How to evaluate credit applications?

With the present economic situation, consumer financing is one of the most challenging industries we have today. Granting credit and collecting accounts are critical areas that need to be given much attention especially that nowadays, granting credit or approving credit applications are no longer exclusive to credit executives. As a matter of fact, lately I have been seeing a lot of salespeople doing credit evaluation pertaining credit sales transactions.

With this, let me offer five simple considerations in evaluating credit applications. The decision to extend credit can be firmed up when the sales or credit officer is satisfied on the following considerations:

First and foremost, determine if the 5 C’s of Credit are favorable.  Check, if the results of analysis are favorable about the applicants’ character, capacity, capital, collateral and conditions, then this is good indicator that the credit application might be granted. These basic credit yardsticks must be found satisfactory based on the completed evaluation of credit applicant’s income statements, cash flow credit investigation reports depicting credit performance; among others.

Second, ask yourself what is the real purpose of credit.  As a rule of thumb, the creditor should always satisfy itself that the essential requirements are provided for before extending credit for needs or wants.  “Needs” are ordinary expenses, while “wants” refer to those things, which the applicant can get along without. It is of paramount importance that the sales / credit officer be thoroughly acquainted with the type of business for which financing is requested, develop facts which will enable arriving at correct decisions, and always give very careful consideration to the purpose/s for which credit is extended.  

Third, analyze the amount to loan. The credit limit should be kept in proper relationship to the strength of the credit factors and permit orderly liquidation from normal operating income or what they commonly called in consumer financing as “net disposable income’.  If the minimum amount necessary for the credit applicant is greater than the projected income, the credit request should normally be declined.    

Fourth, review the repayment plan. The credit line must incorporate a complete and acceptable plan of repayment, which shows clearly the manner in which each credit line is to be liquidated.  The plan of liquidation should be based upon the repayment capacity of the applicant’s income and conform to the general credit policies with respect to the type of credit involved.  It is important to plan repayments so that the borrower can meet them in the course of his normal business operations or income.

Lastly, check the collateral being offered or need for security. The sales and or credit officer should be flexible enough to vary its security or collateral requirements in line with sound business practices. As a general rule, a morally responsible credit applicant with strong financial strength in relation to the line of credit, and a well-established, stable business, which assures a satisfactory margin of income over all expenses may be extended credit on clean basis.  Therefore, collateral requirements such as co-maker, guarantor, among others should be imposed only as the risk increases and if there are unfavorable results in the abovementioned considerations.

For more credit & collection (C&C) questions, comments and rejoinders you want to share or inquire, you can reach me at 0917-7220521 or at [email protected]