Every company needs capital to operate a business. Corporate credit is an option for businesses looking for short term loans at nominal interest rates. Let us know more about the topic.
Corporate Credit Analysis
Corporate credit analysis is the process of evaluating the credit-worthiness of a corporate borrower by assessing its financial ability to meet its debt obligations.
When determining the financial capability of a borrower, the credit analyst uses various tools to analyse the financial data provided by the borrower.
Financial data required is found in a company’s balance sheet, income statement, cash flow statement, or other financial reports that are specific to the borrower’s business. The outcome of the credit analysis determines if a bank will provide the loan that the borrower applied for and if they require an extension.
The credit analysis of a corporate entity shows the financial performance of an entity. It determines if the loan applied for is enough to meet the financial needs of the entity. If the loan amount that the borrower’s used for falls below the amount required to carry out the purpose to completion, there is a high risk of the project failing midway and the lender is incurring losses.
The amount applied for should be sufficient to finance the purpose or project, pay a salary to the owner and its directors, and meet the operating expenses of the business. An analysis of the current and expected cash flows can determine the entity’s ability to service the debt, and it can demonstrate the extent to which the company can withstand debt.
Objectives Of A Credit Analysis
The objective of corporate credit analysis is to evaluate the credit-worthiness of a corporate borrower.
It provides information on the level of risk associated with extending credit to specific borrowers.
Assets to Liabilities Ratio
The asset to liabilities ratio is an indicator of the credit-worthiness of a company. The ratio compares the assets owned by a company against its debts to other companies and individuals. The formula to calculate the ratio is:
Assets to Liabilities ratio = Total Assets / Total Liabilities
Extending credit to such an entity means taking too much risk since the company will likely utilise the funds to pay its liabilities rather than investing in assets that can generate cash flows to settle its debt. Calculating the assets to liabilities ratio can help the credit analyst gain insights into the stability of an entity’s business activities and the level of credit risk exposure.
Components of Corporate Credit Analysis
1. Unpaid Debt
The rate at which debt is defaulted and becoming bad debt provides insights into how stable an entity is. Bad debts are an expense to a company, and the higher their value, the greater the number of losses that the business incurs.
Evaluation of unpaid receivables is done by dividing the number of account receivables by the average sales in a month and multiplying the value obtained by 30 days. It gives you the average number of days in a month that the account receivables remain unpaid.
Accounts receivables require payment within a short time, usually a few days or weeks. If they go unpaid for a longer duration than is allowed, it means that there is a risk associated with lending to that entity.
2. Capital Stability
The capital stability of a company demonstrates the commitment of its shareholders. How much capital can the shareholders add to the business when it is performing dismally? If the owners are willing and ready to provide additional money for the company, it means that they are committed to seeing the success of the company.
The owners’ support and commitment can give a bank the confidence to lend to the company. The business can, therefore, take up additional debts to stabilize its operations, invest in expansion, and purchase other assets.
3. Credit Guarantee
An entity should be able to provide collateral against the commercial loan they intend to take. The collateral acts as security in case the company is unable to honor its debt obligations. Although no financial lender wants to seize a debtor’s property as repayment for a loan, the collateral serves as insurance if there are no other options of recovering the amount extended to the business as a loan.
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