Introduction

Risk assessment is never an easy task for credit professionals. It is an aspect which on most occasions faces multiple challenges, during the gathering and determination of accuracy of the facts collected (Katlein, 2010). It is also hard to meet the expectations of product and sales; evaluation and quantification of risk factors and finally the satisfaction of financial objectives of the company. These are aspects, which credit professional face and whenever they are handling a credit transaction, there always exits the risk of poor timing, legal aspects nonpayment, economic influences security and extra costs (BinGhuslan, Muhammad & Abidin, 2010).

These 5Cs help lenders in the determination of a borrower’s ability to repay any granted loans. The banker analyses these factors before the provision of any loans, in order for them to advance loans with an assurance of payment by borrowers (May, 1993). This paper will provide an analysis of all the five aspects that bankers consider while looking at the worthiness of a borrower. When lenders need to evaluate the credit worthiness of their potential borrowers, they use the 5cs method, which is the Character, Capacity, Capital, Conditions and Collateral (STRISCHEK, 2009).

When evaluating character of a borrower, creditors focus on the reputation of the prospective borrower (Reid, 2009). On the other hand, the measurement of capacity takes a focus on the capability of the prospective customer to repay any loan advancement to him. This is done through the evaluation of the customers’ income and any available debts or debt recurrence. Capital evaluation is done to check any capital used for potential investments. Any evidences of investment of borrowers mean that the borrower has less chances of defaulting and that gives them higher chances for receiving the credits they are looking for (Gitman, Joehnk & Billingsley, 2011).

Evaluation of a prospective borrowers collateral leads into the investigation of the borrowers’ property, and available assets that may help in convincing the borrowers into advancing the loan requested (Reid, 2009).  A borrower can provide his property as security for the convincing of the lender into advancing him a loan. Finally any loan conditions like the principal and interest rates determine the desire a lender may have for him to advance a loan to a borrower. Having briefly described the 5 Cs, it is necessary for the in depth evaluation of their true influences on credits.

Character

Character is a basis of morality and the borrowers’ willingness to pay. This is evaluated through a keen look on the borrowers’ background, abilities and experience (Posey, 2010). The legal aspects of the business, litigation, bankruptcies, settlements and favorable payment records all determine the ability of the borrower to pay for a granted credit. When evaluating character, financers look at the manner in which a borrower relates with his customers and employees for them to be sure that they would be placing their funds to impeccable people (EDUCATIONAL SESSIONS, 2009). The banks may focus so much on personal character to evaluate the corporate leadership ability and financial management capacity. When evaluating a borrowers character, there is focus on his background, references and education help in the determination of the borrowers trustworthiness (BinGhuslan, Muhammad & Abidin, 2010).

Capacity

When focusing on the capacity, the creditors look at the borrower’s ability of paying due bills. Past, present and future cash flow awareness, samples and the management and utilization of current assets. There is a focus on the borrowing history of the company, repayment track records and viable amounts that can be handled by the company. This is done through the evaluation of debt and liquidity ratios before advancement of any loans (Gitman, Joehnk & Billingsley, 2011).

Capital

Creditors also get interested in examples of a borrower’s capital; their net worth and equity, business trends and investment of fixed assets, as well as their utilization (Reid, 2009). Before a lender advances any finances to a borrower, they tend to be very interested on the amount of investment that has been dedicated to the business. This shows some degree of commitment to the business and such risk endeavors provide an understanding of the kind of interest one has on his business. The financial statements of both personal and business transactions are points of evaluation for the determination of this aspect (Katlein, 2010).

Conditions

When evaluating the fourth C, all conditions  prevalent in the industry are analyzed taking a look at the industry trends, products, buying and selling terms, seasonal aspects, delivery, operational changes, rental or ownership of premises, business location and any available examples to prove the position of the claimed conditions. Here any existing sensitivity to economic downturns and evidence of management of expenses of productivity are points of evaluation. The lenders evaluate current trends in the industry and how the company fits ensuring that no negative impacts exist that may deter the company’s capacity of repaying the debt (Brigham & Houston, 2009).

When credits are tight and in times of recession, it becomes very hard for businesses to get loans because lenders look at the effects of the prevailing tough conditions, and weigh them upon the repayment requirements for the loan. These are times when even banks may find inadequate funds for advancing loans to businesses (Singh, 2009). Alternatively, in the evaluation of conditions, the banks look at the intended purpose of the loan a business is applying for. It will look at the reasons for application for the loan for example, if the business needs the loan to buy more machinery, expand its operations looking for funds to build up ones seasonal inventory, or whatever it is that the business requires funds for.

Collaterals

Collaterals make the hard assets and these form the base for guaranteeing a borrower into getting a credit. It focuses on the application of types of collaterals available, and any present risk mitigation alternatives. Collaterals make a second option for debt repayment whenever cash flow fails. So for this, they look for assets that the company can pledge to make up for any repayment failures should any present itself. These could be real estates, manufacturing equipment or any available hard assets (Brigham & Houston, 2009).  Inventories and accounts receivables can also be pledged as collateral. Economic times are very hard and banks and lenders have become more strict regarding the advancement of their loans. On most occasions, lenders would look for guarantors to sign up, taking the responsibility of repaying the loans should the borrower fail to keep his promise. So, in order to get a loan, one may be required to have someone guaranteeing the repayment of the loan (Singh, 2009).

Conclusion

The 5Cs of credit are very essential for everyone in business and credit managers to understand. This can be done through networking, attending business and sales meetings educations, analysis, analytics choices and training as well as being open to new ideas (Posey, 2010).  This can help in making the best out of the 5 Cs as it is not necessary to blame technology, fret when one of the Cs fail to work as they should always be supportive of each other. Alternatively, communication, delegation and taking of initiatives can help one to review their capacities to determine their status and position for accessing credits. It is important to note that there is no existing single standard of evaluation of a company’s credit worth by lenders (Gitman, Joehnk & Billingsley, 2011).

All lenders take a lot of caution before advancing their funds and just a single weak area can deter a borrower from accessing any funds (Singh, 2009). For instance, a company operating in an industry with multiple economic instabilities may find it very hard to get finances during seasons of low economic status regardless of the strong positions of all other factors. Failure of the perception of character and integrity can also act as stumbling blocks to ones accessibility of finances regardless of the positivity of financial statements that one may show (BinGhuslan, Muhammad & Abidin, 2010). This means that lenders take companies as a total package when evaluating its credit worth using the 5Cs (May, 1993). The 5 Cs of credits therefore ensure that a business has adequate cash flow to support the requested loan, collateral for covering the loan amount, capital to support the business and show owners’ commitment, favorable conditions for minimization of risks and owners character to ensure that borrowers have the integrity for honoring any granted loans (Brigham & Houston, 2009).

 

 

References

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Gitman, L. J., Joehnk, M. D., & Billingsley, R. S. (2011). Personal financial planning. Mason,           OH: South-Western Cengage Learning.

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STRISCHEK, D. (2009). The Five Cs of Credit. RMA Journal, 91(8), 34-37.