When a company applies for a loan, the lender completes a corporate credit analysis. The analysis aims to assess the risk that the company won’t fulfill its financial obligations. If the risk is too high, the lender won’t approve the loan.
The analysis process requires a careful review of financial statements and other documents.
Depending on the results of the assessment, a bank may approve the loan but require collateral. The debtor can use assets, such as property, as collateral. Another possibility is that the lender will approve a loan for a different amount than originally requested.
Factors Considered in a Corporate Credit Analysis
How Lenders Assess Corporate Creditworthiness
During the credit analysis process, lenders review a company’s assets and liabilities, credit rating, other debts, and more.
Assets To Liabilities
A business’s assets to liabilities ratio is one figure creditors use to determine risk. To calculate it, the lender divides the business’s total assets by its liabilities. A score of 2 or higher indicates that the company is very creditworthy. If the score is less than 1, the risk is too high for most lenders.
Corporate Credit Rating
A corporate credit rating can help banks determine an entity’s creditworthiness. Three leading independent agencies offer corporate ratings: Standard & Poor’s (S&P), Fitch, and Moody’s. Each agency uses a similar scale, where a rating of AAA indicates the lowest risk.
Lenders should note that there is some controversy regarding the credit rating agencies. Critics believe that by taking payments in return for higher ratings, the agencies contributed to the financial crisis of 2008.
Other Credit Analysis Elements
Along with the assets to liabilities ratio and credit rating, creditors may look at an entity’s unpaid receivables and capital stability.
If the company goes too long without paying receivables, it is less likely to repay a lender on time.
Capital stability means that a company’s shareholders will contribute capital to the company if needed. The shareholders’ confidence is reassuring to lenders.
Completing a corporate credit analysis doesn’t guarantee that the company won’t default on its debts. There is always some risk to the creditor. However, by completing an analysis, the lender can ensure that the level of risk is acceptable.