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The Six C’s of Credit: Your User Manual

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NatalieIn life, there will always be instruction manuals to follow: how to change a flat tire, how to roast a turkey, how to assemble IKEA® furniture without screaming.  Ok, maybe the last one was a bit extreme, but you get the idea.  User manuals are fantastic when it comes to providing guidelines and explanations of the unfamiliar.  In the credit world, guidelines are invaluable when evaluating the creditworthiness of a company.  Information provided by a prospect can seem overwhelming at times, making a review a painstaking task.  When this happens, it’s important to know which key points to assess and the six C’s of credit can help you do just that.

We’ll begin with collateral.  In general, collateral is how a financing company ensures repayment of a loan. The required collateral will vary depending on the type of financing.  If we look at factoring, collateral is the basis for funding and, more specifically, the required collateral is receivables.  It is also important to ensure the required collateral is free and clear of any financing statements, i.e. UCC’s.  The availability of collateral is one of the most essential factors in credit.

Character is another key aspect of credit analysis.  During the due diligence phase, it is important to look at the principals credit report and background.  Poor credit may be indicative of poor character but not always, so it’s very important to thoroughly review credit experiences.  I have found that the phrase often used is “desperate people do desperate things”, and while character can sometimes be countered by controls and conditions, there are those who just won’t make the cut. In addition to the credit report, dig deeper and find out if the principal has the competence and commitment to run the business.   While the story will differ from individual to individual, poor personal finances are hard evidence and should be considered a red flag.

The next C’s I’ll group together as they tend to go hand in hand:  capital and capacity.  Both of these challenge you to analyze the financial statements:  liquidity, margins, other loans, payment history, etc.  Focus on what these statements are telling you.  Overall, you want to ensure a company has the ability to meet current and future financial obligations.

We’re almost there!  The fifth C is conditions.  It’s incredibly important to consider the conditions of the company, industry, and economy.  Review the company’s debtor strength.  Research the industry’s current and future projections, and take a look at the economy’s trends and outlook.  In addition, consider the processes, procedures, and conditions that will be put forth in the financing agreement.   All of these play a significant role in assessing the future of the company as well as the success of the agreements.

The last C can vary, but for this case, we’ll take a look at common sense.  Yes, common sense.   I know you’re telling yourself “well, this is obvious”, but it certainly can become an overlooked step in the review process.  Take a step back and look at all of the information that has been presented to you and ask yourself if the information makes sense.  In other words, does the story match the book?

It is important to note that these C’s can vary from institution to institution.  For instance, we factors like to consider these three C’s: Collateral, Collateral, and Collateral.  Ok, we look at more than that, but collateral is the lifeblood of our business.  In any event, regardless of the financing, credit reviews can be quite the task, and while these six C’s aren’t a cardinal rule, they are a great guideline in determining the creditworthiness of a company.

Natalie Follmer, Senior Credit Analyst

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