What Is Credit Analysis?


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Uploaded on May 12, 2023

PPT on Credit Analysis

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What Is Credit Analysis?

What Is Credit Analysis? Introduction Credit analysis is a process undertaken by lenders to understand the creditworthiness of a prospective borrower, meaning how capable (and how likely) they are of repaying principal and interest obligations. Source: corporatefinanceinstitute.com Commercial Lending The borrower, also known as the debtor, could be an individual or a business entity; the former is referred to as retail (or personal) lending, and the latter is what’s known as commercial lending. Source: corporatefinanceinstitute.com Creditors Lenders, also known as creditors, employ a variety of qualitative and quantitative techniques (including risk models) when conducting credit analysis in order to quantify and effectively price risk. Source: corporatefinanceinstitute.com What is Credit? Credit is “created” when one party receives resources from another party, but payment is not expected until some contracted date (or dates) in the future. Source: corporatefinanceinstitute.com Trade credit The resource may be cash, as is the case with a bank loan. Alternatively, the resource may be a physical product (like inventory); this is called trade credit. In both cases, credit risk exists. Source: corporatefinanceinstitute.com Credit Risk This is defined as the risk that a creditor will advance resources to a debtor, but that payment (or repayment) will not be made. Source: corporatefinanceinstitute.com Credit Analysis Credit analysis is conducted in order to understand the level of credit risk presented by a borrower, given the parameters of a specific credit request. Source: corporatefinanceinstitute.com Qualitative techniques Qualitative techniques include trying to understand risks in the external environment, like where interest rates are heading and the state of the broader economy, among others. A framework like PESTEL is often employed. Source: corporatefinanceinstitute.com Quantitative techniques Quantitative elements of the analysis include assessing financial ratios using risk models, understanding financial projections, employing sensitivity analysis, and evaluating the strength of any physical collateral that could serve as security against the credit exposure. Source: corporatefinanceinstitute.com Credit Analysis Framework – The 5 Cs A popular credit analysis framework is the 5 Cs of Credit; the 5 Cs underpin the component parts of most risk rating and loan pricing models. The 5 Cs are: 1. Character 2. Capacity 3. Capital 4. Collateral 5. Conditions Source: corporatefinanceinstitute.com