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Credit Analysis – In layman terms, Credit analysis is more about identification of risks in situations where a potential for lending is
observed by the Banks. Both quantitative and qualitative assessment forms a part of overall appraisal of the clients
(company/individual). This in general, helps to determine the entity’s debt servicing capacity, or its ability to repay.
In this article, we look at Credit Analysis from Beginner’s point of view –
 What is Credit Analysis?
 Credit Analysis Process
 What does a Credit Analyst looks for?
 The 5 C’s of Credit Analysis
 Credit Analysis Case Study
 Credit Analyst – Obtaining Quantitative Data of the Clients
 Credit Analysis – Judgement
 Credit Analysis Ratios
 Credit Rating
 Lesson Learned from Credit Analysis Case Study
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WHAT IS CREDIT ANALYSIS?
Credit Analysis Definition –
Credit analysis is a process of drawing conclusions from available data (both quantitative and qualitative) regarding the credit –
worthiness of an entity, and making recommendations regarding the perceived needs, and risks.
Credit Analysis is also concerned with the identification, evaluation and mitigation of risks associated with an entity failing to meet
financial commitments.
CREDIT ANALYSIS PROCESS
Below diagram shows the overall Credit Analysis Process. (SEE SUMMER)

WHAT DOES A CREDIT ANALYST LOOKS FOR?

Ever wondered why bankers ask so many questions and make you fill so many forms, when you apply for a loan. Don’t some of them
feel intrusive and repetitive and the whole process of submission of various documents seems cumbersome. You just try to fathom,
as to what they do with all this data and what they are actually trying to ascertain! It is definitely not only your deadly charm and
attractive personality that makes you a good potential borrower; obviously there is more to that story. So here we will try to get an
idea about what exactly a Credit Analyst is looking for.
THE 5 C’S OF CREDIT ANALYSIS
CHARACTER
 This is the part where the general impression of the protective borrower is analysed. The lender forms a very subjective
opinion about the trust – worthiness of the entity to repay the loan. Discrete enquires, background, experience level,
market opinion, and various other sources can be a way to collect qualitative information and then an opinion can be
formed, whereby he can take a decision about the character of the entity.
CAPACITY
 Capacity refers to the ability of the borrower to service the loan from the profits generated by his investments. This is
perhaps the most important of the five factors. The lender will calculate exactly how the repayment is supposed to take
place, cash flow from the business, timing of repayment, probability of successful repayment of the loan, payment history
and such factors, are considered to arrive at the probable capacity of the entity to repay the loan.
CAPITAL
 Capital is the borrower’s own skin in the business. This is seen as a proof of the borrower’s commitment to the business.
This is an indicator of how much the borrower is at risk if the business fails. Lenders expect a decent contribution from the
borrower’s own assets and personal financial guarantee to establish that they have committed their own funds before
asking for any funding. Good capital goes on to strengthen the trust between the lender and borrower.
COLLATERAL (OR GUARANTEES)
 Collateral are form of security that the borrower provides to the lender, to appropriate the loan in case it is not repaid from
the returns as established at the time of availing the facility. Guarantees on the other hand are documents promising the
repayment of the loan from someone else (generally family member or friends), if the borrower fails to repay the loan.
Getting adequate collateral or guarantees as may deem fit to cover partly or wholly the loan amount bears huge
significance. This is a way to mitigate the default risk. Many times, Collateral security is also used to offset any distasteful
factors that may have come to the fore-front during the assessment process.
CONDITIONS
 Conditions describe the purpose of the loan as well as the terms under which the facility is sanctioned. Purposes can be
Working capital, purchase of additional equipment, inventory, or for long term investment. The lender considers various
factors, such asmacroeconomic conditions, currency positions, and industry health before putting forth the conditions for
the facility.
CREDIT ANALYSIS CASE STUDY
From times immemorial, there has been an eternal conflict between entrepreneurs/businessmen and bankers, regarding the
quantification of credit. The resentment on the part of the business owner arises when he believes that the banker might not be
fully appreciating his business requirements/needs and might be underestimating the real scale of opportunity that is accessible to
him, provided he gets sufficient quantum of loan. However, the credit analyst might be having his own reasons to justify the amount
of risk he is ready to bear, which may include bad experiences with that particular sector, or his own assessment of the business
requirements. Many times there are also internal norms or regulations which force the analyst to follow a more restrictive discourse.
The most important point to realize is that banks are in the business of selling money and therefore risk regulation and restrain are
very fundamental to the whole process.Therefore, the loan products available to prospective customers, the terms and conditions
set for availing the facility and the steps taken by the bank to protect its assets against default, all have a direct forbearance to the
proper assessment of the credit facility.
