MODULE 4: ACCOUNT PROFITABILITY ANALYSIS

• Purpose and Requirement of a financial statement

• Components of a financial statement namely:
 Balance Sheet
 Statement of Profit & Loss or Statement of Income
 Statement of Cash Flow
 Statement of changes in Owners’ Equity
• Definition of a Financial Ratio
• Four most used Financial Ratio
 Profitability and Performance Ratio
 Liquidity & Financial Security Ratio
 Effectiveness of Working Capital Management or
Activity Ratios
 Capital Structure / Leverage Ratios

This lesson covers the account profitability analysis of a firm or a borrower using a

financial statement. To analyze business profitability, we need to review first what financial

statement is and its components. After presenting examples of each component, you’ll now

be ready to embrace Financial Ratios. We will be focusing on the four (4) most used financial

ratios. Each ratio will be thoroughly discussed using examples that will practice your skills in

analysis and computation. Lastly, attributes of a good financial projection will be presented.

To analyze the profitability of potential borrowers, specifically of a corporate account,

we need to analyze first their financial statement. Account profitability analysis is one of the

jobs of a credit officer to successfully release a credit transaction. A Financial Statement is

one of the basic requirements when applying for a bank loan. So, as a financial management

student, you need to have a skill in financial analysis.

Financial Analysis

Financial Analysis helps identify and quantify the client’s Financial Risks and prompts questions about
possible operating risks.

Financial Statements

Purposes

• Management report of the company’s financial performance

• Measure management’s success or failure in running the business.
• Factors that have affected the company’s business.
• Warning signals of existing and potential difficulties

Requirements

• Historical – at least 4 years

• Latest – obtain the latest AFS together with the Income Tax (ITR) filed with the
Bureau of Internal Revenue (BIR)
• Audited – get FS audited by SEC accredited auditors, check if the opinion is Qualified
or Not Qualified
• Period Covered – 12 months ending December or Fiscal year.

Component of a Financial Statement

A. Balance Sheet
➢ A snapshot, as of a specific date of a company’s financial health
➢ It shows what the company owns, how much it owes, and how much stake
the owners have put in the business.
➢ It gives us some idea of how much the company is worth at a given period.
➢ If compared with previous years’ balance sheets, we can somehow establish
trends and help us forecast.
 2016 2017 2018 2019
BALANCE SHEET
Audited Audited Audited Audited

ASSETS

Current Assets
Cash 23,080.00 15,977.00 28,005.00 31,670.00
Marketable Securities 0.00 0.00 0.00 0.00
Accounts Receivable - Trade 49,132.00 40,890.00 32,571.00 33,169.00
Inventories 158,599.00 181,489.00 199,431.00 224,623.00
Other Current Assets 7,327.00 3,375.00 4,491.00 12,619.00
TOTAL CURRENT
ASSETS 238,138.00 241,731.00 264,498.00 302,081.00

Non- Current Assets

Investments 0.00 0.00 0.00 0.00
Property Plant and Equipment -
Gross 119,515.00 118,191.00 118,269.00 261,452.00
Less: Accumulated Depreciation 0.00 0.00 0.00 0.00
Property Plant and Equipment - 119,515.00 118,191.00 118,269.00 261,452.00
Net
Intangible Assets 1,000.00 1,000.00 1,000.00 1,000.00
Other Assets 423.00 1,677.00 2,661.00 3,176.00
TOTAL NON-CURRENT
ASSETS 120,938.00 120,868.00 121,930.00 265,628.00

TOTAL ASSETS 359,076.00 362,599.00 386,428.00 567,709.00

LIABILITIES

Current Liabilities
Accounts Payable – Trade 297,174.00 298,261.00 318,708.00 450,487.00
Short - Term Debt 0.00 0.00 0.00 45,000.00
Accrued Expense 1,091.00 1,162.00 1,136.00 1,181.00
Other Current Liabilities 402.00 403.00 384.00 525.00
TOTAL CURRENT LIABILITIES 298,667.00 299,826.00 320,228.00 497,193.00

SHAREHOLDERS' EQUITY

Preferred Stock 0.00 0.00 0.00 0.00

Capital Stock 48,000.00 48,000.00 48,000.00 48,000.00
Additional Paid-in Capital 0.00 0.00 0.00 0.00
Less: Treasury Stock 0.00 0.00 0.00 0.00
Retained Earnings/ Deficit 12,409.00 14,774.00 18,200.00 22,516.00
TOTAL SHAREHOLDERS'
EQUITY 60,409.00 62,774.00 66,200.00 70,516.00
TOTAL LIABILITIES &
SHAREHOLDERS' 359,076.00 362,600.00 386,428.00 567,709.00
EQUITY

B. Statement of Profit or Loss or Statement of Income

➢ It tells us the company’s performance and profitability over a
period, usually one (1) year.
➢ It shows all production and operating costs and other deductions,
translating to net profit that may be available for distribution to
shareholders or retained in the business.
➢ If net profits are plowed back into the business, this
contributes to the increase in the size of the company’s
balance sheet.

INCOME STATEMENT 2016 2017 2018 2019

Audited Audited Audited Audited

Revenues 659,106.00 647,467.00 680,266.00 702,522.00

Revenues 0.00 0.00 0.00 0.00
Revenues 0.00 0.00 0.00 0.00
TOTAL REVENUES 659,106.00 647,467.00 680,266.00 702,522.00
Less: Other Items 0.00 0.00 0.00 0.00
NET TOTAL REVENUE 659,106.00 647,467.00 680,266.00 702,522.00

Cost of Goods Sold 586,276.00 613,711.00 647,479.00 662,160.00

Depreciation 0.00 0.00 0.00 0.00
GROSS PROFIT 72,830.00 33,756.00 32,787.00 40,362.00

Operating Expense 85,058.00 49,348.00 47,806.00 53,933.00

Amortization 93.00 93.00 93.00 93.00
Depreciation 2,395.00 605.00 713.00 666.00
OPERATING EXPENSES 87,546.00 50,046.00 48,612.00 54,692.00

OPERATING PROFIT/LOSS -14,716.00 -16,290.00 -15,825.00 -14,330.00

Interest Income 0.00 0.00 0.00 0.00
Other Income / Expense - Rental
Inc 19,452.00 21,080.00 21,423.00 20,681.00
Exceptional Items 3,778.00 3,769.00 3,884.00 4,471.00

EBITDA 11,002.00 9,256.00 10,289.00 11,581.00

EBIT 8,514.00 8,558.00 9,483.00 10,821.00

Interest Expense 3,578.00 3,695.00 3,855.00 3,911.00

EBT 4,936.00 4,863.00 5,628.00 6,910.00

IncomeTaxes 1,579.00 1,556.00 1,801.00 2,211.00

Net Profit / Loss 3,356.00 3,307.00 3,827.00 4,699.00

C. Statement of Cash Flow

➢ The survival and success of any business would largely
depend on its ability overtime to generate cash more than
its outflows.
➢ It shows in detail the cash movements and helps the analyst
form an opinion to the company’s ability to generate cash
that will meet important payment obligations: interest,
dividend, tax liabilities and service principal payments.
➢ Cash Flow Projections are important especially for
financing projects or expansions.
STATEMENT OF CASH FLOW 2017 2018 2019
Audited Audited Audited
EBITDA 9,256.00 10,289.00 11,581.00
Less: Interest Expense 3,695.00 3,855.00 3,911.00
Less:Income Taxes 1,556.00 1,801.00 2,211.00

CASH GENERATED FROM OPERATIONS 4,005.00 4,633.00 5,459.00

Change in Accounts Receivable-Trade 8,241.00 8,320.00 -598.00

- -
Change in Inventories 22,890.00 17,942.00 25,192.00
Change in Other Current Assets 3,951.00 -1,116.00 -8,128.00
Change in Accounts Payable - Trade 1,087.00 20,447.00 131,779.00
Change in Accrued Expenses 71.00 -26.00 45.00
Change in Other Current Liabilities 1.00 -19.00 141.00

CHANGE IN OPERATING ACCOUNTS 9,538.00 9,664.00 98,046.00

CASH GENERATED AFTER WORKING CAPITAL -5,533.00 14,297.00 103,505.00

ACCTS

Change in Capital Expenditure 718.00 -791.00 -

143,849.00
Change in Intangible Asset -93.00 -93.00 -93.00
Change in Other Assets -1,254.00 -984.00 -515.00

CHANGES IN INVESTMENT ACCOUNTS -629.00 -1,868.00 -

144,458.00

CASH PROVIDED BY INVESTING ACTIVITIES -6,162.00 12,429.00 -40,953.00

Change in Short - Term Debt 0.00 0.00 45,000.00

Change in Long Term Debt 0.00 0.00 0.00
Change in Preferred Stock 0.00 0.00 0.00
Change in Capital Stock 0.00 0.00 0.00
Adustments in Retained Earnings -942.00 -401.00 -382.00

CHANGES IN FINANCING ACCOUNTS -942.00 -401.00 44,618.00

CASH PROVIDED BY FINANCING -7,104.00 12,028.00 3,665.00

ACTIVITIES

CHANGE IN MINORITY EXPENSE 0 0 0

 CHANGE IN CASH -7,104.00 12,028.00 3,665.00

Cash beginning balance 23,080 15977 28005

Cash ending balance 15,976.00 28,005.00 31,670.00

D. Statement of Changes in Owner’s Equity

It shows the details of the increases or decreases in stockholders’ equity:

o Dividends distributed
o Increase in stock subscription or subscription paid- up
o Retained earnings
o Adjustments in retained earnings

Financial Ratios

• A tool in further understanding the movement of the absolute figures found in the
financial statements.

• It makes it easier for the analyst to compare the company’s performance over a
certain number of years and establish trends.

