The Four C’s of Credit

In any business credit receiving and extending credit is a major part of its operation and functionality. When looking at extending credit with regard to customers; four standard guidelines should be used to evaluate a potential credit customer, and the risk of non payment associated with them.

Character is normally considered the most important of the four, but it is also the most difficult to determine. Even though much information can be gleamed from a past credit history and habits; it may not tell the whole story. Unique or unusual circumstances may have occurred; that could account for particular situations that existed in a persons past. Some businesses rely on personal interviews to make an assessment of an individual character. Personal interviews relying on instinct or gut feelings about someone; this may not always the most accurate or fair, but this area is more of an art than a science. Although making such a determination during and interview may be difficult to determine; that does not negate its importance but only capitalizes it, since character determines the actions an individual may or may not take. The other three factors do not determine action but are the result of them; so being able to determine if a person’s character will affect their desire to pay, remains the most important component of the four.

Capacity is the next guideline, and it has to do with a credit recipient’s ability to repay the debt. One must know what the individual’s current financial situation is; does their current debt load exceed or come close to their net income? Also, is their financial situation stable with regards to their employment; how long have they been with their company, have they changed jobs a great deal, does their employers industry have a history of severe ups and downs with layoffs and strikes?

Capital simply has to do with a customer’s financial strength relating to their net worth. Do they have more assets than they owe; what type of assets have they acquired and are they liquid, can they be converted to cash quickly and easily? Does the customer have any collateral to be used as a substitute for capital; such as a vehicle, boat, or other durable goods that can be disposed of easily?

The last of our four is condition is there conditions that exist in the economy, the business or in the customer’s life that will affect repayment of the loan? Does a climate of possible industry downturns, recession, currently exist; that not only affect the individual applying for credit but the business extending it? If a business suffers a downturn or is effected by a recession; they may want to reevaluate there credit practices and make adjustment.

As I stated when evaluating an individual to approve for credit it is important to keep the four things mentioned in mind. One must remember that by extending credit not only does the action stand to increase growth in profitability but it increases risk as well.