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.

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