• The key to a good ratio analysis is that the difference and trends are
scrutinized and the questions “Why?” and “Why Not?” are asked.
FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited

PROFITABILITY

Asset Turn-Over (x) 1.84 1.79 1.76 1.24

Gross Profit Margin

11.0% 5.2% 4.8% 5.7%
(%)

Operating Profit
-2.2% -2.5% -2.3% -2.0%
Margin (%)

EBITDA/ Net Total

1.7% 1.4% 1.5% 1.6%
Revenues (%)

Return on Sales (%) 0.5% 0.5% 0.6% 0.7%

Return on
Stockholders' Equity
(%) 5.6% 5.3% 5.8% 6.7%

LIQUIDITY

Current Assets / Current 0.80 0.81 0.83 0.61

Liabilities (x)

Quick Ratio (x) 0.24 0.19 0.19 0.13

Cash Ratio (x) 0.08 0.05 0.09 0.06

WORKING CAPITAL

Collection Period 27 25 20 17

Inventory Period (Days)

99 101 107 117

Payment Period (Days)

185 177 174 212

Cash Cycle (Days) (59) (51) (47) (78)

Net Working Capital (in

(60,529) (58,095) (55,730) (195,112)
PHP)

LEVERAGE /
FINANCING
STRUCTURE
Long- TermDebt/ Net
Stockholders' Equity
(x) - - - -
Total Bank Debt/Net
Stockholders' Equity
(x) - - - 0.65
Total Liabilities/Net
Stockholders' Equity
(x) 5.03 4.85 4.91 7.15
Total Assets/ Net
Stockholders' Equity
(x) 5.94 5.78 5.84 8.05
Long-Term Funds/
Non-Current Assets
(x) 0.50 0.52 0.54 0.27

DEBT SERVICE
COVERAGE

Interest Service 3.07 2.50 2.67 2.96

Cover Ratio (x)
Debt Service Cover
3.07 2.50 2.67 2.96
Ratio (x)

Debt Payback Ratio (x)

- - - 3.89

Cash Debt Service

- -0.5 4.71 27.46
Cover Ratio

GROWTH RATES

Revenue Growth (%) - -1.77% 5.07% 3.27%

Net Profit Growth (%) - -1.49% 15.75% 22.77%

Asset Growth (%) - 0.98% 6.57% 46.91%

Borrowed Funds
- - - -
Growth (%)

Stockholders' Equity - 3.91% 5.46% 6.52%

Growth (%)
 Some Key Questions:

o Has the ratio changed significantly?

o Does the change establish a trend?
o Are the ratios size and trend like other players in the industry or market?
o From the knowledge/ understanding we have of the company, should we
expect a change in certain ratios, but did not appear / reflect?

The most commonly used financial ratios can be grouped into four (4) types:

A. Profitability & Performance Ratios

B. Liquidity & Financial Security Ratios
C. Effectiveness of Working Capital Management or Activity Ratios
D. Capital Structure / Leverage Ratios

Let us learn the ratio one by one….

A. Profitability & Performance Ratios

✓ Assessment of the viability of the business; a company is

into business in order to make profits and survive in the
long run
✓ Continuous losses would eventually erode the capital structure
of the company

The analyst should be able to evaluate the declining

returns, establish cause and identify possible solutions.
 Commonly Used Ratios:

o Gross Profit Margin (GPM)

The gross margin tells you about the profitability of your goods
and services. It tells you how much it costs you to produce the
product. It is calculated by dividing your gross profit (GP) by your
net sales (NS) and multiplying the quotient by 100:

Gross Margin = Gross Profit/Net Sales * 100 GM = GP

/ NS * 100

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited

PROFITABILITY
Asset Turn-Over (x) 1.84 1.79 1.76 1.24
Gross Profit Margin (%) 11.0% 5.2% 4.8% 5.7%
Operating Profit Margin (%) -2.2% -2.5% -2.3% -2.0%
EBITDA/ Net Total Revenues (%) 1.7% 1.4% 1.5% 1.6%
Return on Sales (%) 0.5% 0.5% 0.6% 0.7%
Return on Stockholders' Equity (%) 5.6% 5.4% 5.9% 6.9%

Remember: The higher the GM the better. A high gross profit margin means that the company
did well in managing its cost of sales.

Significance of GPM:

Indicates the gross margin per peso of sales. Used in determining the adequacy of gross margin
To cover operating expenses and provide desired profit.
The Gross Profit Margin above is based on the Income Statement presented earlier.
Illustration: 2016 Gross Margin = 11.0%

Using the formula GPM = GP / NS x 100, we get 11.0% =

72,830 / 659,106 x 100
Now apply the formula for the succeeding years…

It is your turn…..

2017 2018

2019

o Operating Profit Margin (OPM)

Operating margin takes into account the costs of producing the product or services that are
unrelated to the direct production of the product or services, such as overhead and
administrative expenses.

Operating Margin = Operating Profit / Net Sales

 2016 2017 2018 2019
FINANCIAL RATIOS
Audited Audited Audited Audited

PROFITABILITY
Asset Turn-Over (x) 1.84 1.79 1.76 1.24
Gross Profit Margin (%) 11.0% 5.2% 4.8% 5.7%
Operating Profit Margin (%) -2.2% -2.5% -2.3% -2.0%
EBITDA/ Net Total Revenues (%) 1.7% 1.4% 1.5% 1.6%
Return on Sales (%) 0.5% 0.5% 0.6% 0.7%
Return on Stockholders' Equity (%) 5.6% 5.4% 5.9% 6.9%

OPM = OP / NS

Remember: A higher OM indicates that the company is earning enough money from business
operations to pay for all the associated costs involve in maintaining that business.

The Operating Profit Margin above is based on the Income Statement presented earlier.

Illustration: 2016 Operating Profit Margin = -2.2% Using the

formula OPM = OP/ NS, we get
-2.2% = -14,716 / 659,106

Now apply the formula for the succeeding years…

It is your turn….

2017 2018

2019
 o Return on Sales (ROS)

Return on Sales measures how much of the sales/ revenues generated translate to actual net
profits. It reflects management’s pricing and competitive strategy and ability to manage costs.

Return on Sales = Net Income / Net Sales ROS =

NI/NS

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited

PROFITABILITY
Asset Turn-Over (x) 1.84 1.79 1.76 1.24
Gross Profit Margin (%) 11.0% 5.2% 4.8% 5.7%
Operating Profit Margin (%) -2.2% -2.5% -2.3% -2.0%
EBITDA/ Net Total Revenues (%) 1.7% 1.4% 1.5% 1.6%
Return on Sales (%) 0.5% 0.5% 0.6% 0.7%
Return on Stockholders' Equity (%) 5.6% 5.4% 5.9% 6.9%

Remember: Most companies are happy to get 5-10% return on sales. The higher the better.

Significance:
Indicates the amount of net income per peso of sales of the profitability based on sales.

The Return on Sales above is based on the Income Statement presented earlier.

Illustration: 2016 Return on Sales = 0.5%

Using the formula ROS = NI/ NS , we get 0.5% =

3,356 / 659,106
Now apply the formula for the succeeding years…

It is your turn…..

2017 2018
 2019

o Return on Equity

Return on Equity assesses the company’s ability to effectively use the capital invested by the
stockholders to generate an acceptable level of returns.

Return on Equity = Net Income / Average Stockholders’

Equity

ROE = NI / ASE

Significance: Indicates profitability in the use of invested capital or the amount of return per peso of owner’s
equity.

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited

PROFITABILITY
Asset Turn-Over (x) 1.84 1.79 1.76 1.24
Gross Profit Margin (%) 11.0% 5.2% 4.8% 5.7%
Operating Profit Margin (%) -2.2% -2.5% -2.3% -2.0%
EBITDA/ Net Total Revenues (%) 1.7% 1.4% 1.5% 1.6%
Return on Sales (%) 0.5% 0.5% 0.6% 0.7%
Return on Stockholders' Equity (%) 5.6% 5.3% 5.8% 6.7%

Remember: ROEs of 15-20% are generally considered good. The higher the better

The Return on Stockholders’ Equity above is based on the Income Statement and
Balance Sheet presented earlier.

Illustration: 2016 Return on Stockholders’ Equity = 5.6% Using the

formula ROS = NI/ ASE, we get 5.6% = 3,356 / 60,409
Now apply the formula for the succeeding years…
It is your turn….

2017 2018

2019

B. Liquidity and Financial Security Ratios

➢ Liquidity refers to the speed with which an asset could be

converted into cash
➢ Measures the company’s ability to meet its short-term
obligations
➢ Examines if the company properly matches its current and
long-term requirements with its liability maturities.
➢ A company may be profitable, but if it is continually short of
cash then it may later find itself having trouble repaying
current obligations.

Commonly used ratios:

o Current Ratio
Current Ratio measures if the company has adequate current assets to cover its current
liabilities. Ideally, current liabilities should not exceed current assets.

Current Ratio = Current Assets / Current Liabilities

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited

LIQUIDITY
Current Assets / Current Liabilities (x) 0.80 0.81 0.83 0.61
Quick Ratio (x) 0.24 0.19 0.19 0.13
Cash Ratio (x) 0.08 0.05 0.09 0.06

Remember: A good current ratio is between 1.2 to 2, which means that the business has 2
times more current assets than liabilities to cover its debt.

Significance: Indicates the ability to pay current obligations.

The Current Ratio above is based on the Balance Sheet presented earlier.

Illustration: 2016 Current Ratio = 0.80

Using the formula CR= CA/ CL , we get

0.80 = 238,138 / 298,667

Now apply the formula for the succeeding years…

It is your turn…

2017
2018

2019
 o Quick Ratio

Inventories are deducted from the Total Current Assets for a more conservative estimation of
the company’s liquidity position. Inventories may take a longer while to convert into cash.
Quick Ratio = Cash + Accounts Receivable / Current Liabilities QR =

C + AR / CL

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited

LIQUIDITY
Current Assets / Current Liabilities (x) 0.80 0.81 0.83 0.61
Quick Ratio (x) 0.24 0.19 0.19 0.13
Cash Ratio (x) 0.08 0.05 0.09 0.06

Remember: A result of 1 is considered to be normal. A company with less than 1 may not be
able to fully pay off its current liabilities in the short term while a company having a quick ratio
of higher than 1 can instantly get rid of its current liabilities.