So, let’s have a look at what does a loan proposal looks like:
The exact nature of proposals may vary depending on subsequent clients, but the elements are generally the same.
**To put things into perspective let’s consider the example of one Sanjay Sallaya, who is credited to being one of the biggest
defaulters in recent history along with being one of the biggest businessmen in the world. He owns multiple companies, some sports
franchises, and few bungalows in all major cities.
1. Who is the client? Ex. Sanjay Sallaya, reputed industrialist, owning majority share in XYZ ltd., and some others.
2. Quantum of credit they need and when? Ex. Starting a new airline division, which would cater to the high end segment of
society. Credit demand is $25 mil, needed over the next 6 months.
3. The specific purpose the credit will be employed for? Ex. Acquiring of new aircrafts, and capital for day to day operations
like fuel costs, staff emoluments,airport parking charges, etc.
4. Ways and means to service the debt obligations (which include application and processing fees, interest, principal and
other statutory charges) Ex. Revenue generated from flight operations, freight delivery and freight delivery.
5. What protection (collateral) can the client provide in the event of default? Ex. Multiple bungalows in prime locations
offered as collateral, along with personal guarantee of Sanjay Sallaya, one of the most reputed businessmen in the world.
6. What are the key areas of the business and how are they operated, and monitored?Ex. Detailed reports would be
provided on all key metrics related to the business.
Answers to these questions, helps the credit analyst to understand the broad risks associated with the proposed loan. These
questions provide the basic information about the client and help the analyst to get deeper into the business and understand any
intrinsic risks associated with it.
CREDIT ANALYST – OBTAINING QUANTITATIVE DATA OF THE CLIENTS
Other than the above questions the analyst also needs to obtain quantitative data specific to the client:
 Borrower’s history – A brief background of the company, its capital structure, its founders, stages of development, plans for
growth, list of customers, suppliers, service providers, management structure, products, and all such information are
exhaustively collected to form a fair and just opinion about the company.
 Market Data – The specific industry trends, size of the market, market share, assessment of competition, competitive
advantages, marketing, public relations, and relevant future trends are studied to create a holistic expectation of future
movements and needs.
 Financial Information – Financial statements (Best case/ expected case/ worst case), Tax returns, company valuations and
appraisal of assets, current balance sheet, credit references, and all similar documents which can provide an insight into the
financial health of the company are scrutinized in great detail.
 Schedules and exhibits – Certain key documents, such as agreements with vendors and customers, insurance policies, lease
agreements, picture of the products or sites, should be appended as exhibits to the loan proposal as proofs of the specifics
as judged by above mentioned indicators.
**It must be understood that the credit analyst once convinced will act as the client’s advocate in presenting the application to the
bank’s loan committee and also guiding it through the bank’s internal procedures. The details obtained are also used to finalize the
loan documentation, terms, rates and any special covenants which need to be stipulated, keeping in mind the business frame-work
of the client as well the macro – economic factors.
CREDIT ANALYSIS – JUDGEMENT
After collating all the information, now the analyst has to make the real “Judgement”, regarding the different aspects of the
proposal which will be presented to the sanctioning committee:
 Loan – After understanding the need of the client, one of the many types of loans, can be tailored to suit the client’s needs.
Amount of money, maturity of loan, expected use of proceeds can be fixed, depending upon the nature of the industry and
the credit worthiness of the company.
 Company – The market share of the company, products and services offered, major suppliers, clients and competitors,
should be analysed to ascertain its dependency on such factors.
 Credit History – Past is an important parameter to predict future, therefore, keeping in line with this conventional wisdom,
client’s past credit accounts should be analysed to check any irregularities or defaults. This also allows the analyst to judge
the kind of client we are dealing with, by checking the number of times late payments were made or what penalties were
imposed due to non compliance with stipulated norms.
 Analysis of market – Analysis of the concerned market is of utmost importance as this helps us in identifying and evaluating
the dependency of the company on external factors. Market structure, size and demand of the concerned client’s product
are important factors that analysts are concerned with.
CREDIT ANALYSIS RATIOS
A company’s financials contain the exact picture of what the business is going through, and this quantitative assessment bears
utmost significance.Analysts consider various ratios and financial instruments to arrive at the true picture of the company.
1. Liquidity ratios – These ratios deal with the ability of the company to repay its creditors, expenses, etc. These ratios are
used to arrive at the cash generation capacity of the company. A profitable company does not imply that it will meet all its
financial commitments.
