Free Online Course in International BusinessCredit TakenThe focus of this module has been the concept of extending credit. The next step is to discuss an expanded version of credit extended called “credit taken.” An example of credit taken is as follows: Buyer XZY is given a line of credit of $100,000 and expected to pay in 30 days. On the 25th day, the buyer asks the seller to approve another order for $100,000, meaning that on the 25th of the month, the credit extended is $200,000. The seller agrees because the buyer commits to make payment for the first $100,000 on the 30th of the month. However, the buyer reneges on this promise so that the seller is owed more than the original agreed upon credit line. The chances of nonpayment are always possible, which means the costs associated with nonpayment always take a toll on the profit.Identifying CostsBefore presenting the types of costs associated with nonpayment, you should first consider how sales are tracked from a bookkeeping perspective and then consider how costs impact sales. Some companies do not separate exports sales from domestic sales in their accounting systems. To them, a sale is a sale. However, international sales, as you are learning, sometimes carry costs and risks that domestic sales do not. So what happens if domestic and international sales are combined? Imagine for a moment that Company A sells its products for $100 each. Costs for selling domestically are $92 for each unit. Costs for selling internationally are $94 for each unit (due to a shipping cost differential). It may seem easy enough to track the differences, but a problem could occur when you add the method of payment and potential risk of nonpayment because variable costs (costs that vary from sale to sale) change. Assume, for example, that domestic sales are paid via 25% cash and 75% credit. The chances of losing profits are less than if all sales were credit. If the domestic credit tends to be low risk of nonpayment, costs of nonpayment may not be a large factor. However, international sales would probably be all credit. Add to that an increased risk of nonpayment and the profit associated with international sales could be significantly impacted. Keeping the sales and costs together makes it difficult to identify the true profit of domestic sales versus international sales. Knowing the costs of international sales can impact marketing strategies, pricing strategies, and credit decisions.Bad Debt ValueBad debts are obligations that are not collectible for a variety of reasons such as lack of cash flow from a buyer to remit, misunderstanding of terms and conditions and a resulting inability of a buyer and seller to agree on those differences. Bad debts, under the tax laws of the US, can only be written off as an expense by sellers if they can demonstrate, usually through hiring of a collection agency or lawyer, that every effort has been made to make the collection. In a survey of over 5,000 businesses in manufacturing, distribution and retail, the National Association of Credit Management found that each dollar of accounts past due is worth the following:InterestAssume for a moment that you are a seller and can earn 12% on your money if it were in the bank. This is money that you earned from sales (Sales Cost=Profit). Assume now that you have agreed to wait for your payment (that is, you have extended credit). Had you not extended credit, hypothetically you would have money from the sale, which would be in the bank earning interest. Extending credit means you are losing the opportunity to earn interest and, therefore, this is a cost. Another way to consider interest as a cost is to assume you have a loan from the bank. That loan was used to produce your products. Until that loan is repaid, you are charged interest. If the buyer were to give you cash at purchase, you could apply that money to your loan and thus reduce your interest charges and thus your cost. By extending credit to the buyer, you are agreeing to incur interest costs against the money you borrowed in order to produce the product. Do some math and see how these scenarios might play out (in simple terms). Assume that for each $100 in sales, $95 is cost and $5 is profit. Assume you extend credit and therefore do not receive your monies until some time in the future. If your interest costs are 12% per year (assuming that this money could generate a return of 12% in interest to the seller), your first month’s cost would be $1.00 (12% x $100 = $12.00 divided by 12 months = $1.00). See the table below for additional clarificationImpact of NonpaymentWhat happens if the credit information that is available indicates the buyer is creditworthy but the buyer still defaults? The impact of nonpayment or true cost of credit in international business is almost invariably greater than it appears. There are four types of impacts associated with nonpayment, over and beyond the impact to sales:1. baddebt (loss) 2. lost interest 3. opportunity costs (alternative use of capital) 4. administrative (chasing the reluctant debtor) . Margins, or profits, on export trade are low to begin with and are constantly under attack because often there are more competitors in a global market than in a local market. In many countries, payment delays are expected, so that a credit manager needs to contend with "credit taken" as well as credit extended.
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