The Quick Ratio above is based on the Balance Sheet presented earlier. Illustration:
2016 Quick Ratio = 0.24%

Using the formula QR = C + AR / CL, we get

0.24 = 23,080 + 49,132 / 298,667

Now apply the formula for the succeeding years…

It is your turn…
 2018

2017

2019

o
o Cash Ratio

For sensitive cases, it may sometimes be necessary to assess the company’s cash level
relative to current liabilities. A most conservative measure, this ratio is used when there is
doubt that the current and quick ratios can establish the Borrower’s very short- term ability to
pay-off its current liabilities.

Cash Ratio = Cash + Cash Equivalents / Current Liabilities

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited
LIQUIDITY
Current Assets / Current Liabilities (x) 0.80 0.81 0.83 0.61
Quick Ratio (x) 0.24 0.19 0.19 0.13
Cash Ratio (x) 0.08 0.05 0.09 0.06

Remember: There is no ideal figure but a ratio of at least 0.5 to 1 is usually preferred.

The Cash Ratio above is based on the Balance Sheet presented earlier. Illustration:
2016 Cash Ratio = 0.08%
Using the formula CR = C + CE / CL, we get

0.08 = 23,080 / 298,667

Now apply the formula for the succeeding years…

It is your turn..

2017 2018

2019

o Liquidity Financing Structure

Liquidity / Financing Structure assess how the company finances its long term and other non-
current assets. Ideally, financing of non-current assets should be funded by long-term
funding. It could be by way of capital or long-term borrowing.

Liquidity / Financing Structure = Long Term Debt + Stockholders’ Equity

Non- Current Assets

 FINANCIAL RATIOS 2016 2017 2018 2019
Audited Audited Audited Audited

LEVERAGE / FINANCING STRUCTURE

Long- TermDebt/ Net Stockholders' Equity (x) - - - -
Total Bank Debt/Net Stockholders' Equity (x) - - - 0.65
Total Liabilities/Net Stockholders' Equity (x) 5.03 4.85 4.91 7.15
Total Assets/ Net Stockholders' Equity (x) 5.94 5.78 5.84 8.05
Long-Term Funds/ Non-Current Assets (x)
0.50 0.52 0.54 0.27

Remember: A good liquidity ratio is anything greater than 1.

The Liquidity / Financing Ratio above is based on the Balance Sheet presented earlier.

Illustration: 2016 Liquidity Financing Structure = 0.50

Using the formula L/FS =LTD + SE /NCA, we get

0.50 = 0 + 60,409 / 120,938

Now apply the formula for the succeeding years…

It is your turn….

2017 2018

2019
 o Cash Debt Service Cover Ratio

Cash Debt Service Cover ratio measures adequacy of the company’s cash flow to cover
debt service requirements. The higher the cash DSCR, the lower the risk to the lender.

Cash Debt Service Ratio = Cash after working capital + Interest Expense

Interest Expense + Prior Period’s Current Portion of Long-Term Debt

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited
DEBT SERVICE COVERAGE
Interest Service Cover Ratio (x) 3.07 2.50 2.67 2.96
3.07 2.50 2.67 2.96
Debt Service Cover Ratio (x) 3.07 2.50 2.67 2.96
3.07 2.50 3.07 2.67 3.07
2.50 2
Debt Payback Ratio (x) - - - 3.89
- - - - - 3

Remember: A cash debt cover ratio of over 1.5 3.07 2.50 3.07 2.67 3.07
2.50 2
is considered a good ratio. - - - - - 3
3.07 2.50 3.07 2.67 3.07
2.50 2
- - - - - 3
The Cash Debt Service Cover Ratio above is based on the Income Statement and
Statement of Cash Flow presented earlier.

Illustration: 2017 Cash Debt Service Ratio = -0.5

Using the formula CDSCR = CAWC+ IE /IE + PPCP of LTD ,

we get

-0.5= -5,533+ 3,695 / 3,695 + 0

Now apply the formula for the succeeding years…

It is your turn….

2018 2019

C. Working Capital Management or Activity Ratio

Working Capital = Inventories + Trade Receivables – Trade Payables

Working Capital pertains to the amount of money available during the business
cycle allowing the business to operate daily. Note that working capital requirements
could change considering possible factors, for example peak seasons, change in the
levels of underlying assets.
 Commonly Used Ratios

o Collection Period = Average Accounts Receivable / Sales X 365

Days

It is the amount of time it takes for a business to receive payments

owed by its clients in terms of account receivable.

2019
FINANCIAL RATIOS 2016 2017 2018
Audited Audited Audited Audited
WORKING CAPITAL
Collection Period (Days) 27 25 20 17
Inventory Period (Days) 99 101 107 117
Payment Period (Days) 185 177 174 212
Cash Cycle (Days) (59) (51) (47) (78)
Net Working Capital (in PHP) (60,529) (58,095) (55,730) (195,112)

Remember: Collecting the company’s receivable in a short period of time

gives the company time to pay off its obligation.

The Collection Period above is based on the Balance Sheet and Income Statement
presented earlier.

Illustration: 2016 Collection Period = 27 days

Using the formula CP = AR / S X 365 days, we get 27 days =

49,132 / 659,106 X 365
Now apply the formula for the succeeding years…

It is your turn….

2017 2018

2019
 o Inventory Period = Average Inventories / Cost of Goods Sold X
365 Days

It shows how inventory changes over time. It is a measure of a

company’s efficiency converting goods into sales.

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited
WORKING CAPITAL
Collection Period (Days) 27 25 20 17
Inventory Period (Days) 99 101 107 117
Payment Period (Days) 185 177 174 212
Cash Cycle (Days) (59) (51) (47) (78)
Net Working Capital (in PHP) (60,529) (58,095) (55,730) (195,112)

Remember: A shorter inventory period indicates that a business is efficient.

The inventory period above is based on the Balance Sheet and Income Statement
presented earlier.

Illustration: 2016 Inventory Period =99 days

Using the formula IP = I / CGS X 365 days, we get 99 days =

158,599 / 586,276 X 365
Now apply the formula for the succeeding years…

It is your turn…

2017 2018
 2019

o Payment Period = Average Accounts Payable / Cost of

Goods Sold X 365 Days

It is the period from the point of debt is incurred to the due date of the
repayment.

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited
WORKING CAPITAL
Collection Period (Days) 27 25 20 17
Inventory Period (Days) 99 101 107 117
Payment Period (Days) 185 177 174 212
Cash Cycle (Days) (59) (51) (47) (78)
Net Working Capital (in PHP) (60,529) (58,095) (55,730) (195,112)

Remember: A shorter payment period indicates that a business is efficient.

The payment period above is based on the Balance Sheet and Income Statement
presented earlier.

Illustration: 2016 Payment Period =185 days

Using the formula PP = AP / CGS X 365 days, we get 185 Days =

297,174 / 586,276 X 365
Now apply the formula for the succeeding years…

It is your turn…

2017 2018
 2019

o Asset Turnover = Net Sales / Total Asset

The asset turnover ratio measures the efficiency of a company’s assets to generate revenue
or sales. Generally, a higher ratio is favored because there is an implication that the company
is efficient in generating sales or revenue. A lower ratio illustrates that a company is not using
the assets efficiently and has internal problems.

FINANCIAL RATIOS 2016 2017 2018 2019

Audited Audited Audited Audited

PROFITABILITY
Asset Turn-Over (x) 1.84 1.79 1.76 1.24
Gross Profit Margin (%) 11.0% 5.2% 4.8% 5.7%
Operating Profit Margin (%) -2.2% -2.5% -2.3% -2.0%
EBITDA/ Net Total Revenues (%) 1.7% 1.4% 1.5% 1.6%
Return on Sales (%) 0.5% 0.5% 0.6% 0.7%
Return on Stockholders' Equity (%) 5.6% 5.3% 5.8% 6.7%

Remember: A higher ratio is favorable compared to lower ratio.

The asset turnover above is based on the Balance Sheet and Income Statement presented
earlier.

Illustration: 2016 Asset Turnover =1.84

Using the formula AT = NS / TA, we get

1.84 = 659,106 / 359, 076

Now apply the formula for the succeeding years…

It is your turn…
 2017 2018

2019

D. Capital Structure/ Leverage Ratios

Leverage Ratios describes the amount of debt that the firm has used to finance its
investments in assets.

Commonly used Ratios

o Total Debt Ratio = Total Liabilities / Total Assets

It is a financial ratio that indicates the percentage of a company’s assets that are
provided via debt.

Remember: A ratio of 0.4 or 40% or lower is considered a good debt ratio. A ratio
above 0.6 is generally considered to be a poor ratio, since there’s risk that the
business will not generate enough cash flow to service its debt.

o Debt-to-Equity Ratio = Total liabilities / Stockholders’ Equity

It is a financial ratio that calculates the weight of the total debt and financial
liabilities against total shareholder’s equity.
 Remember: The debt-to-equity ratio should not be above a level of 2.0 (except for
companies in fixed asset-heavy industries such as mining or manufacturing)

Technical words used in this lesson include:

A fiscal year is a one-year period that companies and governments use for financial reporting
and budgeting. A fiscal year is most used for accounting purposes to prepare financial
statements. Although a fiscal year can start on January 1st and end on December 31st, not
all fiscal years correspond with the calendar year. For example, universities often begin and
end their fiscal years according to the school year.

https://www.investopedia.com/terms/f/fiscalyear.asp

EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure

of a company's overall financial
performance and is used as an alternative to net income in some circumstances.

