What Are The 4 Cs of Credit?

Source: CreditGuru.Com -- www.creditguru.com


Credit investigation could get intricate and dense. The information that is being gathered could be getting strewn and scattered all over the place. The 4 Cs of Credit helps in making the evaluation of credit risk systematic. They provide a framework within which the information could be gathered, segregated and analyzed. It binds the information collected into 4 broad categories namely Character; Capacity; Capital and Conditions. These Cs have been extended to 5 by adding 'Collateral', or extended to 6 by adding 'Competition' to it (Reference: Credit Management and Debt Recovery by Dick Bass, Bobby Rozario). How about 'Computer' being one of the Cs in this day and age?...or mere 'Common Sense'!

"What are the 4 C's of credit? What do they mean? Are there 3, 4, 5 or 6 Cs of Credit?

No matter how many Cs we come up with, the fundamental question that remains to be answered by the framework of our analysis is:

'Will I get paid on time?'

So let's discuss the structure of our credit analysis within the context of the 4 Cs of Credit
Character

JP Morgan, a successful businessman once said that 'I will do business with anyone as long as he/she is honest!'

In analyzing Consumer Credit one would consider the following:

• Has the person declared bankruptcy in the past

• Does the person have a good credit record

• Does he/she have a stable job

• What is the level of education/experience

• What is the person earning and what is the earning potential

• Stability at the place of residence, whether rented or owned

In analyzing Commercial Credit one would consider the following:

• The size of the operations

• The number of years in business

• The legal form of the business
  * By this one means 'Retail', 'Wholesale', 'Service' or 'Manufacturing'. Typically the incidence of business failures is high in the Retail and Service segments
  * Is the business a Parent, Subsidiary or a division
  * Does the business have a Holding company?
  The structure of the business
  * Is the business a Sole Proprietor, Partnership or Corporation?
  *For Sole proprietor or Partnership type one would further seek personal information on individual(s) running the business.
  

• The number of employees * There are Industry specific Norms for 'Employees to Sales' ratio

• The management record of the company

• The location of the company

• Any previous evidence of fraud

• Any previous Insolvency record?

• Any Labor disputes or issues?

• Are the products/service sold by the prospect complimenting products/service to the ones that you may sell?

• Is the business practice ethical?

• Is the business seasonal/ non-seasonal

• Is the business Local/ National or International.

• The economy of a business accordingly could depend upon local/ national or international economy.

• Is there a growing or a going market for this business or the business redefining itself and what would be the impact of the internet on this business.

• See what computer downloads (E.g. Napster) has done to the music industry

• How willing is the prospect to share information?

• How diligently does the prospect fill your Credit Agreement/Application?

• What are the references saying?

• Are there too many lay-offs especially of key personnel?

• Are there any Law suits pending against the company?

• What does the website of the company say and look like?

• Is there any recent media coverage about the company?

• Is it positive or negative

• Or are there any rumors floating?

• If the company's stock is publicly traded then see how its stock is performing?

• One can also check the indices for a particular type of Industry to see how in general the Industry is doing. The collapse of the NASDAQ last year was a warning of the debacle of the tech companies.

Capacity

What does one analyze under this segment?
Is it:

• Capacity of the business to pay?

• Capacity of the business in getting paid?

• Capacity of the business to receive/absorb?

• Capacity of the credit grantor to expose?

Sometime a business that you are analyzing might not have the required Capacity in kind but the same could be latent and hidden in some other form. For example a start-up business should have a good business blue-print of succeeding namely a good business plan. A contractor might have a good media advertising plan, say an Ad in the local Yellow Pages. All this adds to the capacity of a business to carry on trade and perhaps be successful.