cent of the business submitted; while C, the third house, steers a middle course and rejects 20 per cent of the orders. For purposes of comparison, it is also assumed that the percentage of net profit prior to the deduction of bad debt losses is the same in all three instances, namely, 5 per cent. The results of the difference in credit policies are indicated below: These illustrations show that the first house has kept its losses down at the expense of possible profits from an increased volume of sales; that the second house, by pursuing too liberal a credit policy, incurred a loss entirely out of proportion, yet it fared considerably better than the first concern. The third house, however, by steering a middle course, reached the ideal of securing a maximum of business profit with a minimum of loss. In view of the foregoing illustration it is suggested, therefore, that in order to test the efficiency of a credit department where comparisons with departments of competing houses is impractical, figures such as those presented in the preceding illustration be compared for a period of years. Specifically, the test should include the following items: 1. Amount of business received SELECTED REFERENCES Beebe, D. E.: "Retail Credits and Collections," Pt. II, chap. 4. MCADOW, F. H.: "Mercantile Credits," chap. 1. TREGOE, J. H.: "The Credit Man" (lecture prepared for the Institute of Credit of the National Association of Credit Men). WAHLSTADT, P. P.: "Credit and the Credit Man," chap. 11. ! CHAPTER VII THE CREDIT RISK Every credit transaction involves the element of futurity, i.e., a promise to pay in the future in exchange for a present consideration. There is, therefore, more or less risk whenever goods or services are sold on time and it is not an ordinary task to determine in just what degree the risk is present in any given instance. One of the chief functions of the credit manager is to determine whether the application for credit is to be accepted or turned down. To do this, he must search for and obtain sufficient evidence, an examination of which will either prove or disprove the existence of willingness and ability on the part of the credit seeker to make payment at the expiration of the credit period. Without any likelihood of the applicant's being both able and willing to pay the bill at maturity, no credit should be extended, lest the losses incurred from freely accepting doubtful accounts exceed the profits incident to increase sales. BASIC FACTORS DETERMINING THE CREDIT RISK In preferring one applicant for credit over another, a process of elimination must necessarily be carried on. This process is based upon information considered essential for the judgment of the grantor in the selection of his risks. If confidence as to the customer's willingness and ability to pay is thereby established, the risk is accepted; otherwise it is turned down. There are at least two decisions involved in the consideration of applications for credit. First, shall credit be granted? Is the risk good? Second, assuming the first decision to have been made in favor of the credit seeker, to what extent shall credit be extended? What limitation shall be placed upon it? The principal factors to be taken into consideration in deciding whether or not credit should be extended and in what amounts comprise what are commonly referred to by men in the credit profession as the "three C's"-Character, Capacity, and Capital. Character. By "character" the credit grantor understands honesty. It is a barometer of a person's willingness and intention to pay his bills when due and discharge his obligations promptly. The applicant's character may be revealed in his antecedents, in his standing in the community, his habits, and moral principles. Obviously, a person's character is not subject to frequent changes. An investigation should, therefore, never fail to include a customer's general history, reputation, and similar factors bearing upon the moral aspects of the risk. Although character is the least tangible of the factors in the determination of the credit risk, it is nevertheless normally the most important basis and is susceptible to definite ascertainment. It is not extremely difficult, for example, to discover and separate the honest from the dishonest, the sane livers from the extravagant, the abstainers from the drinkers and. gamblers, and the moral from the immoral. Experience has shown that capacity and capital count for little when a clever crook deliberately determines to "beat" his creditors. Where character is doubtful or distinctly inferior, no credit should be extended if the purchase of a lawsuit is to be avoided. According to the testimony of the late J. P. Morgan a few years ago before a committee of Congress investigating the Pujo Money Trust and other economic conditions, character is of prime importance in the selection of credit risks. As much as a million dollars was extended by him to a single person on this basis alone. He also stated that a "man with character, without anything at all behind it, can get all the credit he wants, and a man with the property (but without character) cannot get it." The character element doubtless does frequently constitute the most significant factor in the determination as to whether or not credit should be granted, with the exception of banking credit, which is often based on collateral. It is doubtful, however, whether many credit managers would assign character such an exaggerated and envious position in the course of normal business activity and part with their goods on this basis alone. Character merely determines whether the credit risk is good and honest and probably affects 30 per cent of the credit decision. Capacity. To ascertain the credit seeker's ability to redeem his pledge at maturity, his capacity in all of its phases must be 1 Pujo Money Trust Investigation, vol. 2. thoroughly investigated and appraised. From the standpoint of retail credits, capacity is judged by one's ability to earn enough to pay for his purchases, or the ability to get ahead as determined by earning power, the consistency with which the customer holds his position or the efficiency with which he conducts his business, if in business for himself. From the standpoint of banking, and particularly mercantile credit, capacity connotes efficiency. It is ability of the merchant, native or acquired, to conduct his business at a profit. Other things being equal, the far-sighted, able, and aggressive business man is more likely to succeed than the short-sighted, narrow-minded, and easy-going individual. Capacity may be reflected primarily in the customer's knowledge of his business, technical and otherwise, alertness, shrewdness, and ambition. A person's age is usually a reliable index to his progressiveness and conservatism. Again, the inexperienced man "going into business for himself" is greatly handicapped and the chances of success are much against him, unless sufficient experience in the given line has been previously acquired with similar establishments and a reasonable amount of capital has been accumulated to carry the undertaking through the experimental stage. Finally, buying and selling methods and policies and general business management are important considerations in an attempt to ascertain the presence or lack of capacity or ability to make good. Definite knowledge can be gained concerning these matters from records showing the credit seeker's antecedents, paying habits, and the extent to which modern business methods have been adopted in the management of the business. Under normal business conditions, capacity is next in importance to character, for, other things being equal, the able, experienced, healthy, and aggressive person has a greater chance to succeed than the one who lacks business ability, is inexperienced, sickly, and easy-going. This element should be given a rating of at least 25 per cent of the credit decision. Capital. The third "C"-capital-determines the actual means of payment at the time the transaction is consummated. Without the financial strength as denoted by the term, the granting of credit constitutes a "moral risk," meaning thereby that the grantor relies chiefly or entirely upon the character and capacity of the risk. When coupled with capacity, capital furnishes a satisfactory answer to the query relating to the |