EBITDA = Net Profit+Interest+Taxes+D+A where:

D=Depreciation A=Amortization
https://www.investopedia.com/terms/e/ebitda.asp

Earnings before interest and taxes (EBIT) are an indicator of a company's profitability.
EBIT can be calculated as revenue minus expenses excluding tax and interest. EBIT is also
referred to as operating earnings, operating profit, and profit before interest and taxes.
EBIT = Net Profit + Interest + Taxes or

EBIT = Revenue − COGS − Operating Expenses

https://www.investopedia.com/terms/e/ebit.asp

Earnings before tax (EBT) measures a company's financial performance. It is a calculation

of a firm's earnings before taxes are taken out. The calculation is revenue minus expenses,
excluding taxes.

EBT = Net Profit + Taxes or

EBT = Revenue − COGS − Operating Expenses – Interest Expense

https://www.investopedia.com/terms/e/ebt.asp
MODUEL 5: TERMS, CONDITIONS AND LOANS COVENANTS
The main points covered in this module include:

➢ Concept of loan / debt covenants

➢ Purpose and types of loan covenants
➢ Benefits of covenants to lenders and borrowers

➢ Example of financial covenants

➢ Things to do in case of breach of covenants

➢ Actual example of a terms, conditions and covenants governing personal loan

This module focuses on the terms, conditions and loan covenants. The borrower

can’t proceed with the consummation of the loan without confirming that he/ she

understands and agrees with the terms and conditions set by the lender. Loan covenants

also known as debt covenants will be defined and explained in this module. Types and

examples of covenants will also be discussed. Breach of debt covenants cannot be

avoided, that’s why things that should be done by the lender are also discussed in the

latter part. Last part presented an example of an actual terms and conditions governing

loan.

What is a Loan or Debt Covenant?

Any loan agreement negotiated between a lender and a borrower is likely to come with a list of
stipulations known as debt covenants.

These are the requirements and conditions imposed by the lender that the borrower promises to
abide by until the loan is repaid.

A covenant therefore is simply a fancy term for the word ‘promise’. Banks include covenants in
their loan agreements to preserve their position as the lender and to improve the likelihood that a
loan will be paid back by the business owner/borrower on time, in full, and in accordance with the
loan’s terms and conditions.

A covenant is a commitment, promise, agreement, or contract between two parties. As part of the
covenant, the two parties agree that certain activities will or will not be carried out.

Covenants in finance most often relate to terms in financial contract, such as a loan document or
bond issue stating the limits at which the borrower can further lend.

In business, covenants are most often represented in terms of financial ratios that must be
maintained such as maximum debt-to-asset ratio or other such ratios.

Covenants are legally binding clauses, and if breach trigger compensatory or other legal action.
Debt covenants are restrictions that lenders (creditors, debt holders, investors) put on lending agreements to
limit the actions of the borrower (debtor). In other words, Debt covenants are agreements between company
and its lenders that the company will operate within certain rules set by the lenders.

Loan covenant is a condition in a commercial loan or bond issue that requires the borrower to fulfill certain
conditions, or which forbids the borrower from undertaking certain actions or which possibly restricts certain
activities to circumstances when other conditions are met.

Types of Loan Covenants

There are generally 2 types of loan covenants:

1. Positive/affirmative Debt Covenant

2. Negative Debt Covenant

Terms stated in loan agreements that deal with a company’s financial performance, whether
negative or positive, usually are referred to as financial covenants.

Positive debt covenants state what the borrower must do to remain in good standing with the lender or
is a clause in a loan contract that requires a borrower to perform specific actions.

Example, (1) a lender might require the borrower to always maintain a certain minimum level of
working capital or keep financial ratios within specified ranges, or (2) include requirements to
maintain adequate levels of insurance, requirements to furnish audited financial statements to
the lender, compliance with applicable laws, and maintenance of proper accounting books and
credit rating, if applicable.

Negative debt covenants are put in place to make borrowers refrain from certain actions that could
result in the deterioration of their credit standing and ability to repay existing debt. Detail borrower actions
that the lender prohibits or forbid that something might happen in the future. The agreement, for instance,
might prohibit the borrower from using company funds to acquire another company.

Example include restricting a company from issuing dividends to its shareholders, restricting
management fees from being paid to related parties or restricting the amount of debt a business
can carry.

What Is the Purpose of a Debt Covenant?

Debt covenants protect the lender by prohibiting certain actions by the borrowers. They identify the “red
flags” that will be used to indicate problems in a business that might impair its ability to repay a loan.

That said, covenants aren’t meant to place unnecessary burdens on the borrower or hinder the
operations of the business.

How Debt Covenants Benefit the Borrower

Borrowers mainly benefit from debt covenants by receiving lower borrowing costs. When borrowers agree
to certain restrictions on a loan, lenders are willing to lower interest costs and fees because their risks are
reduced. They are used to align the interests of the principal and agent, as well as solve agency problems
between the management (borrower) and debt holders (lenders).

Negotiating a loan agreement with a lender can be a learning experience for borrowers who don’t have
financial backgrounds. The positive and negative loan covenants imposed by lenders tell borrowers which
financial indicators they should be looking at in the operations of their businesses, which can make them
more successful in the long run.

How Debt Covenants Benefit the Lender

Debt covenants protect lenders by restricting specific actions by borrowers that could have
adverse effects on their ability to repay the loan.

This reduces the overall risk for creditors by giving them recourse in case there is a breach of
debt covenants.

Debt Covenant Examples

Debt covenants come in many forms depending on the lender, the state of your business and the
details of the loan.

Some of the most common are based on a borrower keeping its financial ratios and spending
within ranges that the lender is comfortable with.

Here are examples of typical financial covenants lenders use in loan agreements:

Debt payments to Earnings Before Interest, Taxes, Depreciation and

Amortization (EBITDA)
This ratio is key for lenders. It is calculated by dividing EBITDA by annual principal
plus interest payments of the loan. A ratio of 3:1 typically is a good ratio to have.

Anything less, and a borrower could begin to have problems meeting their debt
obligations.

Interest Coverage Ratio

This is calculated by dividing EBITDA by the interest payments on loans. It should be in

the range of 3 or more for adequate coverage. It doesn’t include any allowance for
principal payments.

Debt-to-Equity Ratio
This is the ratio of total debt to a company’s equity capital base. Lenders are generally
comfortable with P1 in debt for each P1 in equity. In some industries, higher debt ratios
are acceptable.

Debt-to-Total Assets Ratio

This ratio tells how much of a company’s assets are financed by creditors. In this ratio,
debt includes long- and short-term business loans plus all current liabilities.

Tangible Net Worth

Tangible net worth is the net worth of a company excluding intangible assets such as
intellectual property, patents and copyrights. It represents the physical assets of a
company.
 Dividend Payout Ratio

The number of dividends paid to shareholders in relation to the amount of net income a
company brings in. This ensures the company doesn’t give too much to shareholders,
which can inhibit its ability to repay loans.

Current Ratio
All businesses need an adequate amount of liquidity to pay vendors, purchase supplies
and meet payroll. A ratio of P2 in current assets for each P1 in current liabilities is good.

Examples of Positive Debt Covenants

Not all debt covenants are related to a borrower’s specific financial numbers. Here are some

examples of positive debt covenants:

 Present financial statements annually within a specified time frame

Lenders require financial statements to make sure the company is in compliance with all
financial loan covenants

 Maintain life insurance policies on key employees

The loss of certain employees, such as a sales manager or production supervisor could
cause a serious setback for the company

 Keep all facilities in good working condition

Companies that don’t take pride in their property and equipment are typically inattentive
to other aspects of their business

 Pay all property and income taxes on time

Tax liens can take precedence over repaying loans

 Maintain property insurance and a reasonable amount of liability

insurance

A disastrous uninsured loss from a fire or flood could ruin the business and wipe out any
chance to repay creditors.
 Examples of Negative Debt Covenants

Here are examples of negative debt covenants, or restrictions on what a borrower can do:

• Incur additional debt

• Lenders don’t want to have to compete with other creditors to be repaid
• Make a change in ownership
• Owners of small businesses are the founders and creators of the company and
the loss of any of them could be devastating to the survival of the business. Any
changes in ownership would need the lender’s approval
• Enter into certain types of lease agreements
• Lease agreements require payments and additional payments would put more
burden on the company’s cash flow.
• Sell key assets
• If a business gets tight on cash, the lenders don’t want the company to start
selling assets to meet loan payments
• Make loans to insiders or affiliates
• Lenders see insider loans as an underhanded way to take cash out of the
business.
• Mergers and acquisitions
• Lenders don’t want owners making major, potentially disruptive changes to the
core business

A Breach of Debt Covenants: What Happens Next?

A debt covenant violation creates a legal breach of contract between the borrower and lender.

The consequences of violating the debt covenant can be severe. Here are some actions that
lenders might take on your loan:

• Request an increase in the amount of collateral

• Raise the interest rate
• Impose immediate penalty payments
• Terminate the loan agreement
• Accelerate the loan and demand immediate repayment
• If a borrower is having difficulty meeting loan payments and is becoming noncompliant
with debt covenants, the best course of action is to meet with the lender and ask for
waivers. Lenders aren’t anxious to call their loans for immediate payment and would
more than likely be willing to work out the situation.
 • Lenders want borrowers to be successful because that improves their chances of
getting the loan repaid and working with them again.
•
• Below is an example of Terms and Conditions governing personal loan. The lender or
the bank cannot proceed with the release of the loan without a confirmation from the
borrower that he/ she fully understand and agrees the terms, conditions and loan
covenants stipulated in the promissory note. Confirmation is being done by affixing the
borrower’s signature in the credit instrument such as promissory note and disclosure
statement.
• Sample Terms and Conditions of a Loan
• https://www.eastwestbanker.com/info/pl_tac.asp

TERMS AND CONDITIONS GOVERNING EASTWEST PERSONAL LOAN

• IMPORTANT: Please carefully read these Terms and Conditions Governing
EastWest Personal Loan that constitute the Agreement between East West
Banking Corporation ("Bank") and the Borrower. By signing the Promissory Note,
the Borrower acknowledges receipt of a copy of the instrument including the
Disclosure Statement on loan transaction and loan amortization schedule prior to
the consummation of the credit transaction. The Borrower further confirms that
he/she has read, fully understands and fully agrees with the Terms and
Conditions of the Promissory Note and acknowledges that he did not sign the
instrument with any blank space thereon.
•
1. The Obligation. The Obligation refers to the obligations arising from the loan
extended by the Bank to the Borrower under this Promissory Note (“PN”),
including increases, renewals, extensions, restructurings, amendments, or novations
thereof. The Obligation shall include the principal, interest, penalties, fees, and other
charges that appear in the accounts, books, and records of the Bank, whether direct or
indirect, principal or accessory, contingent or otherwise, which are presently or hereafter
owing to the Bank, and all expenses which the Bank may advance or incur in enforcing
any of its rights, powers, and remedies under this PN.

