Credit Analysis – An Important Task to Assess the Borrower’s Capacity to Repay

As the term is self explanatory, credit analysis is a method through which professionals calculate the creditworthiness of a business or organization. It basically defines company’s ability to pay its obligations. This process can be used to assess the company’s ability when it issues bonds through its audited financial statements. Sometimes, even banks need to take credit review of a small business before it decides to give or renew a commercial loan.

Various techniques to conduct credit analysis

There are various methods with which this process can be undertaken. Some of them are: ratio and trend analysis, creation of projections, and a detailed analysis of cash flows. The individual or the agency undertaking this process also takes into consideration an examination of collateral and other sources of repayment as well as credit history and management ability.

By taking into considerations these points, analysts essentially tires to predict whether the borrower in question is capable enough to repay the acquired loan. All these factors will be taken into consideration before granting the loan with primary focus being the cash flow of the borrower.   

Debt service coverage ratio is very important yardstick against which a credit analyst reviews the loan. Typically, this analysis would have the analyst measuring the cash generated by a business before interest expense and excluding depreciation and any other non-cash or extraordinary expenses. Usually, commercial bankers prefer the debt service coverage of at least 120 percent. To put it simply, the debt service coverage ratio should be 1.2 or higher to prove that there is an extra cushion and that business is strong enough to afford its debt requirements.   

Post credit audit

Having analyzed the risks involved in granting the loan, the immediate action on part of the credit analyst is to convey the decision to the client. Mostly, it is conveyed through letter or e-mail. 

In case, the credit analyst is not available, the information then is sent out to the personal banker who will then inform the client about the decision made. If the decision is in negative, there is an option of appeal in some situations. However, it would be the responsibility of the applicant to come up with the valid documents to support her argument with regards to inappropriate decision. So, basically credit analysis is the process undertaken to analyze the ability of the borrower to repay. If the analyzing entity decides against the borrower, there is always an option to choose another company and borrow the required money.

To learn more about credit analysis, credit review and credit audit call us at Toll Free at 888.967.7380.