MEANING OF CREDIT
Credit occurs when a seller grants permission to a buyer to take possession and enjoy a commodity with a promise to pay in the future. It is the process by which goods and services are transferred to the buyer from the seller for his use and enjoyment without value being given immediately. The credit worthiness of the buyer must be taken into consideration before granting credit so that it will not lead to bad debts. This can be obtained through the status enquiry agency. Before granting credit, there must be a contractual agreement between the seller and buyer. The use of credit in transactions has increased tremendously in recent times. Despite shortcomings, credit system of transaction has played prominent roles in facilitating trading activities.
Basis for Credit Sales
- The income of the buyer.
- Sources of payment.
- The integrity of the person.
- Availability of guarantors.
- Present employment.
- Time of payment.
ADVANTAGES OF CREDIT SALE
- Increase in Sales: Credit sales can lead to increase in sales of goods.
- Increase in Profit: It can bring increase in profit as higher prices are charged for credit transaction.
- Reduction in Problem of Stock being Tied Down: Credit sales will reduce the problem of holding stock for too long as the goods can be outdated or become expired.
- Enjoyment of Goods Without Payment: Customers can possess and enjoy goods without giving value immediately.
- Increase in Standard of Living: Credit sales can increase the living standard of people as buyers can buy goods they never thought they could afford to buy, e.g. cars.
- Means of Meeting Temporary Needs for Cash: Credit can serve as a means of meeting temporary needs for cash because the individual can buy on credit and use the cash for other things.
- Encouragement of Bulk Purchase: Credit can also encourage bulk purchase.
Disadvantages of Credit Sale
- Increase in Price: Credit sales lead to increase in the price of goods.
- Customers can Over Buy: The customer can be tempted to buy more than what they can afford.
- Seller Can Repossess: The seller has the right to repossess the product if the last instalment is not paid.
- It Involves a Lot of Record Keeping: Credit involves a lot of record keeping as both cash and sales records must be kept.
- It can Lead to Bad Debt: It can lead to a situation whereby some debts cannot be recovered.
- Capital Can be Tied Down: The working capital can be tied down and eventually eroded.
- Problem of Non Payment: There is always the problem of non payment by buyers.
- Business Can be Liquidated: Too much credit transactions can lead to the liquidation of an organisation, e.g. National Bank of Nigeria before its resuscitation in 2000.
- It can Lead to Court Action: Credit sales can lead to court action if the buyer refuses to pay.
TYPES AND SOURCES OF CREDIT
- Loan and overdraft.
- Hire purchase.
- Deferred payment.
- Credit card.
- Debt factoring.
- Hiring and leasing.
- Club trading.
- Budget account.
- Monthly account.
- Conditional credit sales.
- Trading cheque or voucher.
Mortgage is a system of credit in which building societies or mortgage banks assist people to buy landed property or houses by lending them a proportion of the purchase money. The building or property will be used as collateral security while interest will be paid by the mortgagor, i.e ., the borrower. The lender is known as the mortgagee.
- Loan and Overdraft
Loan is a sum of money borrowed by individuals, firms and governments from financial institutions or individuals for a particular period at an agreed rate of interest. Through this means, a sum of money is lent out to customers for a specific period at an agreed interest rate. On the other hand, an overdraft is a form of credit provided by banks in which a customer is allowed to draw over and above the money in his account. It is a method of credit facility in which a customer is allowed or permitted to draw a cheque greater than the amount of money in his credit. Interest will be paid on the overdraft.
- Hire Purchase
Hire purchase is a system whereby the buyer or hirer has possession and the use of the goods while the owner retains the ownership of goods until the final payment has been made. It is a system of instalmental payment which is used for purchasing durable goods.
After the final payment, ownership will pass to the buyer; if the buyer defaults, the seller can repossess the goods. Hire purchase agreement must be evidenced in writing and signed by the parties involved.
Features of Hire Purchase
- In hire purchase, buyers can take possession of goods but not ownership.
- Hire purchase is good for durable goods.
- It must be evidenced in writing (documented) and signed.
- The cash price and hire purchase price of the goods must be stated.
- The seller has the right to repossess the goods if the buyer fails to pay.
- It attracts higher prices.
- The goods will continue to be under hire and will not belong to the buyer until the final instalment is paid.
- The Act establishing hire purchase stipulates that if the customer had paid more than one-third of the total amount due, the owner could reclaim the article only if he obtains an order of the court.
- The hirer may at any time before making the final payment terminate the agreement by giving notice in writing, provided he has paid half of the stated amount.
- A copy of the agreement is to be made available to the hirer within 14 days of entering into the agreement.
Difference between Hire purchase and Credit sale
Hire purchase is a contract of hire whereby the buyer takes possession of goods with an agreement to pay the price instalmentally. This means that goods are merely on hire and not owned by the buyer until the final instalment is paid whereas credit sales is a contract of sale whereby the buyer takes possession and ownership with an agreement to pay the price of goods later or instalmentally.
Parties to the Contract
There are two parties: The hirer and the owner or dealer.
In certain situations, however, there may be three parties, thus: The dealer, the hirer and the finance company.
Advantages of Hire Purchase to the Seller
- Hire purchase facilitates the promotion of durable goods.
- The profit will increase as a result of increase in price.
- Hire purchase increases the rate of turnover.
- It leads to large scale production as a result of increase in demand.
- The seller can repossess the goods in order to avoid bad debt.
- The seller retains ownership of goods until full payment is made.
Disadvantages of Hire Purchase to the Seller
- A lot of capital can be tied down.
- Customers may fail to pay their debt which may become bad debts.
- Court action for recovery of debts usually brings additional cost.
- Goods repossessed may be difficult to sell.
- It can lead to court action.