2. Applicability of the Terms and Conditions of the Promissory Note. Whenever

this PN refers to the Borrower, the same shall also refer to the Co-Borrower. Therefore, all
obligations of the Borrower under this PN shall also be deemed the obligations of the Co-
Borrower.

3. Representations and Warranties of the Borrower. The Borrower represents and

warrants that:
This PN has been authorized by all necessary acts and deeds, and when executed and
delivered as contemplated herein, will be valid and binding in accordance with its terms
and conditions; and
There is no pending, impending, or threatened action or proceeding before any court or
government agency which may materially and adversely affect the financial condition or
capacity of the Borrower to promptly and fully pay the Obligation and such capacity shall
remain unimpaired.
4. Borrower Covenants and Undertakings. The Borrower covenants and
undertakes that:
Use of Loan Proceeds. The proceeds of his/her Personal Loan will not be used for any
purpose or in any endeavor which is against Philippine laws, rules or regulations.
Furthermore, the proceeds of his/her Personal Loan will be used for the purpose stated
on his/her application.
Other Deeds. The Borrower shall execute and deliver such further instruments and
perform such other acts as the Bank may deem necessary or proper to more effectively
carry out the intention of this PN; and
Fees. The Borrower shall pay any and all taxes, fees, and expenses in connection with
the execution of this PN, including any extension, renewal, amendment, or cancellation of
this PN. Fees and charges which are deducted from the loan proceeds shall be non-
refundable in any case.
Performance of Agreement. The Borrower shall pay the Obligation and perform all
covenants and agreements set forth in this PN.

5. Due Date. If the due date of this PN or of any installment payable hereunder falls
on a holiday or a non-working day, the Due Date shall be understood to be the
immediately following business day.

6. Adjustment. If there is any extraordinary increase or decrease in the effective

purchasing power of the Philippine currency, the Bank shall have the right to make
corresponding adjustments in the interest rate under this PN which, except
for manifest error in the computation thereof, shall be conclusive upon the Borrower. A
change of at least fifteen percent (15%) in the Consumer Price Index
for Manila from the date of this PN as set forth in the figures released by the Bangko
Sentral ng Pilipinas (“BSP”), or other agencies of the Philippine Government should the
figures of the BSP be unavailable, shall be regarded as an extraordinary increase or
decrease in the effective purchasing power of the Philippine currency. If the Borrower
disagrees with the adjustment, the Borrower shall, subject to Section 8 hereof, have the
right to prepay this PN within thirty
(30) days from receipt of the notice of adjustment from the Bank. If the Borrower does not
prepay this PN within the said 30-day period, the Borrower shall be deemed to have
agreed to the adjustment.

7. Additional Taxes and Statutory Fees. Any additional taxes, fees, and charges
that may be imposed on the Obligation under this PN, pursuant to law, executive
issuances, or other rules and regulations enacted and issued by the Philippine
Government, its agencies and other instrumentalities during the effectivity of this PN, shall
be automatically included herein and the Borrower shall be liable for these additional
charges without necessity of executing any notice, new agreement or other document.
The Bank shall have the right but has no obligation to apply any installment payment for
the payment of these additional taxes, fees, or charges.

8. Continuing Liability. The Borrower shall continue to be liable with respect to

his/her obligations to the Bank during any extension or renewal, in whole or in part, of this
PN and/or following a partial payment of this PN, and/or following any change in the
interest rate or other terms and conditions of this PN as a result of such extension,
renewal and/or partial payment, without the necessity of executing a new promissory
note.
9. Loan Processing Fee. The Borrower shall pay a one-time fee imposed to answer
for the cost of processing the loan application. The loan processing fee shall be One
Thousand Nine Hundred Pesos (Php1,900.00) and shall be deducted from the loan
proceeds.

10. Prepayment. In the case of prepayment of this PN, the outstanding net obligation
shall be computed based on the principle of diminishing balance. If the Loan is prepaid
before maturity, the Borrower is entitled to an interest rebate (where the computation is
also based on the principle of diminishing balance). The Borrower, however, will be
charged a processing fee equivalent to Five Hundred Pesos (PhP500.00) or eight percent
(8%) of the principal balance of the Obligation, whichever is higher. Furthermore,
whenever applicable, the Borrower shall be charged the cost of any item given to him as
an incentive for the availment of a Personal Loan in accordance with the terms and
conditions governing the grant of such incentive. Prepayment of this PN shall be
processed and posted only after the Borrower have paid the prepayment processing fee,
the outstanding net obligation and the cost of any item given to the Borrower as incentive
for the availment of a Personal Loan, if applicable, through any of the Bank’s branches.
Proof of payment of said items must be submitted to the Bank at least ten (10) banking
days before the due date of his/her next amortization. Failure of the Borrower to submit
the proof of payment of said items within the prescribed time shall entitle the Bank to
deposit the post-dated check issued by the Borrower for the next amortization and the
Borrower shall hold the Bank free and harmless for any fees, charges, and losses that the
Borrower may incur in case such post-dated check is deposited by the Bank. The
Borrower hereby authorizes the Bank to destroy any and all post-dated checks issued by
the Borrower to the Bank in connection with the Obligation and/or this PN thirty (30) days
after receipt by the Bank of the proof of payment of the prepayment processing fee, the
outstanding net obligation and the cost of any item given to the Borrower as incentive for
the availment of a Personal Loan. The Borrower hereby agrees to hold the Bank free and
harmless from any liability in connection with such destruction of the subject post-dated
checks.

11. Check Retrieval and Replacement. Retrieval and replacement of post-dated

checks initially issued by the Borrower to the Bank upon claiming by the Borrower of
his/her loan proceeds shall be charged a fee of Two Hundred Pesos (PhP200.00).
Check retrieval and replacement shall be processed only after the Borrower shall have
paid the check retrieval and replacement fee through any of the Bank’s branches and
submitted the complete replacement checks and proof of payment of the check
replacement fee to the Bank at least ten (10) banking days before the due date of the
Borrower’s next amortization. Should the Borrower fail to submit the complete
replacement checks and proof of payment for the check retrieval and replacement fee
within the prescribed time, the Borrower must settle his/her next amortization by funding
the checking account from which he issued his/her original post-dated checks or through
an over-the-counter payment at any of the Bank’s branches. The Borrower shall not hold
the Bank liable for any fees, charges, and losses that the Borrower may incur in case any
post-dated check intended to be replaced by the Borrower is deposited by the Bank due
to the Borrower’s failure to submit the said requirements for check replacement within the
prescribed time.
12. Check Disposition. Checks issued by the Borrower which the Bank will no longer
negotiate due to replacement, payment over the counter or for any other reason shall be
destroyed within a period of thirty (30) days from the date of check replacement or
Borrower’s notification of pre-payment, full payment, or payment over-the-counter duly
supported by the proof of payment without notice to the Borrower. The Borrower holds the
Bank free and harmless from any liability in connection with the destruction of the checks.

13. Payments. Check payments received after clearing up the cut-off time shall be
valued the next banking day. Payments made by check or other negotiable instruments
shall produce the effect of payment only when the same shall have been cleared.
Acceptance by the Bank of payments made after the Borrower has delayed or defaulted
in the performance of his/her obligations shall not prejudice the Bank’s rights to claim full
payment and exercise its rights and remedies under this PN or prejudice pending legal
actions filed by the Bank. Acceptance of late or partial payments shall not be construed as
a waiver or estoppel on the part of the Bank.
Payment/s made by third person/s shall not constitute a novation of the original loan
agreement.

14. Default. Each of the following events, irrespective of the reasons for its occurrence
or whether it is voluntary or involuntary, constitutes an event of default:
Failure to pay on a due date any installment, interest, penalty, or amount payable under
this PN, whether at maturity, by acceleration or otherwise;
Failure to perform any of the terms and conditions of this PN or of any agreement
evidencing indebtedness; Death of the Borrower; Severance or termination of
employment of the Borrower; The insolvency of the Borrower, the making by the Borrower
of a general assignment for the benefit of other creditors, the commencement by or
against the Borrower or any proceeding for insolvency, suspension of payments,
appointment of receiver, foreclosure, or the issuance of a writ or order of attachment,
garnishment, execution or similar act against the property, assets or income of the
Borrower; Any information, representation, or warranty made by the Borrower in
connection with the Obligation shall become or shall prove to have been false when so
made, given or furnished, including the use of the loan or a purpose other than that stated
in this PN; or
The Bank's good faith belief at any time that the prospect of payment of the Obligation or
the performance of this PN is impaired as shown by a default with respect to other
obligations of the Borrower to the Bank under any other credit accommodation, the sale or
disposition of any substantial portion of the assets or property of the Borrower, a default in
any obligations of the Borrower to a third party, or such other circumstances and
conditions which materially and adversely affect the financial standing of the Borrower or
the ability of the Borrower to perform his/her obligations under this PN.

