The importance of credit analysis has grown in the last two decades as the financial domain continues to evolve with innovations. After the global financial crisis, conducting credit analysis was an important step to filter the bad credit risk borrowers and improve the profitability of the lending party.
Corporate credit analysis can be explained as a process in which the creditworthiness of a corporate borrower seeking funds is assessed. The main emphasis is laid on evaluating the cash flow process of the business and check whether it will be able to meet its loan obligations or not.
Credit analysts have various financial tools to evaluate the creditworthiness of the borrower based on the information collected related to the financial standing of the corporations. The tools and techniques applied by the analysts include both qualitative and quantitative measures.
Relevant financial data is collected from multiple sources including the company’s financial statements like balance sheet, cash flow statements, profit and loss statements, etc. After conducting thorough research and analyzing all the financial data the lending party concludes as to whether or not it will be feasible to provide credit to the corporation.
The credit analysis process of a corporation depicts the financial performance of the business. It also evaluates whether the loan amount applied for by the business is enough to meet the financial requirements of the project being undertaken by the company.
The purpose of evaluating the loan amount is to find out whether it will be sufficient to meet the needs of the project or the company will require additional funds. If the loan amount applied for is lower than the actual amount needed to finance the project, the lending party might not approve the loan as the chances of project failure will be higher.
Let’s delve deeper into some of the major elements of the corporate credit analysis process.
- The Asset to Liability Ratio: The asset to liability ratio is one of the key indicators of a corporation’s creditworthiness. It measures the overall assets owned by an entity in comparison to its aggregate liability. It can be easily computed by dividing the total asset figure by the total liabilities amount of the company. A higher asset to liability ratio acts in favour of the company and means that the creditworthiness of the corporation is high. Generally, the asset to liability ratio of 2 or higher is considered as good.
- Unpaid Receivables: Unpaid receivables are among one of the major elements of the corporate credit analysis process. To evaluate the stability of a business, it is important to look at the rate at which the receivable is becoming bad debts. If the account receivables are not paid for a higher duration, the risk associated with that particular corporation is higher.
- Stability of Capital: A stable capital source for the company means that the stakeholders believe in the mission of the company and are committed for the long haul. This commitment helps to establish trust with the lenders and it is easier to lend money to corporations with a stable capital source. If the shareholders of the corporation are committed to the long term performance it is easier for the business to borrow money for expansion and stabilizing operations.
- Collateral: It’s no secret that borrowing a loan using collateral is way easier than without it. Having collateral helps to instil trust among the lenders and they are more confident to provide loans as they have a safety net in the form of collateral offered by the borrower. The collateral makes up for insurance for the lending party and they can use it to recover the loan amount in case the business fails to meet its debt obligations continuously.