AAT L4 Credit Management 4 — Questions and Answers
Question 1: The 'five Cs of credit' framework for assessing creditworthiness includes character, capacity, capital, conditions, and:
- Collateral (Correct answer)
- Credit history
- Cost
- Cash flow
Correct answer: Collateral
The five Cs of credit are: Character (integrity and willingness to pay), Capacity (ability to repay from cash flows), Capital (financial strength), Conditions (economic/industry environment), and Collateral (security offered).
Question 2: A debenture is a form of security given by a company to a lender that:
- Provides a personal guarantee from the directors
- Creates a fixed or floating charge over the company's assets as security for the debt (Correct answer)
- Is an unsecured acknowledgement of debt only
- Requires HMRC approval before creation
Correct answer: Creates a fixed or floating charge over the company's assets as security for the debt
A debenture is a document evidencing a company's indebtedness to a lender, typically secured by a fixed charge (specific assets) and/or floating charge (all assets) — providing the lender with security if the company defaults.
Question 3: When a customer becomes insolvent and enters administration, the credit manager should:
- Continue supplying goods on normal credit terms
- Stop all further credit supply and register the debt with the administrator as an unsecured creditor as soon as possible (Correct answer)
- Write off the debt immediately without taking any action
- Wait to be contacted by the administrator before taking action
Correct answer: Stop all further credit supply and register the debt with the administrator as an unsecured creditor as soon as possible
On insolvency, the business should: stop further credit supply immediately, enforce any retention of title rights, and submit a proof of debt with supporting documentation to the administrator promptly to maximise recovery prospects.
Question 4: Under the Insolvency Act 1986, which of the following categories of creditor is paid FIRST in a liquidation?
- Unsecured trade creditors
- Ordinary shareholders
- Secured creditors with a fixed charge (Correct answer)
- Preferential creditors such as employees' arrears of wages
Correct answer: Secured creditors with a fixed charge
The order of priority in liquidation: (1) fixed charge holders, (2) liquidator's expenses, (3) preferential creditors (employees' wages, pension contributions), (4) floating charge holders, (5) unsecured creditors, (6) shareholders. Fixed charge holders rank first.
Question 5: Debt factoring provides immediate liquidity because:
- The factor pays 100% of all debts within 24 hours
- The factor advances a percentage (typically 70–90%) of the face value of invoices immediately, before customers have paid (Correct answer)
- Customers pay the factor directly on day one
- The factor provides a guarantee against all bad debts at no cost
Correct answer: The factor advances a percentage (typically 70–90%) of the face value of invoices immediately, before customers have paid
Invoice factoring: the factor advances typically 70–90% of invoice value on the day the invoice is raised. When the customer pays (or after the recourse period), the factor remits the balance less their fees.
Question 6: The purpose of a credit policy document is to:
- Set out the standard terms and conditions offered to all customers without exception
- Provide a consistent framework governing credit limit decisions, payment terms, collection procedures, and escalation processes (Correct answer)
- Authorise individual invoices for despatch
- Replace the need for individual customer credit assessments
Correct answer: Provide a consistent framework governing credit limit decisions, payment terms, collection procedures, and escalation processes
A credit policy sets out the business's approach to credit management — who can authorise credit, at what levels, the criteria for credit assessment, standard payment terms, collection procedures, and escalation steps — ensuring consistent and controlled decision making.
AAT L4 Credit Management 4
The 'five Cs of credit' framework for assessing creditworthiness includes character, capacity, capital, conditions, and: