credit analysis

What you should know about credit analysis?

What is credit analysis?

Credit analysis is simply the evaluated creditworthiness of a business or organization. Simply put credit analysis determines whether or not a company can fulfill all of its financial obligations. Credit analysis is used in a variety of financial transactions, including banks that lend to small businesses or companies that issue bonds. Credit analysts investigate both the borrower and the lender and determine a risk rating. The rating is based upon metrics designed to determine the probability of default by the borrower and the estimation of loss the lender will suffer if a default should occur.

credit analysis

How credit is evaluated?

In simple terms credit is evaluating, by assessing the ability of a borrower to repay a loan, with interest in a timely fashion. Usually for businesses, analysts evaluate borrower’s cash flow statements, balance sheets, inventory turnover rates, market conditions and other factors to determine whether or not a borrower is “credit-worthy.” Often this means the amount of a company’s debt do not exceed its earnings and profitability.

What are credit scoring systems?

Decades of research and development have used various systems to determine scoring credits. One of these models is the univariate; a scoring system that compares various account ratios of potential borrowers with industry norms and trends. Using this approach enables analysts to determine whether or not a particular variable for a borrower differs from the norm in the industry. In turn this is used as indicator of possible future performance for a particular borrower. In today’s financial world, organizations such as Standard & Poor’s and Moody’s provide industry ratios to banks.

What are the 5 C’s?

The five C’s are another set of metrics used to determine a borrower’s creditworthiness. Many of these variables are evaluated before a risk rating is granted by a credit analyst.
Capacity –This refers to a company’s ‘capacity,’ to repay from the businesses’ cash flow.
Capital –The owner’s investment into the company as well as that individual’s risk if the company failed to perform well.
Collateral –This is a guarantee provided by the borrower to the lender as a form of repayment if the loan granted cannot be repaid under the loan agreement.
Character –In short, this is an evaluation of a company’s character or reputation. Much of what is used in this assessment determines the impression of the borrower by the lender. Usually information such as education, references and past financial dealings help to create the company’s ‘character.’
Conditions –This is the particular purpose of the loan. Part of credit analysis is to consider the conditions surrounding the requested loan. For instance analysts look at the particular industry and its conditions as well as the local economic climate and determine possible risks/rewards that may influence the borrower.

What is Financial Risk?

In the industry of finance, financial risk is any type of risk that is associated with financing. Financial risk is a term when used, that people often associate with downside risk. However modern financial risk assessment takes into a count a more complete picture of financial risk. Currently financial risk is determined by the standard deviation of a financial portfolio.

What are the types of Financial Risk?

There are many different types of financial risk; the main risks considered are listed here:
Liquidity Risk – In the event that a company or businesses’ cash flow is inadequate to cover operational costs and the company is forced to stop operation, the institution will face liquidity risk. Liquidity risk essentially prevents a company from trading services/products/assets, because no one in the market will purchase it. Thus liquidity risk is also correlated to credit ratings.

Types of Liquidity Risk:

§ Market Liquidity- This type of liquidity risk examines the market for specific products/services.
§ Funding liquidity- This type of liquidity risk examines the funding and financial-trading activities of the company.
Credit Risk –This is an assessment of the borrower’s default risk. Analysts measure the repayment record/default rate of a borrowing entity, determine market conditions and evaluate default ratios of similar borrowers to determine the possibility that a borrower will default on a loan.
Market Risk –This form of risk focuses on adverse prices or market volatility that affects assets held by a firm or institution. Market risk considers the uncertainty of a financial institution’s earnings as well as its sensitivity to movements of the market. There are four aspects of market risk
o Equity risk — Evaluates the risk that a stock or stock indices price will change
o Interest Rate Risk —The risk that interest rates will rise or fall dependent market conditions
o Currency Risk — Evaluates the risk of currency exchange rates increasing or decreasing
o Commodity Risk—Examines the risk that commodity prices may increase or decrease
Operational Risk — this form of risk involves the possibility that a company or institution will suffer financial losses due human or machine errors. Risks in this category include employee settlements and/or customer liability suits.
Foreign Investment Risk— Rapid and extreme changes pervade the market both domestically and globally. Foreign investment risk evaluates these changes internationally and their causes such as: accounting differences, smaller markets, auditing standards, economic conflict, etc.,

How do I become a credit analyst?

Becoming a credit analyst requires a mind for numbers and formulas. Other requirements include at the very least a bachelor’s degree in statistics, accounting, business or economics. The national average salary for a credit analyst is $48,000 per year. While many find this work rewarding, there appears to be very little variance in pay after ten years of experience.