tend to carry a higher rate
of interest.
Company loan stock
Although there is some risk of default on company loan stock (also called
corporate bonds), the stock is usually secured against corporate assets.
CDs and Bills of Exchange
The riskiness of CDs and bills of exchange varies with the creditworthiness
of the issuers. They are riskier than government securities, but less risky thanshares.
Application activity 6.1.
Questions
8. Give and explain the types of loans
9. What is the purpose of analyzing financial statements in evaluating
the credit worthiness?
10. Discuss the importance of liquidity management
11. List external sources of available external information which help to
understand creditworthiness?12. What do you understand by A certificate of deposit (CD)?
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6.2. Effect of legislation to credit control
Learning Activity 6.2
Questions:
What do you observe on the above picture?
Explain the function of each image found in this picture
After watching careful this picture is there any relationship between theimages in the picture?
6.2.1. Law legislating the credit and remedies for breaches
a. Relevant contract law and remedies for breaches
• What is a contract?
A contract is a legally enforceable agreement between two or more parties.
Main elements of contract: Agreement; Consideration and Intention to create
legal relations• The importance of contract
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The importance of contract law is that if a contract is made between two parties
and if one party does not satisfactory carry out its side of the agreement, the
other party can take the defaulting party to court for breach of contract.
The following are the main legal contract elements
a) Offer: An offer is the beginning of a contract.
b) Acceptance. An offer can be accepted in writing, in person or over
the phone. Volunteer of each group to operate or Free Consent of each
group.
c) Consideration. Consideration is something of value that the parties are
contracting to exchange.
d) Mutuality of obligation; each contracted party has reciprocal duties
and responsibilities, one to another.
e) Competence/Capacity: Competent parties who have the legal capacity
to contract. By this each party legally assign what is able to do to another
and to the business concerned.f) Legality: all job contracts must be legal tender.
An invitation to treat
Care must be taken to distinguish between an offer and the invitation to treat.
An invitation to treat is an invitation by the seller of goods for the buyer to make
an offer to buy them at that price. Examples are advertisements, catalogues, and
the price tickets displayed on goods.
Duration of an offer
If an offer is made then it does not have to remain in place indefinitely. There are
a number of ways in which an offer can be brought to an end:
If there is a set time period for an offer, then the offer will lapse at the of time
period. If there is no express time period set then the offer will lapse after a
reasonable period of time.
An offer can be revoked by the offeror at any point in time before it has been
accepted. Revocation of an offer means that the offer is at cancelled.
An offer comes to an end if it is rejected. An offer can be rejected by a counter
offer. Eg. If an offer is made to sell an item for Frw 1M and the offeree replies
to say that he will buy at Frw 0.9M this is a rejection of the original offer to seller.
The offer comes to an end when a valid acceptance is made.Acceptance of an offer
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The acceptance of an offer must be absolute and unqualified
Acceptance can be made verbally or in writing
If an offer requires a particular form of acceptance (such as verbal, in writing or
by fax) then this is the form in which the acceptance must be made.
It must be unqualified- if any additional conditions or terms are included in an
acceptance then takes the form of counter-offer, which rejects the original offer.
Value
The second required element of a contract is that of there being some value.
The basis of contract law is that we are dealing with a basis of contract law is
that we are dealing with a bargain of some sort, not just a promise by one of the
parties to a contract to do something.
What is required for there to be a valid contract is known in legal terms as
consideration. Consideration can be thought of as something given, promised
or done in exchange for the action of the other party.
In terms of business transactions, the consideration given for a sale of goods is
either the money paid now or the promise by a receivable to pay at a later date.
Both parties must bring something of value to the contract for it to be legally
binding i.e. valid. It can be item or service.
