The 5 C’s of Credit is also known as the 5 C’s of banking. It refers to main 5 points which the banks use to take approval decision of loans. The main points the banks analyze are
Cash Flow refers to the cash flow that the business generates or the monthly income for an individual. The cash flow is checked to determine whether the business or the individual will be able to repay the loan from the cash flow from business or his monthly income.
For companies, banks use different financial ratios like “Debt Service Coverage Ratio” and “Interest Coverage Ratio” to analyze the loan repaying capability of the company. For individual, it should be the monthly salary and the credit rating of the company they are employed in. Banks normally don’t provide the loan in case of cash flow uncertainty.
Collateral provides some security to the banks when they are giving high amount of loans to the borrowers. Banks use the collateral as the secondary source of repayment of the loan if the company or individual fails to repay the loan within the agreed time period.
It provides some comfort to the banks as they will be able to recover either some parts or the entire amount of the loan in future by selling the collateral. Banks accept account receivables, Inventory, Land, Fixed assets, real estates as collaterals while providing loans.
Capital refers to the current capital that the company or the individual is holding. For a company, it is same as the owner’s equity in the company and it should be sufficient enough for the loan to be approved.
Enough capital will ensure that the company can continue with its business operations even if it fails to generate positive cash flow for some time. Also high owner’s capital in the company gives more confidence in the bank that the owners have very high interest in the current business and will stick to it during any crisis situation as well. Banks normally check “debt-equity ratio” to analyze the current status of owner’s capital and debt level in the company.
Conditions refer to the current business scenarios and the overall credit environment. Banks normally hesitate to provide loans if the current business situation is not good and profitability of the companies is not up to the mark. Also if the overall credit environment is bad and NPA (Non-Performing Asset) is already high then banks normally don’t provide loans easily.
For companies, banks also analyze the sector they are operating in and the current condition of the entire sector. Banks check the below details while analyzing the condition of a company while providing loans.
After checking all these parameters, banks provide loan to the company only if they find it suitable based on these conditions.
Character of the company owners or the individual is one of the most important parameter, banks check while providing the loans to companies or individuals. Banks refer to the previous track records of the borrower and his willingness to repay the loan amount. Banks provide loans only to the borrowers with sound character whom can also be trusted to honor their commitment in repaying the loan amount.
These are very important parameters that the banks use to take decision about the approval of the loans. The Individuals and companies should also try to improve these parameters before going for any fresh loan application.