- There is the possibility that a buyer may run away with the goods.
Advantages of Hire Purchase to the Buyer
- Buyer enjoys the use of goods even when he has not fully paid for them.
- It affords buyer the opportunity to acquire expensive goods which he could not have been able to buy by cash.
- Hire purchase helps to improve the general living standard of people as buyers are able to have what they need at the right time even when they have not fully paid for them.
- Buyer has an opportunity to return goods to seller before completion of payment especially when buyer is no longer interested.
- Buyer has access to credit which he could otherwise not have obtained from the banks.
Disadvantages of Hire Purchase to the Buyer
- Customers may be tempted to over buy.
- They will pay more than they would pay under cash transaction.
- The customer pay high rate of interest.
- The customer may not be able to insist on high quality goods.
- The buyer may not be able to negotiate for a better contract.
Effects of Hire Purchase on a Buyer
- He is able to beat any future increase in price by buying now in hire purchase.
- Buyer will find it convenient paying by instalments.
- He gets the goods for use, though full payments have not been effected.
- He could lose through repossession in the event of default.
- Buyer pays more for the goods.
- He is encouraged to mortgage his future income/to live beyond his income.
- He enjoys increased standard of living.
- He can return the goods after paying 50% of the price.
- The buyer can be sued in case of defaults.
Effects of Hire Purchase on a Seller
- There will be increase in sales.
- Seller gets more profit selling on credit as hire purchase price is more than the cash price.
- Hire purchase encourages faster sales of durable expensive goods.
- It also increase in bad debts as a result of debtors running away.
- Repossessed goods may be so badly used that it is not possible to dispose of them.
- He will incur additional cost to collect the necessary instalments (keeping records).
- He can only repossess the goods through the courts after 2/3 of the price has been paid.
- In hire purchase, seller can repossess his goods.
- Deferred Payment
Deferred payment is a system whereby ownership and possession are transferred immediately to the buyer from the seller after paying an initial deposit. Payment for the balance will be paid later. The seller cannot repossess the goods if the buyer defaults in payment. He can only reclaim through court action.
Similarities between Hire Purchase and Deferred Payment
- Both system of credit ensure that the buyer takes possession of the goods.
- Both accommodate instalmental payment and credit facilities.
- The hirer or buyer can use and enjoy the goods.
- Durable goods are involved.
- Initial deposit is required in both system.
Differences between Hire Purchase and Deferred Payment
- Goods are on hire.
- Seller retains ownership until final instalment is paid.
- The price charged is higher.
- Hire purchase favours the seller.
- Durable goods are involved.
- On default, seller can repossess the goods.
- Goods are sold.
- Buyer retains ownership after paying initial deposit.
- Price charged is lower.
- Deferred payment favours the buyer.
- Less durable goods are sold.
- Seller cannot repossess the goods.
- Credit Card
Credit card is a card issued by some large stores to approved applicants which enables a holder to obtain goods and services on credit at specified suppliers up to an agreed amount. The holder has a borrowing limit. It is advantageous in the sense that, it economises the use of cash, e.g. Eurocard, Valuecard, Smartcard. This is common in advanced countries, e.g. America, Britain etc.
Factoring is a system whereby trade debts can be sold immediately for cash to factoring firm (bank) for a lower amount than the actual value of the debt. The factoring firm after purchasing the debts will then collect them as its own. The firm will by arrangement purchase the trade debt of its client and collect them on its behalf.
Leasing is a system whereby the owner of a property grants to another the right to exclusive possession for a fixed time in return for periodic payment, e.g. leasing of equipment, houses, etc.
- Club Trading
Club trading is a system of credit whereby some organisations set up clubs to collect regular contribution from members. This contribution can be withdrawn periodically in order to make purchases at the shops.
- Budget Account
Budget account is a system operated by departmental stores whereby a customer agrees to pay a certain sum per month which enables credit up to eight times that amount to be obtained. This is common in advanced countries and among high income earners. The customer will pay service charge on all goods bought. The main problem with this type of credit is that choice of goods will be restricted to a single shop.
- Monthly Account
In this type of credit, large departmental stores open an account for the customer which enables them to buy goods on credit. At the end of the month, the customer is sent a statement showing details of all goods bought. This will ensure monthly payment instead of paying for individual transactions.
Advantages of Monthly Account
- There is no additional charge.
- The goods are bought at cheaper prices.
- It saves the customer the trouble of writing cheques everytime.
- Conditional Credit Sales
Conditional credit sales is an agreement for the sale of goods and not hire in which title to goods does not pass absolutely until all instalments have been paid. The buyer is unable to transfer a good title to an innocent purchaser. The seller has the right to take the title under specified condition. It has to be witnessed by somebody.
Book-me-down is common within the low income earners in underdeveloped countries like Nigeria. The customer will purchase goods on credit and their names are written down. Payments may be made at the end of the month after receiving their remuneration from their places of work.
- Trading Cheque or Voucher
In this system of credit, a voucher is issued by a club which is formed to enable its members buy from specified local shops in the locality. This provides alternative to hire purchase. A percentage charge will be made with the actual amount paid over a certain week at an agreed rate.
Credit instruments are written documents or agreement as evidence of repayment in credit transactions. They are numerous and cover a variety of ways in which credits are extended.
- Bill of exchange.
- Promissory notes.
- Letter of credit.
- Credit cards.
- Trading cheque.
- Hire purchase contract.
- I owe you (IOU).
- Mortgage agreements.
- Lease agreements.
- Bank draft.
Finance house is a major source of financing credit transactions, e.g. hire purchase. They mobilise funds from deposit from the public which attract high rate of interest or by borrowing from banks, e.g. merchant banks, commercial banks and insurance.