Understanding the credit score
A credit score is a number, based on an analysis of a person’ s credit file, to represent the creditworthiness of an individual. Lenders use credit scores to determine who qualifies for credit, at what interest rate, and what credit limits are applied. There are two types of decision that a lender has to make, that’ s to grant credit to a new applicant, and also how to deal with existing customers including whether to increase their credit limits or not. The techniques that aid in making the first decision is known as application scoring while the second decision is called behavioral scoring. Credit report from Credit Reference Bureaus scores range from 100 to 900 with inclination towards 100 meaning poor score while towards 900 means a good score.
Understanding income and employment stability
A prospective or existing customer ' s income level and the length of the employment history play a big role in assessing their ability to repay loans or credit. A steady income indicates that the person is more likely to meet their financial obligations. Lenders utilize databases that provide real-time employment verification to confirm a borrower’ s job status and income level. This information is particularly useful for individuals who may not have extensive credit histories but have stable employment situations that indicate their ability to repay loans
Need to understand the Debt-to-Income Ratio( DTI)
The Debt-to-Income ratio is a measure of a person’ s monthly debt payments against their gross monthly income. This number is one way lenders use to measure the person’ s ability to manage the monthly payments to repay the money that one plans to borrow. A lower DTI suggests that the customer has a greater capacity to repay additional debt.
The evaluation of credit Reports
Credit reports, which are typically compiled by credit bureaus Metropol,
Creditinfo, and Transunion, contain detailed information about a person’ s borrowing history. Most lenders review these reports to check for credit accounts on how many active credit accounts a customer has and the types of credit used, how many times a customer has applied for new credit in recent months and public record Information like bankruptcies and judgments.
Credit history and repayment track record
The customer’ s payment history with the company is the most obvious way to obtain an estimate of a customer’ s likelihood of non-payment, whether he or she has paid previous debts with the company granting credit or has consistently paid on time therefore seen as lower risk. Defaults, Bankruptcies, or Late Payments are negative markers that significantly lower creditworthiness.
Other behavioral factors and trends
The emergence of modern credit assessment models use behavioral data such as transaction history, spending habits, and even social factors to assess creditworthiness. Commonly used nowadays, these models go beyond traditional credit score models to get a more comprehensive picture of a customer ' s financial responsibility. Behavioral data encompasses patterns in how borrowers interact with financial services.
Alternative credit scoring models
For customers who may not have an established credit history( e. g., young adults or those new to borrowing), alternative credit scoring models are emerging. These models take into account factors like rent payments, utility bills, and subscription services to evaluate a customer’ s creditworthiness, expanding access to credit for those who might otherwise be overlooked.
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Financial statement analysis plays a pivotal role when extending a higher credit is required as they are invaluable source of information in assessing the financial health and creditworthiness of borrowers. Lenders can make informed choices about whether to approve a loan and under what terms.
By examining the income statement, balance sheet, and cash flow statement, lenders can evaluate the borrower’ s overall financial health and determine if they have the capacity to meet repayment obligations.
Five fundamental items to inform your review and analysis are Profitability as obviously, it’ s a plus if a company is making a profit as shown by their Income Statement, Liquidity ratio is the sum of cash, marketable securities, and receivables divided by current liabilities, Inventory to net working capital, the net working capital is defined as the excess of current assets over current liabilities, leverage- current debt to tangible net worth, it’ s known that when the ratio exceeds 1.0, it’ s an indicator that the suppliers are at risk, especially if there should be a deterioration of business conditions or an interruption in cash flow, total debt to worth that is the higher the ratio, the greater the leverage and corresponding risk.
With both these ratios, you need to understand how much of the debt is secured( typically the bank loans), and the free cash flow. The FCF is simply the cash a company generates for paying creditors, or to pay interest and dividends to investors.
It important to note that customer creditworthiness is a multi-dimensional concept that involves evaluating a variety of factors, from traditional credit scores and income verification to newer behavioral and alternative data. Businesses, especially lenders, rely on these assessments to gauge the likelihood of repayment and mitigate financial risk.
By understanding these factors, businesses can make informed decisions about extending credit and managing their financial relationships, while customers can better understand how their financial behaviors impact their access to credit. 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.
Wasilwa Miriongi is a Certified Credit Professional currently working as the Managing Director, Del Creder Credit Management Limited. You can engage him on this or related matters via email at: WMiriongi @ gmail. com.