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What are the Stages of Evaluation in Credit Analysis Process?
What is Credit Analysis?
Every business that offers credit to its customers faces a risk of losing money in terms of bad debts. Moreover, many organizations that are granted credit may delay in making payments which may hurt the firm that offers credit to such customers. It is therefore necessary for businesses to analyze the creditworthiness of customers before the credit is granted to them.
This process of analyzing the creditworthiness of customers is known as credit analysis. It should be noted that credit analysis is one of the many processes to judge the creditworthiness of customers. There are other tools to analyze the credit rating of customers available to help the businesses that offer credit to their customers.
Additionally, the business must ask for a business consulting report of the customers from a reputed third party so that the data of the customer’s business is used to analyze the creditworthiness of the company.
Evaluation of Credit Analysis
Various ratios available on the financial statements can be used to determine the potential creditworthiness of a customer. However, all companies do not have a financial report and all businesses cannot be asked to provide a financial report.
It is usually the big companies that seek a big line of credit that need to provide financial statements. However, the credit-seeking companies may ask the credit-grantors to sign a nondisclosure agreement to keep the confidentiality intact.
Credit Analysis Ratios
The three most common credit analysis ratios are as follows −
Working Capital
Working capital shows a business’s ability to meet its obligations. It is the difference between current assets and current liabilities. A business with enough working capital is able to run its business successfully.
Quick ratio
The quick ratio shows the ability of a company to meet its current liabilities with the current assets and assets that can be converted to cash within a short span of time. This helps the analyzers determine the ability of the company to pay back the credit amount within a limited schedule.
Current Liabilities to Net Worth
This ratio represents the amount due to creditors within one year as a percent of owners’ shareholders’ investment. Any business having 80% or more of this ratio, there is an indication of trouble piling up.
Trade References
Trade references that show that the customer was able to honor the previous lines of credit can be produced along with the financial statement by companies looking for credit. It is an excellent tool for business managers to judge the creditworthiness of customers.
These references can be provided with to credit bureaus. The credit bureaus may use this to offer credit ratings to the customers. This rating is also available in the company report of the customers. These ratings help credit suppliers get insider information that can be used to offer credit to creditworthy companies.
Consulting a Business Credit Report
The business credit reports formed by reputable third parties can be an excellent source to understand the creditworthiness of credit-seeking companies. These reports show proprietary ratings and scores, credit limit recommendations, public information including lawsuits and judgments, etc.
Such information is useful for the clients who extend credit to the customers especially when the creditworthiness determination is an urgent need. Moreover, this can show whether the credit-seeking companies would follow the norms while repaying the credit amount back to the clients on time.
Conclusion
The credit analysis process involves various tasks related to the determination of the perceived ability to pay back the extended credit by the customers. For this, the businesses must analyze the information provided in the credit application forms, such as analyzing various financial ratios, reviewing trade references, and checking the financial statements.
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