Character
What is the question that the character part of the five cs asks?
Will they repay the debt?
This is the primary source a bank expects a borrower to use to repay a loan — not selling assets or getting lucky
Cash flow
Collateral
Net worth
Cash flow
What does the Capital part of the Five Cs of Credit ask?
borrower’s financial stake + ability to absorb losses before the bank loses money
whether the borrower has high-value equipment or real estate that the bank can seize and sell if the loan is not repaid.
the education level, specialized skills, and management experience of the business owners and their employees.
What is an example of a capital growing process?
Equity capital
Debt capital
Retained earnings
All of the above
borrower’s financial stake + ability to absorb losses before the bank loses money
What question does ‘Collateral’ ask?
What are the additional forms of security a borrower can provide with the agreement that it will be the repayment source in case they cannot repay the loan?
What does the ‘Conditions’ part of the Five Cs of Credit look at?
Current profitability, free cash flow, and overall performance of the business. Looks at the balance sheet.
The borrower's ability to service the debt through steady cash flow and income.
Broader market environment and external factors that could affect the success of the business
The contractual agreement of the loan, and what the business will agree to do if it can’t pay it back
Broader market environment and external factors that could affect the success of the business
What is a FICO score?
A 3-digit snapshot of credit risk. It helps lenders determine a business's ability to pay back a loan.
One-sentence summary of ‘Capacity’
Proven, recurring cash flow that comfortably covers debt payments even when business conditions worsen.
Measure of the ability to pay back loans based on total net worth and asset base of the company.
Borrower’s reliability and track record of paying obligations on time.
Proven, recurring cash flow that comfortably covers debt payments even when business conditions worsen.
A profitable business distributes nearly all profits to the owner every year instead of keeping earnings in the company. This is an example of reinvested profits.
True
False
Which do lenders most commonly look at when considering collateral, book value or market value?
Market value- market value represents how much a lender could actually receive from the sale of an asset, whereas book value looks at how much it is worth to a company based on original price and depreciation.
When considering ‘Conditions’, which is important for a business to look at when preparing to apply for a loan?
The quality of material you use for your products
The financial health of the company
The Debt Service Coverage Ratio (DSCR)
Demand for the product you are selling
Demand for the product you are selling
What are 2 factors that show a good character in a business when applying for a loan?
Examples: maintained high credit score, debts paid on time, professional references provided
A credit analyst is giving a report on a company applying for a loan which has a negative net cash balance. Which of the following might the analyst use to justify the company's capacity to pay back debt despite the negative net cash balance?
A) Cash flow statement
B) Balance sheet
C) LTV ratio
A) Cash flow statement
This can show where the cash is going- it can show that the loss of cash is due to investing activities (for example, buying better factory equipment) rather than operating activities (profits not covering daily expenses)
How do lenders assess capital to determine overall financial strength?
Income statement
Balance sheet
Statement of cash flows
2. Balance sheet
Which is not a typical example of collateral?
Accounts receivable
A company’s trademarked logo
Factory equipment
Cash
A company’s trademarked logo
When considering conditions, what are the most important factors that lenders evaluate to decide whether it’s appropriate to extend credit?
The amount of principle, the interest rate, and the repayment period
The borrower’s credit score, payment history, and banking relationships
The company’s industry outlook, market competition, and economic forecasts
The company’s industry outlook, market competition, and economic forecasts
A new small business owner applies for a commercial loan. Despite their business showing strong current profitability, which would most likely make a Credit Analyst hesitant?
a. The business is new
b. The owner has a bad personal credit score
c. The owner was rude during the meeting
b. The owner has a bad personal credit score. This shows a lack of priority to pay off debt- even if operations are very profitable right now, they might not be in the future. Rudeness doesn't really matter the guy can still be a great business man
A borrower applying for a business loan states that their plan for repayment is to sell a specific piece of machinery if they run low on funds. Why would a credit analyst still view this as a failure of Capacity?
Equipment is difficult to value
Repayment is not coming from a primary source
The borrower did not provide enough collateral
2. Repayment is not coming from a primary source
Banks want repayment from operations, not asset liquidation- that should be a backup, not the main plan.
What does it mean to have “skin in the game”?
Being extremely involved with the company and overseeing all financial duties and profits.
Have a personal investment in an organization and take risk, therefore having a vested interest in its success.
Having decision-making authority and control over company operations.
Have a personal investment in an organization and take risk, therefore having a vested interest in its success.
Lenders typically apply discounts to the market value of collateral to account for potential price volatility, ensuring that the loan stays secure even if the market worsens, and the assets are worth less than they are currently. What is this an example of?
Risk mitigation
Valuation and appraisal
Use of LTV (loan-to-value) ratio
Perfection of security interest
Risk mitigation
BONUS! Bankers sometimes refer to applying discounts when risk mitigating as.. What barbershop term?
When is lending most inappropriate due to the ‘conditions’ component of the credit decision for a loan application?
When the borrower’s industry is entering an economic downturn that could impair future repayment ability.
When the borrower’s asset base has uncertain liquidation value and recovery estimates are unreliable
When the borrower has limited operating history and management lacks demonstrated experience
When the borrower’s industry is entering an economic downturn that could impair future repayment ability.
True or False: In a bankruptcy scenario, 'Character' is the primary 'C' used to determine the difference between a 'Strategic Default' and an 'Involuntary Default'. If true, which one does ‘Character’ apply to? If false, how does ‘Character’ apply to both?
True; strategic default, because the borrower has the capacity to pay out, but chooses not to
A business generates $200,000 in annual cash flow and owes $160,000 in annual loan payments. The bank calculates this repayment safety ratio.
Loan-to-Value Ratio (LTV)
Debt Service Coverage Ratio (DSCR)
Return on Equity (RE)
Debt Service Coverage Ratio (DSCR)
Businesses are better able to withstand economic downturns, unexpected expenses, or revenue volatility when they:
Maintain a strong capital cushion that can absorb operating losses without impairing debt repayment
Hold significant collateral that could be liquidated if performance declines
Continuously increase borrowing to stabilize short-term cash flow
Maintain a strong capital cushion that can absorb operating losses without impairing debt repayment
What is an LTV?
a financial metric used by lenders to compare the amount of a loan against the appraised value of an asset. Calculated as (loan amount/appraised value of asset)x100. Used to help determine risk, and therefore terms of a loan
Which might a credit analyst include in a report, in reference to a ‘condition’, as a reason not to extend credit?
High material costs declared by the firm’s fabric supplier will likely wipe out the firm's profit margins.
Reduced government spending creates a critical shortage of future project leads.
The deteriorated condition of the machinery in the factory may trap the firm with unmarketable equipment.
Reduced government spending creates a critical shortage of future project leads.