15. Remedies. Upon the occurrence of any event of default, the Bank shall have all
the rights and remedies available under the law, including but not limited to:
Acceleration. The Bank may, without notice or demand to the Borrower, accelerate the
payment or performance of any or all of the obligations of the Borrower hereunder.
Right to Set-off. All deposits, placements, or other properties belonging to the Borrower
that are in the possession, custody, or control of the Bank may be applied by the Bank to
the payment of the Obligation without need of further notice to the Borrower. The Bank is
hereby irrevocably constituted and appointed the attorney-in-fact of the Borrower, with full
power and authority and without prior notice, to debit from and set-off or apply to the
payment of the Obligations any funds which the Borrower may have deposited with the
Bank, or which the Bank may have in its possession or control, including all or any
 interests or other income which may accrue thereon, including but not limited to time
deposit accounts and/or long-term investments, which the Bank is hereby authorized to
pre-terminate accordingly, to convert the funds into Philippine peso if denominated
in foreign currency at the prevailing exchange rate at the time of set- off or pre-
termination, it being understood that all taxes, expenses, and charges arising from the
pre-termination or the account or investment shall be shouldered by the Borrower.
Cumulative Rights. The Bank’s rights hereunder are cumulative and not alternative.
16. Late Payment Fee (LPF). In the event any installment to or advance made by the Bank is
not paid when due or when this PN is deemed in default, the Borrower is liable to pay the
Bank an LPF equivalent to Five Hundred Pesos (PhP500.00) per month or eight percent
(8%) per month of the past due amount, whichever is higher, with a fraction of a month to
be considered as one (1) whole month, until such time the unpaid installment, the
advances made by the Bank, or the whole sum remaining unpaid, as applicable, is paid in
full.

17. Collection and Litigation Fees and Expenses. If the Bank is compelled to engage the
services of a collection agent or attorney to enforce any of its rights under this PN, the
Borrower shall pay the Bank the reasonable costs and expenses of engaging such
collection agent and/or lawyer and such other expenses reasonably incurred by the Bank
in recovering such payment and enforcing its rights under this PN.

18. Application of Payment. The Borrower waives his/her right to make application of
payment under Article 1252 of the Civil Code and the Bank shall have the right to apply
payments made by the Borrower to any of his/her obligations to the Bank, regardless of
the source and nature of the said obligation. Payments for the Obligation shall be applied
in the following order: (1) first to the expenses or payments advanced or incurred by the
Bank, (2) to the fees and charges imposed on the Obligation; (3) to penalties incurred; (4)
to the interest then accrued and unpaid, and; (5) the remainder, to the principal balance.

19. Change of Borrower’s Information. The Borrower shall immediately notify the Bank in
writing of any change in his/her Personal Data (including civil status, residence, office
and/or residence address and/or telephone number/s, and all related information) and
change of his/her financial status which may prejudice or adversely affect his/her being a
Borrower.

20. No Implied Waiver. The exercise of the rights, privileges, and remedies in this PN shall
be at the discretion and option of the Bank. Acceptance by the Bank of payment of any
installment or any part thereof after any due date shall not be considered as extending the
time for the payment of any of the installments or as a modification of the conditions
hereof. No failure, omission, or delay on the part of the Bank in exercising any of the said
rights, privileges, and remedies shall operate as a waiver thereof. No modification or
waiver of any provision or consent by the Bank shall be effective unless the same shall
be in writing.

21. Assignment. The Bank may assign, cede, sell, or otherwise transfer part or all its rights
and/or obligations under this PN. The Borrower will be notified in the manner provided
under Section 23 hereof in event of any completed assignment, sale or transfer of part or
all of the rights and/or obligations under this PN.

22. Venue of Actions. All actions for the enforcement of the rights and obligations under this
PN shall be filed in the proper courts of Metro Manila; all other venues are hereby waived.
23. Notices. All notices and correspondence relative to this PN, including but not
limited to demand letters, summonses, and subpoenas, shall be sent to the
Borrower’s address above stated or to such other address as the Borrower may
hereinafter give in writing to the Bank. The mere act of sending any communication
by mail or personal delivery to said address shall be valid and effective notice to
the Borrower for all legal purposes. The fact that such notice or communication is
not actually received by the Borrower, or has been returned unclaimed to the Bank,
or that no person is found at said address or that said address is fictitious, shall not
excuse the Borrower from the effects of such notice or communication.

24. Severability. The unenforceability or invalidity of any provision of this PN by a

court of competent jurisdiction shall not affect the validity, legality, and
enforceability of the remaining provisions.
25. Effect of Agreement. The rights and privileges of the Bank hereunder shall inure
to the benefit of its successors and assigns, and the duties and obligations of the
Borrower shall bind his heirs, representatives, successors, and assigns.
26. Cooling Off. The Borrower is granted a “cooling off” period of seven (7) banking
days immediately following the signing of the loan documents to cancel the loan
without penalty, subject to an administrative processing fee of One Thousand Nine
Hundred Pesos (Php1,900.00) and provided that the Manager’s Check issued to the
Borrower will be returned to the Bank and that no drawdown has been made on the
loan. The cancellation shall be communicated to the Bank through a written notice.

27. Amendments. The Borrower agrees that the Bank may change any of the
provisions in this PN, including but not limited to the data privacy policy, and/or
the Fee Schedule, from time to time and the Borrower agrees to be notified of such
changes through notice sent through any of the following means, at the option of
the Bank unless the Borrower requests otherwise: (i) mailed and/or emailed notices
(sent to the Borrower’s mailing or email addresses indicated in the Bank’s records),
(ii) notices posted at the Bank’s branches, or (iii) notices in the Bank’s website, and
the Borrower agrees to be bound by such changes unless the Borrower expressly
notifies the Bank otherwise through the contact information provided by the
Borrower. The Bank’s non-receipt of advice from the Borrower within thirty (30)
days from receipt of notice from the Bank in relation to said changes shall be
deemed the Borrower’s agreement to all such changes or modifications. Where
such Amendments are to the Fee Schedule or affect the fees and charges and the
Borrower’s liabilities or obligations under this PN, the Borrower will be given not
less than thirty (30) days’ notice before the Amendments take effect unless such
changes are not within the Bank’s control.
28. Complaints. The Borrower must immediately communicate to the Bank upon
his/her knowledge of a possible cause of complaint, unauthorized application, or
any dispute regarding his/her loan account through EastWest Bank's 24-Hour
Customer Service at (+632) 8888-1700 or e-mail [email protected].

The Bank shall acknowledge the complaint/dispute no later than two (2) banking
 days upon receipt of report by responding to the said complaint/dispute or requiring
from the Borrower additional information or such other instructions as may be
necessary to properly resolve it.
29. Agreement. The Borrower acknowledges that he/she has fully read and understood
the Terms and Conditions Governing EastWest Personal Loan, and the Data
Privacy Policy as published in the Bank’s
website:https://www.eastwestbanker.com/info/ew_privacy.asp. The Borrower
agrees to abide by and be bound by the said Terms and Conditions and Data Privacy
Policy, any and all amendments thereto as well as all laws, rules, regulations, and
official issuances applicable to the Bank which may hereinafter be issued, including
other terms and conditions governing the use of other facilities, benefits, products
or services which shall be made available to him/her. The Borrower hereby certifies
that all information and documents given are complete, true and correct, and the
signatures therein are genuine. The Borrower understands that non-disclosure
and/or falsification of information and documents herein required shall be grounds
for the filing of legal action/s against him/her, as may be appropriate under the
circumstances.
30. Disclosure and Sharing of Information. The Borrower consents and authorizes
the Bank to disclose information relating to the Borrower, the Obligation and/or the
performance of the Borrower’s obligations under this PN to the Bank’s subsidiaries,
affiliates, agents, and third parties that are authorized by the Bank to receive such
information, for confidential use in connection with the Bank’s exercise of its
functions to provide banking and related services. The Borrower also consents and
authorizes the Bank or the parties to whom the Bank makes the disclosure to collect,
process, store, record, organize, update, modify, block, erase and destroy
information obtained from third parties in connection to Borrower’s Obligation.
The Borrower further consents and authorizes the Bank to disclose, receive, process
information for any business purposes (including but not limited to sales and
marketing, credit investigation and collection, information technology systems and
processes, data processing, imaging and storage, back-up and recovery, and
statistical and risk analysis purposes). The Borrower hereby gives permission for
the Bank to request information and to make necessary inquiries about the
Borrower from third parties in connection with any of the Borrower’s Obligation,
including its updates, renewals, re-issuance, or extensions.
Processing of Application.The Borrower hereby consents and authorizes the Bank,
any of its offices, branches, subsidiaries, affiliates, agents, representatives and third
parties, to conduct verification with the BIR, any other appropriate government
agency or third party including banks and financial institutions, to establish the
authenticity of the information he/she declared and the documents he/she submitted
in relation to his/her application as it may be necessary for the processing and
evaluation of his/her application and he/she hereby waives any rights on the
confidentiality of his/her income information as required by BSP Circular 622, as
amended by BSP Circular 855. The Borrower further consents and authorizes the
disclosure of personal and sensitive personal information by the Bank, provided
that such disclosure is in accordance with the provisions of
Republic Act (R.A.) No. 10173 or the Data Privacy Act of 2012, its Implementing
Rules and Regulations, and other rules and regulations relating to data privacy,
 including the Bank’s Data Privacy Policy published in its website.
Account Maintenance and Servicing.The Borrower hereby authorizes the transfer,
disclosure and communication of the Bank of any information, including personal and
sensitive personal information, relating to his/her account/s with the Bank together with all
of the documents submitted for his/her application to any of its offices, branches,
subsidiaries, affiliates, agents, representatives of the Bank and third parties for application
processing, data processing/storage, customer satisfaction surveys, and for any other
purpose as the Bank may deem appropriate, and/or as described in the Bank’s Data
Privacy Policy, and as may be required by law or regulation. The Borrower hereby also
authorizes the regular submission and disclosure to any and all credit information service
providers listed in the Bank’s Data Privacy Policy published in its website, of any
information, whether positive or negative, relating to his/her basic credit data (as defined
under Republic Act No. 9510) with the Bank, as well as any updates or corrections
thereof. The foregoing constitutes his/her written consent for any such submission and
disclosure of information relating to his/her account/s for the purpose indicated above and
under applicable laws, rules and regulations. The Borrower agrees to hold the Bank free
and harmless from any liabilities that may arise from any transfer, disclosure or storage of
information relating to his/her account/s.

