INFORMATION REQUIRED
The most important function of the credit man is the determining of the credit risk—the amount of credit that can safely be extended to each individual. When he consents to the delivery of goods to be paid for at a future date, he is loaning his firm's money.
Before credit is granted extreme care must be exercised in determining the ability of the purchaser to pay, or that he will be able to pay when the bill is due. After necessary precautions against assuming too great a risk have been taken, a further insurance against loss is included in the amount added to cost—a certain per cent of the profit is expected to offset the risk.
In determining the credit risk, different classes of information are necessary in different lines of business. While certain specific information about individual applicants for credit is necessary, the subject may be divided into two general classes—wholesale and retail. Under the head of wholesale, is included information about all business concerns, whether a single proprietor, a partnership, or a corporation. In a general way also, the same information is required in respect to these concerns by the banker, the manufacturer, the jobber, and the wholesaler. Under the head of retail, is included the transactions of a retailer with his customers, who may be regarded as individuals.
Leading authorities on the subject of credit place the factors which determine the credit risk in two classes—the man and the business. Under the first heading is considered the business morals of the debtor and his ability in, and familiarity with the business in which he is engaged. The second heading—the business—is considered from the financial standpoint, divided as to its assets and liabilities, and the profits or losses made in its operation.
But as to the relative importance of the two principal factors—the man and the business—authorities differ. In his valuable contribution to the literature of credits, Mr. E. St. Elmo Lewis takes the stand that the man—his character—should be considered secondary. To quote from Mr. Lewis' book:
If goods are the basis of all credit, character of the owner is and should be an after consideration. The very first question any credit man should ask, is, can he pay?
The question of a man's ability to pay is becoming of greater ease of solution.
The question of the intention or inclination to pay must always be shrouded in the nebulæ of psychological theory.
What is the applicant worth? is the crucial test. Then we shall test him by another. What sort of a man is he?
Do we buy a law suit when we sell him goods?
How much must we add for moral insurance against loss?
Character is of vital importance in small concerns; of vital importance in concerns doing a large business on small capital, and it becomes of less importance as we progress into the field of corporations.
In direct contrast to this contention are the views of Mr. Ernest Reckitt, as expressed in an address delivered before an organization of bank clerks. After naming the factors to be considered by the banker before extending credit, he said:
You will note that in enumerating these factors I place first, and purposely so, "The Man Himself," and I believe I am correct in stating that bankers are now placing more stress upon this point than ever before. The man of good character and intelligence, who is full of energy and perseverance, will not find it difficult to obtain a reasonable line of credit with his bankers, while the man who is deficient in those qualities, whatever his reputed wealth may be, will be looked upon with suspicion. It therefore behooves you to become students of human character as well as students of banking, if you are to fill the highest positions within your reach.
These comments may be out of the range proposed by this paper, but I feel I cannot leave this topic without giving you an illustration of the point I wish to emphasize, namely: That it is the character of the man, or men, in a business, which must be first considered before the banker makes a loan. Some time ago, in a certain city, there was a large corporation reputed to be very wealthy, whose balance-sheets were beautiful to behold. Their business being large, they were borrowers of some of the largest banking institutions of their city. Apparently without any warning the corporation was declared bankrupt and went into the hands of a receiver. Later, investigation showed that the balance-sheet was misleading; some people might have called it a worse name, for the assets had been overstated and the liabilities understated. I happened to be in that city at the time of this failure, and, meeting a director of one of the banks with whom I was well acquainted, I inquired if his bank had been caught. "No," said he, "they did try and open an account with us some time ago with the object of becoming borrowers, but we turned them down." I asked him what reasons he and his colleagues on the directorate had for such action at a time when this corporation was supposed to be so prosperous. "Well," said my friend, "some time ago it came to my knowledge that this corporation paid no water tax and that its personal property tax was a mere bagatelle to what it should have been, and I figured out that the officers of a corporation that would be guilty of petty bribery would not be good customers for our bank."
So it will be seen that a knowledge of the business morals of the men in your community and a high ideal, on your part, of what constitutes good business morals is a most essential quality in the make-up of a banker, and that it was these factors that enabled the bank of which my friend was a director to escape what otherwise would have been a bad debt.
Financial Statements. Without attempting to decide the relative importance of the two principal factors, it can safely be stated that one of the first steps to be taken by the credit man is to secure a financial statement from the applicant. And the character of the statement may serve as a guide in determining the character of the man with whom he has to deal.
Most business men are willing to comply with any reasonable request relative to their financial standing, when applying for credit. Until recently, the average man had objected to giving out such statements, except to his bankers, but with the more universal demands for such statements has come a change, and now a statement of some sort is almost always obtainable.
The form of statements used by banks differ somewhat from that used by manufacturers and jobbers, and, while it differs slightly as between banks, and also as to whether the borrower is an individual, a partnership, or a corporation, in general the statement required follows the lines of the form shown in Fig. 1. This statement is signed, in the name of the firm by a member, in the case of a partnership; and in the name of the company by one of its officers, in the case of a corporation. A statement in the same form gives all of the information of a financial nature required by the manufacturer or merchant.
Analysis of the Statement. Of equal importance with the statement is the ability to read it—to correctly interpret its real meaning. This calls for a careful analysis of the several items of which it is composed. To make a correct analysis means that the credit man must have a general knowledge of the business in which the one asking for credit is engaged. The banker must know, for example, whether the season is one in which more capital is likely to be needed in the trade of the borrower, or one in which he should be liquidating his indebtedness.
