Credit analysis is done as a way of measuring an entity’s ability to meet its debt obligations. Experts assess and analyse creditworthiness of credit applicants. This analysis is designed to make it easier for lenders to assess risk levels.
It is ideal for identifying the level of default risk that is involved in granting credit. This rating guides the decision on whether to loan money to the entity or not.
A positive rating may lead to credit being granted, while a negative rating is likely to mean that credit providers won’t want to risk providing credit. The latter result is more likely to mean that the applicant will not be able to afford to repay the loan.
It is essentially used to assess how severe losses will be should there be a default.
This can be done by using a variety of financial ratios that derive details from the financial statements of the applicant. This qualitative information is used to complement the quantitative analysis involved in the process, which is about identification of risks. As a risk management process, credit analysis can be a great way of identifying potential problems that may emerge.
Analysis process includes 5Cs:
By drawing conclusions from available data, lenders are able to work out how reliable an individual or business is. The data reflects their past credit behaviour and other financial decisions they have mad, as well as cash flow. The credit analysis process is about making recommendations regarding perceived needs and risks.
If an the recommendations are positive, then the applicant is likely to be granted finance, according to how much they can afford to repay.