Marketing and Sales Offers.The Borrower hereby authorizes the transfer, disclosure, and
communication of the Bank of any information, including personal and sensitive personal
information, relating to his/her accounts with the Bank together with all of the documents
submitted for his/her application to any of its offices, branches, subsidiaries, affiliates,
agents, representatives, and third parties for product and service offers to be made to
him/her through mail/e- mail/fax/SMS/telephone or through other forms of media, and for
any other purpose as the Bank may deem appropriate, unless the Borrower expressly
notifies the Bank otherwise through the following contact information:

Customer Service Hotline (+632) 8888-1700

Email [email protected]

The Borrower agrees that such disclosure or exchange of information shall not be the
basis of any claim against the Bank or the parties to whom the Bank makes the
disclosure.

The Borrower agrees and authorizes the Bank to enroll his/her personal loan account in
the Bank’s online banking facility.

For purposes of this authority to verify and disclose information, the Borrower waives
confidentiality of any such information relating to him/her and/or his/her business under
applicable laws such as but not limited to Republic Act Nos. 1405, 6426 and other laws
relating to the secrecy of bank deposits.
 https://www.investopedia.com/terms/d/disclosurestatement.asp
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borrowed, Capital
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https://www.investopedia.com/terms/d/disclosurestatement.asp
Technical words used in this lesson include:
MODULE 6: COLLECTION SYSTEM

The main points covered in this module include:

• Qualities of a Good Collector

• Various Types of Delinquent Debtors

• Principles of Collection

• Tools and Aids in Collection

• Basic Collection Approaches

• Wise Tips of Collecting Loans

• Workout Strategies

• Penalty and Service and other charges

This module is all about the collection system. We will be discussing how collection is being made by a

lender or a collecting agency. Enumerated are the qualities of a good collector and types of delinquent

debtors. Another one is the three (3) tools in collection where examples were presented in each tool. You

will also know the basic collection approaches and tips on collecting loans. After that there is the major

workout strategy such as restructuring and refinancing. Lastly are the fees and charges for having a loan

and credit card. They were discussed for you to be able to avoid having those unnecessary charges and

penalties.

The picture that many people have in mind when they think about the stereotypical debt collector is a
hard-hearted scoundrel of melodrama infamy, threatening to throw widows and orphans into the street
because the rent is overdue.

While it’s tempting to portray these individuals as

dastardly villains out to wreck lives — and
historically some of their behaviors have been
less than admirable — it’s important to
remember one fact: Nobody
is forced to borrow money. Ultimately, if you owe a debt, it’s because you chose to
borrow money. Your lender made that loan, or offered the credit line, contingent upon
your promise to pay it back.

Your creditors do have a right to their money, and a debt collector is simply trying to
claim what is legally and ethically owed by you.
5 Traits Any Debt Collector Should Master

1. Communication
Communication is one of the keys to becoming a successful debt collector. When
you can effectively communicate the debt collection message to your clients, you
put yourselves in a position to resolve differences while you build a trust
relationship between you and them. Not only does this put you in your clients’
good books but the more effective your communication is, the easier it becomes
to solve problems. As a debt collector therefore, you are seen as a problem
solver and your ability to resolve problems lies primarily in being able to
effectively communicate in this regard.

2. Negotiation

A successful debt collector is a good negotiator. The word negotiation is derived

from a Latin word and simply means the art of dealing with people. Through
negotiations you can resolve problems, since most problems arise from unmet
needs. Therefore, the solutions you suggest must have your clients’ needs at
heart. The most effective form of negotiations is known as assertive
negotiations. You need to set aside your judgment and withhold blame and
criticism to fully understand your clients’ situation. Your objective is to reach WIN-
WIN outcomes in any given negotiation, in other words you want everyone to
walk away from the negotiation table satisfied. Your sincere eagerness to help
needs to be perfectly reflected in your attitude towards the client.

3. Empathy

Empathy has more to do with logic than feelings. A successful debt collector
must have the ability to view the situation from the clients’ perspective. And this
process is logical in that to understand your clients’ position, you need to walk
away from your own. And in doing this you allow your client to be free and to
open to you instead of being hostile towards you. Scientists speak of “mirror
neurons” and they say these neurons are accountable for the responses
triggered in another person when you act in a certain way towards that person. A
successful debt collect excels in empathy because they understand that it holds
the key to a productive outcome in any given situation. Treat your clients how you
would like to be treated and soon enough they will be doing what you want them
to do.
 4. Goal Orientated

Goal orientation is the degree to which a person focuses on what needs to be

done and the end results of their efforts. Strong goal orientation focuses more on
the end results that your actions will accomplish instead of the efforts necessary
to bring about the desired end results and how those end results will affect you in
the end. Therefore, a goal oriented person focuses all their attention on getting
the job done, no matter what it takes. A successful debt collector understands
that their personal success is linked to their organization’s success and therefore
aims to achieve their goals on a personal level.

5. Persistence

And finally, a successful debt collector knows and understands that there is no
such thing as over-night success. To be successful you will need to define some
goals and be persistent in carrying them out. Day in and day out you must
commit your focus to attaining your goals. Successful people all have one thing
in common, they never gave up on their goals no matter how often they might
have failed in the past. Despite difficulty or opposition, successful people rise
above their challenges.

What is Delinquent?

Delinquent describes something or someone who fails to accomplish that which is

required by law, duty, or contractual agreement, such as the failure to make a required
payment or perform a particular action. It refers to a situation where a borrower is late or
overdue on a payment. When this happens, the collection system along with the
penalties and charges take place.

A debt becomes delinquent when:

• Payment is not made by the due date or the end of the “grace period” as established in
a loan or repayment agreement, in the case of a debt being paid in installments. The
date of delinquency is the payment due date.

Example: Borrower’s loan payment is due January 1. The loan agreement allows
a grace period of 15 days, meaning that the lending agency will not assess late
charges or declare the loan delinquent if the payment due on January 1 is made
before January 16. If the Borrower makes his or her payment before January 16,
the loan is not delinquent. However, if Borrower fails to make a payment by
January 16, then the loan is delinquent, and the date of delinquency is January 1
(the payment due date).
 • Payment is not made by the due date specified in the initial billing notice, in the case of
administrative debts such as fines, fees, penalties, and overpayments. The due date is
usually 30 days after the agency mailed the notice. The date of delinquency is the date
the agency mailed or delivered the billing notice.

Example: Agency discovers that duplicate payments were made to beneficiary

and seeks to recover the overpayment. On March 1, the Agency mails a notice to
beneficiary informing him about the overpayment. The notice states that payment
must be made by March 31 to avoid assessment of late charges and enforced
collection action. If the beneficiary pays the amount requested before March 31,
the debt is not delinquent. However, if the beneficiary fails to pay by March 31,
then the debt is delinquent, and the date of delinquency is March 1 (the date of
the initial notice about the debt).

Various Types of Delinquent Debtors

1. The negligent- does not bother about due dates of loans

2. Debtor boasts of being well connected with politicians and people in power – one
who builds an image of being untouchable

3. Heavily leveraged debtor

4. Seasonal delinquent

5. Debtor who deliberately commits fraud

6. Chronically slow- delays payment till creditor gives liberal terms

7. Wittingly late- uses supplier’s interest free credit terms instead of bank loan

8. Stretcher- deliberately delays payment

9. Tightrope walker- usually on the verge of financial crisis

10. Vanishing debtor – one who is not around when it is time to make payment
Principles of Collection

Certain principles have been found especially useful in the field of collection and may be
grouped into the following areas:

• collect the money

• maintain a systematic follow-up
• get the customer to discuss the account
• and, preserve goodwill

1. Collect the money

The primary job of the person responsible for collecting is to collect the money
as close to the terms of the obligation as possible. There should never be any
doubt as to why the individual is engaged in this task. The debtor has an
obligation to pay within the terms of the agreement. It is the job of the collector to
make sure that this obligation is met. The tone may be indulgent at first but
should be intensified and accelerated as much as necessary to ensure payment
by a debtor.

2. Systematic follow-up
After the initial contact with the delinquent customer, it is important to keep
additional contacts on a strict schedule. If the collector, for example, is told that a
check will be mailed in a few days, it should be noted. If the check is not received
at the promised time, follow-up is essential, otherwise the collection effort will
become ineffective.

Systematic follow-up of accounts, even those which cannot pay immediately,

reinforces the serious nature of the outstanding debt and emphasizes the
importance attached to it by the creditor. That is an important collection
advantage.

3. Discussing the account

Once the collector gets the customer to talk about the delinquent account, the
collector is well on the way to receiving payment. That is why emphasis is placed
on inviting the debtor to talk. The objective of the discussion is to get the debtor's
explanation of the delinquency. It may be a question of a dispute; it may be due
to a temporary shortage of funds; or the customer may intend to hold off payment
so the creditor's money can be used in his own business.

During the discussion, the collector may begin to see the debtor's situation more
clearly. If the slow payment is the result of a temporary cash flow problem,
tolerance of slower payments may be accepted, but
It should be emphasized to the customer that the new schedule of payments
must be completed.
 4. Preserve goodwill

Even though the customer may be experiencing some difficulty in meeting

payments, it does not preclude them from becoming a good customer in the
future. Therefore, it is important to preserve goodwill while pressing for collection.
This requires not only tact, but knowledge of the customer and industry. One of
the advantages claimed by specialized collection personnel is that they can
develop these techniques to their fullest. On the other hand, the team concept
presents the opportunity for credit and customer service personnel to better
understand the relationship of the customer to the industry and overall marketing
objectives of the company.

