Credit Analysis
AdvancedCredit analysis is the process of assessing how likely a borrower is to repay a loan or debt in full and on time, by examining its finances, business, management and the terms of the borrowing.
Banks, bond investors, suppliers and credit rating agencies all carry out credit analysis before lending or extending credit. The aim is to estimate the risk of default and how much could be recovered if it happened.
A traditional framework is the five Cs of credit: character, the borrower's track record and reliability; capacity, the ability to repay from income or cash flow; capital, the borrower's own financial resources; collateral, assets pledged as security; and conditions, the purpose of the loan and the economic environment.
For a company, credit analysis typically examines cash flow, profitability, debt levels, interest coverage, liquidity, industry risks and the strength of management. For example, an analyst might find that a company's debt is five times its annual EBITDA and its interest costs are only just covered by profits, suggesting high credit risk.
The result helps lenders decide whether to lend, how much, at what interest rate and with what conditions, such as collateral or covenants.
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