2. Solvability ratios – These ratios deal with the balance sheet items and are used to judge the future path that the company
may follow.
3. Solvency ratios – These ratios are used to judge the risk involved in the business. These ratios take into picture the
increasing amount of debts which may adversely affect the long term solvency of the company.
4. Profitability ratios – These ratios show the ability of a company to earn satisfactory profit over a period of time.
5. Efficiency ratios – These ratios provide insight in the management’s ability to earn a return on the capital involved, and the
control they have on the expenses.
6. Cash flow and projected cash flow analysis – Cash flow statement is one of the most important instrument available to a
Credit Analyst, as this helps him to gauge the exact nature of revenue and profit flow. This helps him get a true picture
about the movement of money in and out of the business
7. Collateral analysis – Any security provided should be marketable, stable and transferable. These factors are highly
important as failure on any of these fronts will lead to complete failure of this obligation.
8. SWOT analysis – This is again a subjective analysis, which is done to align the expectations and current reality with market
conditions.
If you wish to learn more about financial analysis, then click here for this amazing Financial Statement analysis guide
CREDIT RATING
Credit rating is a quantitative method using statistical models to assess credit worthiness based on the information of the borrower.
Most banking institutions have theirown rating mechanism. This is done to judge under which risk category the borrower falls. This
also helps in determining the term and conditions and various models use multiple quantitative and qualitative fields to judge the
borrower. Many banks also use external rating agencies such asMoody’s, Fitch, S&P etc. to rate borrowers, which then forms an
important basis for consideration of the loan.
LESSON LEARNED – MR. SANJAY SALLAYA
So, let’s illustrate the whole exercise with the help of an example of Mr. Sanjay Sallaya, who is a liquor barron, and a hugely
respected industrialist, who also happens to own a few sports franchises and has bungalows in the most expensive locals. He now
wants to start his own airline, and has therefore approached you for a loan to finance the same.
The loan is for a meagre $1 million. So, as a credit analyst we have to assess whether or not to go forward with the proposal. To
begin, with we will obtain all the required documents which are needed to understand the business model, working plan and other
details of his new proposed business. Necessary inspection and enquires are undertaken to validate the veracity of his documents. A
TEV i.e Techno Economic Viability can also be undertaken to get an opinion from the experts in aviation industry about the viability
of the plan.
When finally we are satisfied with the overall efficacy of the plan, we can discuss the securities that will collaterally cover our loan
(partly/fully). Mr. Sanjay Sallaya being a well-established industrialist holds a good reputation in the business world and therefore
will hold good recommendations. Such a proposal if it meets all other aspects can be presented for sanction, comfortably, and
generally enjoys good terms from the bank’s side as the risk associated with such personalities are always assessed to be less.
Therefore, to conclude, Mr. Sanjay Sallaya will get a loan of $1 million approved and will go on to start his airline business, however,
what the future holds can never be predicted, when a loan is sanctioned.
also, checkout the difference between Equity Research vs Credit Research
CONCLUSION
Credit Analysis is about making decisions keeping in mind the past, present and the future. As a Credit analyst, two days in life are
never the same. The role offers a plethora of opportunities to learn and understand different types of businesses as one engages
with a multitude of clients hailing from different sectors. Not only is the career monetarily rewarding but also helps an individual
grow along with providing good opportunities to build one’s career.
Credit analysis by a lender is determined by the “5Cs”: credit, character, capacity, collateral, and condition.
• Credit: As history is the best predictor of the future, a lender will examine the personal credit of all borrowers and guarantors.
Good personal credit is a must. Any problems must be thoroughly explained.
• Character: Lenders need to know the borrower and guarantors are honest and have integrity. Additionally, the lender needs to be
confident the applicant has the background, education, experience, and industry knowledge to successfully run the business.
• Capacity (cash flow): The business should have sufficient cash flow to support its business expenses and debts comfortably while
providing the principals salaries that will support personal expenses and debts.
• Collateral: A lender will consider the value of the business’ assets and the personal assets of the guarantors securing the loan as a
secondary source of repayment if the loan cannot be repaid. Collateral is an important consideration for a conventional loan, but not
as imperative with an SBA loan.
• Condition: The lender will need to understand the condition of the business, the industry, and the economy. Are current
conditions likely to change, deteriorate, or improve?

The five components that make up a credit analysis help the lender understand the owner and the business and determine credit
worthiness. By knowing each of the “5 Cs,” you will have a better understanding of what is needed and how to prepare for the loan
application process.
What you should know about credit analysis?
What is credit analysis?