Tools and Aids in Collection

1. Statement of Account

• It must request payment

• Inform the debtor how much he owes

• Itemize the loan or debt

• Easy to understand

• States’ due date, interest rates and penalty charges

2. Collection Letters

• It must be concise and direct to the point

• Should give the debtor a chance to state his repayment problems

• Should request the debtor to give his repayment plan at the same time
his commitment to comply with it

• It should contain details of the loan

• It should mention any penalty under the law if the loan remains unpaid.

3. Telephone or Cell Phone Calls

• Plan your calls and strategize on how to persuade the debtor to pay

• Speak clearly and talk at the debtor’s language level

• Pay attention to the debtor’s story and do not interrupt

• Persuade the debtor to commit to a time-bounded repayment plan

• Remember to persuade the debtor to do the next step in the process of

loan collection.
 Client Call Checklist Opening the Call-
Tips
a. Plan your call-
know your a. Be positive
creditor and b. Identify the
his policies person you are
b. Have all the talking with
information c. Identify
materials yourself
ready d. State the
c. Make the call- reason for
your call

Body of the Call Statements that Collect

a. Ask and get a. You want to maintain

information a good credit record.
for causes of b. You need a good
non- payment credit record in
b. Request for his business.
repayment plan c. Show your good
c. Give the debtor faith by paying the
alternative courses account now.
of action d. Unless you pay the
d. Tell him the amount due, we will
benefits of your be constrained to
suggestions undertake drastic
e. Overcome action to recover our
objections fund exposure.
f. Use trial closes e. Do you want your
loan account to be
referred to an
attorney?

f. You will save on

litigation
expenses if you
will settle the
loan amicably.
 Watch this https://youtu.be/rKka6t7poGI for a sample telephone collection

Basic Collection Approaches

1. Educate the debtor of the credit policies and procedures of the creditor. For example:
penalty charges will be imposed once payment is not done on time.

2. Firm persuasion done in the a friendly atmosphere

3. Assist the debtor if he has repayment problems with the end in view of formulating a
mutually acceptable repayment plan
4. Use coercion in collection under applicable laws

Wise Tips for Collecting Loans

1. Give the debtor a clear choice of action

2. Prefer a short repayment term to minimize risks of payment defaults
3. Identify the debtor’s vulnerability as a persuasion tool
4. Convince the debtor that settling the loan amicably is better than pursuing court
litigation

Major Workout Strategies

These are strategies to settle delinquent accounts:

• Restructuring- includes change in the original credit terms such as extension of grace
period, reduction or waiver of interest and penalty charges, reduction of amount to be
paid per amortization on a step ladder basis (where lower amortizations are paid during
a period of time and escalates on a gradual basis based on the debtor’s capacity to
pay) or extension of maturity period.

• Refinancing-– this mode of settlement is thru extension of a new loan or

line with major part of proceeds to be applied to outstanding past due loan
and any remaining balance to be utilized for the borrower’s project. Prudence
must be exercised in granting refinancing to avoid throwing good money after
bad.
Some considerations in refinancing:

o The company is viable and the market continues to exist.

o Cash flows still adequate under a restructured mode.

o Collaterals are adequate.

o Emergency operating/financial controls are instituted.

o Use of new loan is justified/controlled and monitored.

o Borrowers e n j o y suppliers’ support, other creditors’ support,

government support.

Sale of mortgaged assets with or without assumption of obligation – involves the sale of the mortgaged
collateral to an interested buyer and the proceeds applied to the loan. When the buyer cannot raise the
entire purchase price, the creditor could allow the purchaser to assume the obligation and pay the creditor
accordingly. The new obligor should have the capacity to pay.

Sale of free assets – involves sale of debtor’s other free assets and the proceeds to be applied to the loan.

Dacion en pago or more popularly known as payment in kind- a real estate property or personal property
such as car can be used to pay off the loan using a mutually agreed upon value of the property to be
applied to liquidate the loan. Under this scenario, transfer of ownership and immediate possession of the
property in favor of the creditor are attained easily.

Penalty and Service and other charges

Here are some of the fees and charges involved when applying for loan in the Philippines:

a. Processing Fee. While some banks have no cash out policies they will still
deduct a small amount from your loan to cover for the processing. Some banks
will charge you P1500 to P2,500 for the loan processing alone.

b. Early Payment Fee. You can pay off your loan balance in full anytime, some
lenders will require you to pay your outstanding principal balance plus a
standard fee but this is a case to case basis. Some banks charge a flat fee of
P3,000, or a percentage of the outstanding balance, while others don’t require
an early payment fee at all. The main advantage of allowing you to pay off
your balance earlier than your maturity date is that you can save on interest
expenses.
 c. Late Payment Penalty. Late monthly installment payments are usually
charged at 5% per month, but the rate varies depending on the lender or
the bank. To avoid late payment charges be sure to pay your monthly
installment before your due date.
d. Documentary Stamp Tax. A DST is a tax applied on loan agreements,
contracts, legal documents and other law binding documents. In the
Philippines loans above two- hundred and fifty thousand pesos are
charged with documentary stamps tax of one peso for every two hundred
peso of the approved loan amount.

Here are some of the fees and charges involved with a credit card transaction:

a. Finance charge or fee

This fee is charged when cardholders do not pay off their credit card balance. The longer you take to
completely pay off your balance, the higher the finance charge will be. In other words, the finance charge
is the interest that you incur for not paying promptly.

A credit card is a revolving credit, hence, its interest or finance charges will snowball over time. Here’s
how it works based on a 3.5% interest rate per month:

Balance Payment Interest

Month 1 ₱11,000 ₱5,000 ₱6,000 x 3.5% = ₱6,210

Month 2 ₱6,210 ₱3,000 ₱3,210 x 3.5% = ₱3,322.35

Month 3 ₱3,322.35 ₱3,000 ₱322.35 x 3.5% = ₱333.63

The above example assumed that the cardholder does not make any new transactions on the card. If
there are new transactions on the card, the more interest you will incur.

If you just can’t avoid carrying a balance, then the goal is to minimize your interest charges by using a
low-interest credit card instead of other credit cards like a rewards card. Rewards credit card tends to
have higher interest rates, and if you are unable to clear off your balance every month, the interest will
outweigh the value of your rewards.

How to avoid it

Paying off your balance in full each month is the only way to dodge finance
charges. If you purchase a big-ticket item which you can’t pay off in a single
payment, call your bank and arrange an installment scheme. However, not all
banks offer the luxury of converting purchases into installment plans, hence;
another option is to take advantage of installment plans in store.

a. Late payment fee

A late payment fee is charged to the cardholder when the minimum payment is not settled within the due
date. Basically, it’s a fee charged on top of the interest or finance charge when cardholders don’t make
any payment within the due date at all.

The late payment will be added into the balance, which will snowball according to the interest rate.

Fortunately, today, some banks have different credit cards catered for different consumers. Some no-frills
credit cards like Citibank’s Simplicity Card don’t penalize cardholders for missing their due date. While
such credit card offers flexibility, not paying your credit card debts promptly will still hurt your credit record
in banks and incur finance charges.

How to avoid it

This is the easiest to avoid. All you need to do is to ensure you pay at least
the minimum payment or choose a card that doesn’t charge late fees.

b. Cash advance fee

Cash advance is a means of withdrawing cash from an ATM with a credit card which will be restricted
according to your credit limit. This transaction typically imposes a one-time fee and is immediately
deducted from your credit limit.
Some banks like HSBC offer a fixed cash advance fee of ₱500 while some charge a 2% to 5% of the
borrowed amount.

The cost of making a cash advance with your credit card doesn’t just end with the cash advance fee.
Standard ATM withdrawal fees will also apply, and failure to pay off the entire amount will incur late
payment fees and interest charges, as explained in the points above.

How to avoid it

Cash advance is never the best source of cash during an emergency. If you
want to have a source of funds for your immediate needs, the aim is to build
an emergency fund with enough money to cover at least 3 to 12 months’
worth of your household expenses. If it is completely unavoidable, then
ensure you can pay off the balance completely before the due date.

a. Balance transfer fee

A balance transfer fee is charged when you move debt from one credit card to another. The idea
behind a balance transfer plan is to save on interest while paying off your credit card balance.

The typical balance transfer fee is 3% to 5% of the amount transferred. This is a one-time fee, and the
facility will spread your debt over a set period, with many cards offering 0% interest on balance transfers
for a year or more.

Some credit cards don’t charge a fee for balance transfers in certain circumstances. However, they do
come with conditions like lesser payment terms and/or reaching a certain amount of balance transfer.

How to avoid it

For a balance transfer program to be worthwhile, you need to ensure you can
pay off your balance according to the schedule. Failing to do so will incur
Over-limit fee

a. OVER LIMIT FEE

An over-limit fee is charged when your card’s balance exceeds your credit limit. Cardholders may opt for
the fee to keep transactions from being rejected at the register. Depending on your bank, you could be
charged between ₱500 and ₱1,500, no matter the amount you have overcharged your card with.

While credit limits are there for your consumption, maxing it out can hurt your credit health. Generally, a
good credit utilization ratio should be 30% or less. Going above it may impact your credit record
negatively.
 How to avoid it

If you do opt in, the simplest way to avoid the fee is to stay well under your
credit limit. If you’re constantly on the verge of maxing out your card, the
problem lies in your spending habit.

b. Returned payment fee

A returned payment fee is charged when your check to the credit card company bounces or an automatic
payment out of your bank account is blocked for insufficient funds. This fee will vary by card, but around
₱1,500 will be charged for every check that is returned or bounced due to the insufficiency of funds,
uncollected deposits, stops payment order, closed account, alteration, erasure or deficiency, or for any
other reason.

How to avoid it

Make sure you have the money in your account before writing that check or
clicking that “Pay Bill” button on your credit card’s online portal.

If you don’t want your credit cards to accumulate unwanted debts, other than using it wisely,
understanding how the fees work can help you dodge unwanted charges. The secret that not everyone
knows about credit cards is that you can usually find a way to avoid many of these credit card fees.