The 5 C’s of Credit

Most people have heard of the 5 C’s of credit. The 5 C’s encapsulate the most important factors to consider when deciding whether to grant credit to a customer or not.

Character

Before examining the financial side of the equation, it is always important to take a set back and think about what type of person this client is. Morally speaking, do they appear to be the type of person that will pay? If you are willing to extend credit to a customer, you should know them well enough to be able to answer that question.

Capacity

The next step is to determine if they even have the financial ability to pay for the good or services. Even if their heart is in the right place, some businesses simply do not have the capacity to pay.  In this case, you should find out how profitable the company is and whether they are in a sound long-term financial situation.

Capital

Does it appear that the applicant has financial strength measured by net worth or equity?

Collateral

If the client is unable to pay, do they own assets that could cover any unpaid debts. This could be in the form of machinery, inventory, property, or any other asset of value. You should also make sure that the assets being considered for use as collateral are not being used to cover an existing loan.


Conditions

Does it appear that current economic or industry conditions will affect your applicant favorably? While past performance and metrics can paint an almost complete picture, you must also look forward to see how changing economic conditions could affect the business moving forward. Will they be able to pay 6 months or a year from now?

Obviously there are plenty of other factors to consider when considering to grant credit, but the 5 C’s provide a baseline guide to get the ball rolling.

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