Unilateral Contracts
Most contracts are known bilateral Contracts meaning that two persons or
parties have taken action to form a contract. Unilateral Contracts involve an
action undertaken by one person or a group alone. In contract law, Unilateral
Contracts allow one person to make a promise, so only they are under an
enforcement obligation
A common example is with the insurance contracts, the insurance company
promises it will pay the insured person a specific amount of money if certain
event happens. If the event doesn’t happen, the company won’t have to pay. The
insured party doesn’t make any promise and to his part of the deal, only needs
to pay the insurance premium.
Defective contracts
There are situation in which an apparent contract will only have limited legal
effect or even no legal effect at all.
A void contract is not a contract at all. The parties are not bound by it and if they
transfer property under it, they can sometimes recover their goods even from a
Management Accounting | Experimental Version | Student Book | Senior Sixthird party. This normally comes about due to some form of common mistakes
on a fundamental issue of the contract.
A voidable contract is contract which one party may set aside. Property
transferred before avoidance is usually irrecoverable from a third party. Such
contracts may be with minors, or contracts induced by misrepresentation, duress
or undue influence. In these cases, it can be deemed that a party did not have
legal capacity to consent to a contract. For instance here can be intoxication,
mental health impairment or being too young to enter into contract. A contract
may be voidable due to coercion; this is where one party to the contract may be
using behaviors towards the other party.
An unenforceable contract is a valid contract, property transferred under it cannot
be recovered, even from the other party to the contract. However, it either party
refuses to perform or to complete their part of the performance of the contract,
the party cannot compel them to do so. A contract is usually enforceable when
the required evidence of its terms, for example written evidence of a contract
relating to land, is not available.
Terms in a contract
Legally, different terms of a contract have different effects.
Express terms are terms that are specifically stated in the contract and are
binding on both parties.
Conditions are terms that are fundamental to the contract and if they are broken
then the party breaking them will be in breach of contract and can be sued for
damages. The injured party can regard the contract as is ended.
Warranties are less important terms in a contract. If any of these are not fulfilled
then there is a breach of contract but the contract remains in force. The injured
party can still claim damages from the court for any loss suffered but he cannot
treat the contract as is terminated.
Implied terms are terms of a contract which are not specifically stated but are
implied in such a contract, either by trade custom or by law.
Remedies for breach of contract
A breach of contract arises where one party to the contract out of its side of the
bargain, such as a credit customer who does not pay. The following are some
of the remedies:
Action for the price- a court action to recover the agreed price of the goods/services
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Monetary damages- compensation for loss
Termination-one party refusing to carry on with the contract
Specific performance-a court order that one of the parties must fulfill its
obligations
Quantum merit -payment ordered for the part of the contract performed
Injunction- one party to the contract being ordered by the court not to do
something
In terms of credit customer not having paid for goods or services provided, the
most appropriate remedy would normally be an action for the price.
6.2.2. Terms and conditions associated with granting credit
The credit terms offered to a customer are part of the agreement between the
business and the customer and as such should normally be in writing. The terms
of credit are the precise agreements with the customer as to how and when
payment for the goods should be made. The most basic element of the terms
of credit is the time period in which the customer should pay the invoice for the
goods. There are a variety of ways of expressing these terms as follow:
Net 10/14/30 days- Payment is due 10 or 14 or 30 days after delivery of the
goods.
Weekly credit-all goods must be paid for by a specific date in the following
week.
Half-monthly credit-all the goods delivered in one-half of the month must be
paid for by a specified date in the following half-month.
Monthly credit-all goods delivered in one month must be paid for by a specified
date in the following month.
Settlement and cash discounts
In some cases customers may be offered a settlement discount or cash discount
for payment within a certain period which is shorter than the stated credit period.
The terms of such a settlement discount may be expressed as:
Net 30 days, 2% discount for payment within 14 days. This means that the
basic payment terms are that the invoice should be paid within 30 days of its
date but that if the payment is made within 14 days of the invoice date a 2%
discount can be deducted. It is up to the customer to decide whether or not totake advantage of the settlement discount offered.
