The 5Cs of Credit: What a Credit Analyst Must Know

As a credit analyst, it is important to know about the 5Cs of credit. As it is the primary determinant while analyzing a credit application. It gauges the creditworthiness of the applicant. From the customer point of view, it is better to know what the lenders are looking for, so that you can prepare yourself beforehand. 

The 5Cs of credit are: 
  1. Character
  2. Capacity
  3. Capital 
  4. Collateral 
  5. Condition
In this post, we will explain each and everything you need to know about the 5Cs of credit and how to use it while preparing a credit appraisal. So let’s begin!!

The first “C” stands for the character of the borrower. It is often referred to as the borrower’s reputation and trustworthiness. It is basically the history of the borrower and the track record that shows how good he is in repaying the debts. It also tells the borrowers the ability and willingness to repay the borrowed money. For a credit analyst, it is important to understand the borrower’s strengths, weaknesses, business acumen, attitude toward risk, attitudes toward growth, fulfilling commitment, problems, and possibilities while analyzing the character. 

Capacity measures the borrower’s ability to repay the loan; a credit analyst should compare recurring debts and borrower’s debt t income ratio. A credit analyst can also have a look into the cash flow statement to identify sources and uses of funds and The drivers of sustainable profitability and growth. As it explains the borrower’s operational efficiency. An analyst can take help of the following tools:-
  • Cash flow statements
  • Cash flow projections
  • Bank statements
  • Debt service coverage ratio (DSCR)
  • Debt-to-income ratio (DTI)
Capital is the money the borrower has invested in his business. It shows the financial strength of the borrower. Higher investment lowers the chances of default. For a mortgage loan down payment shows the level of seriousness of the borrower. It also gives an overview of -how well the borrower be able to withstand in difficult times?

  4. Collateral
Collateral relates to the assets a company has available to act as security for a loan in the event of a default. But, it should not be the primary determinant of disbursing the loan. Cash flow capacity should be the main determinant. Security is only a backstop to protect the lender in the event of a default. While taking collateral, it is important to assess the quality of the collateral. There are four criteria to assess the quality of the collateral:- Marketability, Ascertainability, Stability and Transferability. 

Conditions such as interest rate and principal play an important factor in determining creditworthiness. Factors such as the economy and business’s market can also play a role in how likely the business is succeeding and able to repay a loan. An analyst can apply Porter’s 6 forces theory or PEST analysis. 

5Cs of credit is the primary determinant of the creditworthiness of any borrower. After analyzing the 5Cs the credit analyst can move forward to other procedures of credit approval and disbursement. 

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