PRESENTED BY: PRIYA KHICHI JYOTI RANA

Credit analysis is the method by which one calculates the creditworthiness of a business or organization. The audited financial statements of a large company might be analyzed when it issues or has issued bonds. Or, a bank may analyze the financial statements of a small business before making or renewing a commercial loan. The term refers to either case, whether the business is large or small.

CASH FLOW COLLATERAL CAPITAL CHARACTER CONDITIONS

Cash Flow- is the first "C" of the 5 C's of Credit (5 C's of Banking). Your banker needs to be certain that your business generates enough cash flow to repay the loan that you are requesting. In order to determine this the banker will be looking at your companys historical and projected cash flow and compare that to the companys projected debt service requirements. There are a variety of credit analysis metrics used by bankers to evaluate this, but a commonly used methodology is the Debt Service Coverage Ratio .

In most cases, the bank wants the loan amount to be exceeded by the amount of the companys collateral. The reason the bank is interested in collateral is as a secondary source of repayment of the loan. If the company is unable to generate sufficient cash flow to repay the loan at some point in the future, the bank wants to be comfortable that it will be able to recover its loan by liquidating the collateral and using the proceeds to pay off the loan.

When it comes to capital, the bank is essentially looking for the owner of the company to have sufficient equity in the company. Capital is important to the bank for two reasons. First, having sufficient equity in the company provides a cushion to withstand a blip in the companys ability to generate cash flow. For example, if the company were to become unprofitable for any reason, it would begin to burn through cash to fund operations. The bank is never interested in lending money to fund a companys losses, so they want to be sure that there is enough equity in the company to weather a storm and to rehabilitate itself. Without sufficient capital, the company could run out of cash and be forced to file for bankruptcy protection. Secondly, when it comes to capital, the bank is looking for the owner to have sufficient skin in the game. The bank wants the owner to be sufficiently invested in the company such that if things were to go wrong, the owner would be motivated to stick by the company and work with the bank during a turnaround. If the owner were to simply hand over the keys to the business, it would clearly leave the bank fewer (and less viable) options on how to obtain repayment of the loan.

Another key factor in the five C's of credit is the overall environment that the company is operating in. The banker is going to assess the conditions surrounding your company and its industry to determine the key risks facing your company, and also, whether or not these risks are sufficiently mitigated. Even if the companys historical financial performance is strong, the bank wants to be sure of the future viability of the company. The bank wont make a loan to you today if it looks like the viability of your company is threatened by some unmitigated risk that is not sufficiently addressed. In this assessment, the banker is going to look to things such as the following: The competitive landscape of your company - who is your competition? How do you differentiate yourself from the competition? How does the access to capital of your company compare to the competition and how are any risks posed by this mitigated? Are there technological risks posed by your competition? Are you in a commodity business? If so, what mitigates the risk of your customers going to your competition?

Character While we have left Character for last, it is by no means the least important of the 5 Cs of Credit or Banking. Arguably it is the most important. Character gets to the issue of people are the owner and management of the company honorable people when it comes to meeting their obligations? Without scoring high marks for character, the banker will not approve your loan.

How does a banker assess character? After all, it is an intangible. It is partly fact-based and partly gut feeling. The fact-based assessment involves a review of credit reports on the company, and in the case of smaller companies, the personal credit report of the owner as well. The bank will also communicate with your current and former bankers to determine how you have handled your banking arrangements in the past. The bank may also communicate with your customers and vendors to assess how you have dealt with these business partners in the past. The soft side of character assessment will be determined by how you deal with the banker during the application process and their resultant gut feeling.

To summarize, the 5 Cs of credit forms the basis of your bankers analysis as they are considering your request for a loan. The banker needs to be sure that (1) your company generates enough CASH FLOW to service the requested debt, (2) there is sufficient COLLATERAL to cover the amount of the loan as a secondary source of repayment should the company fail, (3) there is enough CAPITAL in the company to weather a storm and to ensure the owners commitment to the company, (4) the CONDITIONS surrounding your business do not pose any significant unmitigated risks, and (5) the owners and management of the company are of sound CHARACTER, people that can be trusted to honor their commitments in good times and bad. Hopefully this article has succeeded in helping you understand where your banker is coming from. With a better understanding of how your banker is going to view and assess your companys creditworthiness, you will be better prepared to deliver information and position your company to obtain the loan that it needs to grow and thrive. You should use these 5 C's as a credit managment tool to run your company

The nature of your customer relationships are there any significant customer concentrations (do any of your customers represent more than 10% of the companys revenues?) If so, how does the company protect these customer relationships? What is the company doing to diversify its revenue base? What is the longevity of customer relationships? Are any major customers subject to financial duress? Is the company sufficiently capitalized to withstand a sizable write-down if they cant collect their receivable to a bankrupt customer? Supply risks is the company subject to supply disruptions from a key supplier? How is this risk mitigated? What is the nature of relationships with key suppliers?