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6.2.3. Data Protection law
Data Protection law is becoming increasingly onerous in the modern, digital
world. For instance, in Europe, the new General Data Protection Regulation
legislation(GDPR) places significant responsibilities on companies to safeguard
the data they use, and only to keep personal data that is authorized to be kept
,and is current, complete and accurate.
Due to mounting international regulation, pressure is being exerted on Rwandan
economy to improve regulations, to in turn protect its key export markets.
Recently adopted legal frameworks in Rwanda exclusively focus on security
and confidentiality of electronic communication data, leaving aside all other
categories of personal data. In Rwanda, there is information and communication
Technology law that provides that ‘Every subscriber or user’s voice or data
communications carried by means of an electronic communication network or
service must remain confidential to the subscriber and or user for whom the
voice or data is intended (ICT, 2016:art 124), but development of the law and
regulation is ongoing.
General Data Protection Regulation (GDPR) is the latest European regulation
relating to data protection, which more strictly enforces data subject rights and
significantly increases the potential fines for breaches.
What follows may be considered best practice based on the General Data
Protection Regulation requirements:
What is personal data?
The GDPR applies to the processing data that is:
Wholly or partly by automated means or
The processing other than by the automated means of personal data which
forms part of, or is intended to form part of, a filing system.
What are identifiers and related factors??
An individual is ‘identifiable’ if you can distinguish him from other individuals.
A name is the most common means of identifying someone. However, whether
any potential identifier actually identifies an individual depends on the context.
GDPR provides non-exhaustive list of identifiers, including:
NameIdentification number, location, data and
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An online identifier
An online identifier includes IP address and cookie identifiers which may be
personal data. Other factors can identify an individual.
There will be circumstances where it may be difficult to determine whether data
is personal data. If this is the case as a matter of good practice, you should treat
the information with care, ensure that you have a clear reason for processing the
data and, in particular, ensure you hold and dispose of it securely.
Inaccurate information may still be personal data if it relates to an identifiable
individual
Eight principles of good practice
Information should be:
Fair and lawfully processed
Processed for limited purposes
Adequate, relevant and not excessive
Accurate and up to date
Not kept for longer than necessary
Processed in line with the data subject’s rights
No transferred to countries elsewhere unless such data is adequately protected
in those countries
6.2.4. Legal and administrative procedures for debt collection
Restitutionary and compensatory damages
Restitutionary damages aim to strip from a wrongdoer, any gains made by
committing a wrong or breaching a contract. They are concerned with the
reversal of benefits that we have been earned unjustly by the defendant at the
expense of the claimant.
If the monetary remedy or damages is to be the loss made by the claimant, these
are known compensatory damages and are intended to provide the claimant
with the monetary amount necessary to replace what was lost and nothingmore. Common examples are loss of wages or income.
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Bringing a dispute to court
If it is decided that the only course of action to recover money owed by a credit
customer is that of legal action, then the first step is to instruct a solicitor. The
solicitor will require details of the goods or services provided, the date the liability
arose, the exact name and trading status of the customer, any background
information( Such as disputes in the past) and a copy of any invoices that are
unpaid.
Which court?
Outstanding amounts owed to an entity are civil claims. Uncomplicated claims
with a similar value will be dealt with in the local district court. Larger and more
complex claims will be heard provincial courts.
Methods of receiving payment under a court order
Once there has been a court order that the money due must be paid, there area number of methods of achieving this.
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6.2.5. Bankruptcy and insolvency
Bankruptcy arises when an individual cannot pay his or her debts and is declared
bankrupt. Insolvency is where a company cannot pay its debts as they fall due.
Petition for bankruptcy
A statutory demand can be issued for a payment of the amount due within a
certain period of time. This may result in the customer offering a settlement.
If, however, there is no settlement offer from the customer a petition for a
bankruptcy will be received from the court.
Once the individual has received the statutory demand they have 21 days, either
to pay the debt or reach an agreement to settle the outstanding amount.
