Credit Management
Demystifying The Concept Of Customer Creditworthiness
By Wasilwa Miriongi
Whenever approached by a customer with intention of transacting business on credit two risks will always keep ringing alarm bells in your ears the first being default risk, which is about assessing a firm’ s or individuals’ capacity and willingness to service the debt in a timely fashion and secondly the recovery prospects, which provides an assessment of how much a creditor would recoup in the event of default, and is measured by assessing the characteristics of each debt instrument and structure, and collateral valuation.
Many theories and models have been developed on the issue of customer creditworthiness as well as volumes being written about the criteria you should use to make a credit decision. It is a known fact in the credit circles that the decision to grant credit to a customer should be a conscious one and not an accident of selling meaning that Companies that just sell first and hope to collect later are killing their businesses knowingly. That is why when granting credit, a firm has no choice but try to distinguish between customers who will pay and customers who will not pay.
The most common model applied in assessing the customer’ s credit worthiness is called the 5 Cs of credit, where the first C, Character indicates that credit analysts must look at the leadership of the firm, its reputation, and its strategy, here the aim is to get a customer with good character
The second C, is Capacity, on capacity the focus should be on the firm’ s ability to make enough money to honor its obligations as it is known in credit circles that even though a customer, may be very honest and his character is very good, he may not be a good businessman if he does not possess the required skills for doing the job.
The third C, Capital, reviews how well capitalized the firm is or how much money
For borrowers, creditworthiness can significantly impact access to loans and the terms offered, influencing the types of disbursement solutions available to them. For lenders, accurately assessing creditworthiness is essential for mitigating risks associated with lending, ensuring that they provide appropriate disbursement solutions tailored to the customer’ s financial profile.
the owner has invested in the venture as this determines the level of commitment of the owner since any endeavor he undertakes would come only when he has his fair share of money invested in the business
The fourth C, is Conditions, which focuses on the competitive environment of the firm and how well it fits, among them are the political stability of the country, the demand for the product, the industry prospects, availability of raw materials, and infrastructure facilities.
The last C, Collateral, analyzes other potential sources of repayment of the obligations, if these are supported by collateral security. Collateral literally means something additional but subordinate.
Being in an era where there is abundancy of information and availability of artificial intelligence, the way in which this information is often presented belies the fact most business credit decisions are not that difficult. Using objective criteria, it is relatively easy to determine which companies are worthy of open credit terms and which are not.
When appealing to common sense it dictates that credit evaluations need to be more rigorous when the amount of credit required exceeds the working capital and cash flow capabilities of the company being evaluated or when derogatory information clouds an otherwise financially stable enterprise, but that’ s a discussion for another day. Therefore, the credit review of the ABCs of credit evaluations focuses on the decisions that will be relatively easy to make based on the following factors:
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