Fig. 1. Customer's Financial Statement
So important is this phase of the question that some of the larger banks have adopted the plan of assigning requests for loans in different businesses to different officers. One man will investigate real estate securities, one, applications from board of trade houses, another handles applications from packing houses, others look after the steel, building, jobbing, and manufacturing enterprises. Each man is a specialist, making a special study of conditions in the business to which he is assigned.
In making an analysis of a statement, each item must be taken up separately and considered with respect to its relationship to other items, and its bearing on the statement as a whole.
Cash on Hand. The cash on hand should be consistent with the needs of the business, and, if listed separately, the cash in office should never be a large sum. There is seldom any good reason why cash should not be deposited daily. The banker will find it necessary to carefully scrutinize the amount in bank, particularly if the borrower claims to deposit in no other bank.
Merchandise. This item is always a somewhat uncertain quantity; often an estimate pure and simple, and the debtor is unlikely to make his estimate too low. In the absence of provable figures, it is necessary for the credit man to apply his knowledge of the business. Is the stock larger than should be required? Is it too low to enable the debtor to keep pace with his competitors? Or, if a manufacturing business, how much is raw material and how much finished goods?
One of the important factors in making an analysis of this item is a knowledge of the accounting methods of the debtor. Does he keep stock records, or if not, is his stock well cared for and stored in a manner to permit of a reasonably accurate estimate? On the latter point, reports of the observation of salesmen, referred to later on, have an important bearing.
Bills Receivable. On the statement form shown, this item is divided as to notes, secured and unsecured, not due and past due. To state that the amount of bills receivable is so much is one thing, to state the amount not due, is quite another. Any considerable amount of unsecured and past due paper indicates lax methods in the debtor's own credit department.
Accounts Receivable. This item is divided as to accounts less than 60 days past due and accounts more than 60 days past due. These items require the same close scrutiny as bills receivable.
The two items—bills and accounts receivable—should bear a reasonably constant ratio to the amount of sales. Any unusual increase in the percentage of book debts to sales calls for careful scrutiny, and leads to one of three conclusions: that trade conditions are bad, that the credit department has been lax, or that the amount is overstated.
The first of these conclusions is supported or rejected by the credit man's knowledge of financial conditions in general, and of conditions in the particular trade of the debtor. During a financial panic, or in a season following crop failures, it is to be expected that book debts will be greater in amount than in ordinary times. In the event of the third conclusion, it is time for a careful investigation. As a rule, the investigation will be productive of best results if an examination of the books by a public accountant is included.
Due from Stockholders. This is an item which must be carefully studied. Who are the stockholders or partners who own the firm, and for what? What is their financial responsibility?
Sometimes, stockholders whose entire fortunes are invested in a corporation are found to be debtors to the same corporation for borrowed money.
Due for Merchandise. This item is divided as to accounts not due and past due. It should be carefully compared with the same item in statements furnished in the past. An increase may or may not be due to natural causes such as the requirements of the trade during a particular season.
Due for Borrowed Money. Any increase in this item should be offset by an increase in assets, or a decrease in other liabilities.
Liability as Surety. This is an item of more importance than is generally accorded to it. True, the liability is a contingent one, but many a man has been forced into bankruptcy by the failure of another, for whom he had become endorser.
Another item which should in the opinion of the writer appear among the liabilities, is discounted paper. When a man discounts the paper of a customer, received in the course of business, he assumes a liability for the amount, if not paid at maturity. True, the liability is contingent, but a liability nevertheless. The extent of the liability depends on the prosperity of his own customers and the care which he has exercised in accepting their paper.
Information for Retailers. The information available for the retailer is of a very different class. Here, the factor, the man himself, plays a more important part. The retailer is obliged to depend more largely on his personal knowledge and the general reputation of his customer.
The city retailer, for instance, needs to know where the man works, his salary, his reputation for paying others—his landlord, grocer, and butcher—and something about his personal habits and general reputation.
How long has he been in his present position?
Does he make frequent changes?
Does he own a home?
What rent does he pay?
Any other wage earner in the family?
These are some of the questions, the answers to which will assist in determining the credit risk.
The country retailer needs other information about his customers. As a rule, he can answer all of the questions asked by the city retailer in respect to his own customers. He is more intimately acquainted with his customers; he has a better opportunity to learn their characteristics and habits, than the city retailer. The country retailer has another advantage, in that a closer bond of friendship exists between him and his neighbor merchants. The interests of city merchants are no less common, but distances separating them make an interchange of views more difficult.
About his country customers—the farmers—the retailer requires still different information. Besides full information about the real estate owned, and mortgages given, he needs to know something about the man himself.
Does he market his crops early, or is he a speculator—always holding for possible higher prices?
Is the farm well kept up?
Are the implements properly housed, or left outside at the mercy of the elements?
Does he keep his live stock in good condition, and how much does he feed for market?
Is he thrifty or shiftless?
Only by personal contact can these things be learned. The country merchant who keeps in closest touch with his farmer customers—sympathizing with them in their misfortunes and rejoicing in their prosperity—is usually the most successful. As one country merchant puts it, he must act as a general advisor, and help them bear their very aches and pains.