There are time limits in making a statutory demand and these are:
The demand should be made within four months of the debts. If the debt is older
than four months a court has to be contracted to explain the reasons behind
the delay.
Normally a statutory demand cannot be made after six years have elapsed.
Consequences of a petition for Bankruptcy
The consequences of a petition for bankruptcy against receivables
If the customer pays money to any other suppliers or disposes of any property
then these transactions are void.
Any other legal proceedings relating to the customer’s property or debts are
suspended.
An interim receiver is appointed to protect the estate.
Consequences of a bankruptcy order
The following are among others:The official receiver takes control of assets
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A statement of the assets and liabilities is drawn up-this is known as statement
of affairs.
The receiver summons a meeting of creditors of the individual within 12 weeks
of the bankruptcy order.
The creditors of the individual appoint a trustee in bankruptcy.
The assets are realized and a distribution is made to the various creditors.
The creditor who presented the petition does not gain any priority for paymentover other creditors.
Order of distribution of assets
The assets of the bankrupt will be distributed in the following order:
Secured creditors
Bankruptcy costs
Preferential creditors such as employees, pension schemes, government taxes
payable
Unsecured creditors, such as trade payables
The bankrupt’s spouse
The bankrupt
Insolvency
The process of insolvency for a company that cannot pay its debts as they
fall due is similar to that of a bankrupt individual; there are 2 main options for
companies
Liquidation
Administration
Liquidation
In liquidation the company is dissolved and the assets are realized, within
debts being paid from the proceeds and any excess being returned to their
shareholders. This process is carried out by a liquidator on behalf of shareholders
and/or creditors. The liquidator’s job is simply to ensure that the creditors are
paid and once this is done the company can be wound up. Again, unsecured
creditors are a long way down the list of who is paid first, therefore there maybe little left in the pot.
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Administrative receivership
An alternative to liquidation is that the shareholders, directors or creditors can
present a petition to the court for an administration order. The effect of this is that
the company continues to operate but an insolvency practitioner (administrator)
is put in control of it, with the purpose of trying to save the company from
insolvency, as going concern - or at least achieve a better result than liquidation.
Administrative receivership is a process whereby a creditor can enforce security
against a company’s assets in an effort to obtain repayment of the secured
debt. It used to be the most popular method of obtaining payment by secured
creditors, but legislative reforms have reduced its significance.
Administrative receivership differs from liquidation in that an administrative
receiver is appointed over all of the assets and undertakings of the company.
This means that an administrative receiver can normally only be appointed by
the holder of a floating charge. Usually an administrative receiver will be an
accountant with considerable experience of insolvency matters.
Retention of title clause
A ‘retention of title’ clause can be written into agreements with customers.
Such a clause expressly states that the buyer doesn’t obtain ownership of the
goods unless and until payment is made. Accordingly, if the buyer goes out of
business before paying for the goods, the supplier can retrieve them. If payment
is not made goods can be stopped in transit and a lien secured on the goods
by the seller.
Official receivers do not need the authority of an insolvency practitioner to
determine if a claim is valid. If an official receiver sells goods that are subject to
a valid retention of title claim then the supplier can sue the official receiver fordamages as ownership of the goods still belong to the supplier
Application activity 6.2
1. Describe the role of a contract in law legislating the credit
2. Discuss on Terms and conditions associated with granting credit3. Enumerate Legal and administrative procedures for debt collection
Skills Lab 6
Student will visit a bank operating nearest the school especially in the
credit department and ask questions related to the credit with the aim of
knowing the procedure or the process of offering the credit and the lowlegislating the credit.
End of unit assessment 6
Question :
Discuss on Importance of liquidity management
What is the purpose of analyzing the financial statements evaluating credit
worthiness?
It is known that the relationship between a seller of goods and a buyer of
goods is a contract what is a contract and what is its importance in Law
legislating the credit and remedies for breaches?Discuss on Bankruptcy and insolvency in