Credit analysis is simply the evaluated creditworthiness of a business or organization. Simply put credit analysis determines
whether or not a company can fulfill all of its financial obligations. Credit analysis is used in a variety of financial
transactions, including banks that lend to small businesses or companies that issue bonds. Credit analysts investigate
both the borrower and the lender and determine a risk rating. The rating is based upon metrics designed to determine the
probability of default by the borrower and the estimation of loss the lender will suffer if a default should occur.

How credit is evaluated?

In simple terms credit is evaluating, by assessing the ability of a borrower to repay a loan, with interest in a timely fashi on.
Usually for businesses, analysts evaluate borrower’s cash flow statements, balance sheets, inventory turnover rates, market
conditions and other factors to determine whether or not a borrower is “credit -worthy.” Often this means the amount of a
company’s debt do not exceed its earnings and profitability.
What are credit scoring systems?
Decades of research and development have used various systems to determine scoring credits. One of these models is the
univariate; a scoring system that compares various account ratios of potent ial borrowers with industry norms and trends.
Using this approach enables analysts to determine whether or not a particular variable for a borrower differs from the
norm in the industry. In turn this is used as indicator of possible future performance for a particular borrower. In today’s
financial world, organizations such as Standard & Poor’s and Moody’s provide industry ratios to banks.
What are the 5 C’s?
The five C’s are another set of metrics used to determine a borrower’s creditworthiness. Many of th ese variables are
evaluated before a risk rating is granted by a credit analyst.
Capacity –This refers to a company’s ‘capacity,’ to repay from the businesses’ cash flow.
Capital –The owner’s investment into the company as well as that individual’s risk if the company failed to perform well.
Collateral –This is a guarantee provided by the borrower to the lender as a form of repayment if the loan granted cannot be
repaid under the loan agreement.
Character –In short, this is an evaluation of a company’s character or reputation. Much of what is used in this assessment
determines the impression of the borrower by the lender. Usually information such as education, references and past
financial dealings help to create the company’s ‘character.’
Conditions –This is the particular purpose of the loan. Part of credit analysis is to consider the conditions surrounding the
requested loan. For instance analysts look at the particular industry and its conditions as well as the local economic climat e
and determine possible risks/rewards that may influence the borrower.
What is Financial Risk?
In the industry of finance, financial risk is any type of risk that is associated with financing. Financial risk is a term wh en
used, that people often associate with downside risk. H owever modern financial risk assessment takes into a count a more
complete picture of financial risk. Currently financial risk is determined by the standard deviation of a financial portfolio .
What are the types of Financial Risk?
There are many different types of financial risk; the main risks considered are listed here:
Liquidity Risk – In the event that a company or businesses’ cash flow is inadequate to cover operational costs and the
company is forced to stop operation, the institution will face liquid ity risk. Liquidity risk essentially prevents a company
from trading services/products/assets, because no one in the market will purchase it. Thus liquidity risk is also correlated to
credit ratings.
Types of Liquidity Risk:
§ Market Liquidity- This type of liquidity risk examines the market for specific products/services.
§ Funding liquidity- This type of liquidity risk examines the funding and financial -trading activities of the company.
Credit Risk –This is an assessment of the borrower’s default risk. Analysts measure the repayment record/default rate of a
borrowing entity, determine market conditions and evaluate default ratios of similar borrowers to determine the possibility
that a borrower will default on a loan.
Market Risk –This form of risk focuses on adverse prices or market volatility that affects assets held by a firm or institution.
Market risk considers the uncertainty of a financial institution’s earnings as well as its sensitivity to movements of the
market. There are four aspects of market risk
o Equity risk — Evaluates the risk that a stock or stock indices price will change
o Interest Rate Risk —The risk that interest rates will rise or fall dependent market conditions
o Currency Risk — Evaluates the risk of currency exchange rates increasing or decreasing
o Commodity Risk—Examines the risk that commodity prices may increase or decrease
Operational Risk — this form of risk involves the possibility that a company or institution will suffer financial losses due
human or machine errors. Risks in this category include employee settlements and/or customer liability suits.
Foreign Investment Risk— Rapid and extreme changes pervade the market both domestically and globally. Foreign
investment risk evaluates these changes internationally and their causes such as: accounting differences, smaller markets,
auditing standards, economic conflict, etc.,
How do I become a credit analyst?
Becoming a credit analyst requires a mind for numbers and formulas. Other requirements include at the very least a
bachelor’s degree in statistics, accounting, business or economics. The national average salary for a credit analyst is
$48,000 per year. While many find this work rewarding, there appears to be very little variance in pay after ten years of
experience.