What are the 5 C's of Credit Analysis?

Credit Analysis

Credit analysis is an important part of businesses that provide credit to their customers in order to expand their business portfolio. However, like all other protocols of business, credit analysis is also based on some important factors.

To get rid of losses created by bad debt and lengthy payments, businesses can depend on these factors to understand and apply credit analysis to their potential customers.

5 C’s of Credit Analysis

There are select parameters on which the credit analysis process rests. These are known as the 5 C’s of credit analysis. These are the following −

Character

Lenders want to judge the financial character of their customers before lending them credit. It is important for the lenders to know how diligent the financial character of the customer has been in order to minimize the risk of bad debt.

The character of a firm that wants to avail credit is judged by credit rating or credit scores. The better the rating or the score, the better the potential of the firm to return the credit in time.

The character can be improved by firms by paying back older debts in a systematic and organized manner. Staying professional and dealing systematically to impress the lenders go a long way in making credit character superior. In the case there is a need, making a professional rapport can also be good.

Capacity

Capacity is the ability of the firm to pay back the debt availed and it shows how much credit is good enough for a particular firm. It shows the lenders the profit made by the applicants of credit lately which is a measure that is very important for the lenders.

The capacity of a firm is assessed by analyzing the cash flow statements and their projections, debt service coverage ratio (DSCR), bank statements, and debt to income ratio (DTI).

To increase capacity, a firm should lower its expenses and increase its income. Professional software can be used to do this.

Capital

It is the money a credit-seeking firm has already invested in the business and the amount it wants to invest more. In general, the more the capacity of a firm, the more its ability to raise more credit from lenders. This is so because a big firm usually has a sound business process that is able to pay back the loans within a given period of time.

To make an impression related to capital a firm should invest money in a business and earn some profit before applying for credit. Keeping the plan of using the credit amount can also help the firms in obtaining a loan readily.

Conditions

Conditions refer to the terms that are put by lenders on the credit management process to minimize their anticipated losses in the process. It may include the credit rules and regulations a credit-seeking firm has to follow to get the credit approved.

Lenders create conditions depending on industry practices, market segments, risks involved in the business, and competitors in the market.

In order to be eligible, firms should explain how they will spend the money in the businesses they have. Applying for a loan when the cash flow is superb can increase the chances of getting loans many times.

Collaterals

Collaterals include assets, such as jewelry, a car, a home, and land that can be pledged as security against the loan. Collaterals make loans secured as the valuables can be seized if the credit-seeking firm fails to pay the credits.

The collaterals asked by the lenders differ from organization to organization. While some may ask for property some lenders ask for bank liens or personal guarantees.

It is important to learn about the depreciation and market price of the collaterals being used for getting the credit. Looking for lenders that offer loans on favorable terms is also helpful for the firms who apply for loans.

Conclusion

The 5 C's of Credit Analysis are basically the key factors used by financial institutions to determine a potential borrower's creditworthiness; to decide whether a borrower is eligible for the credit and what would be the interest rates.