Credit Analysis – An Important Task to Assess the

Borrower’s Capacity to Repay

As the term is self explanatory, credit analysis is a method

through which professionals calculate the creditworthiness of a

business or organization. It basically defines company’s ability to

pay its obligations. This process can be used to assess the

company’s ability when it issues bonds through its audited financial

statements. Sometimes, even banks need to take credit review of a

small business before it decides to give or renew a commercial loan.

Various techniques to conduct credit analysis

There are various methods with which this process can be

undertaken. Some of them are: ratio and trend analysis, creation of

projections, and a detailed analysis of cash flows. The individual or

the agency undertaking this process also takes into consideration

an examination of collateral and other sources of repayment as well

as credit history and management ability.

By taking into considerations these points, analysts essentially tires

to predict whether the borrower in question is capable enough to

repay the acquired loan. All these factors will be taken into

consideration before granting the loan with primary focus being the

cash flow of the borrower.

Debt service coverage ratio is very important yardstick against

which a credit analyst reviews the loan. Typically, this analysis

would have the analyst measuring the cash generated by a

business before interest expense and excluding depreciation and

any other non-cash or extraordinary expenses. Usually, commercial

bankers prefer the debt service coverage of at least 120 percent. To

put it simply, the debt service coverage ratio should be 1.2 or

higher to prove that there is an extra cushion and that business is

strong enough to afford its debt requirements.

Post credit audit

Having analyzed the risks involved in granting the loan, the

immediate action on part of the credit analyst is to convey the

decision to the client. Mostly, it is conveyed through letter or e-mail.

In case, the credit analyst is not available, the information then is

sent out to the personal banker who will then inform the client

about the decision made. If the decision is in negative, there is an

option of appeal in some situations. However, it would be the

responsibility of the applicant to come up with the valid documents

to support her argument with regards to inappropriate decision. So,

basically credit analysis is the process undertaken to analyze the

ability of the borrower to repay. If the analyzing entity decides

against the borrower, there is always an option to choose another

company and borrow the required money.

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