The 4 Cs Of Credit Risk

Does your finance proposal address the 4Cs of Credit?

These are the fundamental planks of Credit Risk which must be satisfactorily addressed in a Loan Proposal. They should frame your thought process as you argue your business financing case.

Character

This is about the integrity of the key people who are responsible for meeting a company’s undertakings. Business is about people and character is absolutely fundamental in assess of a quality of a credit – and in all business deals as well.

The most tightly drafted documentation and apparent abundance of security cannot guarantee the safety of a financier’s exposure from fraudulent dealings. Mistrust is a poor foundation for any business relationship.

In a loan proposal, an informed opinion has to be made about the key people involved in the proposed transaction.

• Do the business owners and key management always endeavour to meet their commitments as and when they fall due?
• Do they have a sound reputation for being honourable in all their business dealings?

Cash Flow

Cash flow is the lifeblood of any business. A critical assessment of a detailed cash flow forecast to assess ability to meet interest and scheduled principal repayments is an essential part of any financing proposal.

Simply presenting a Profit & Loss Statement and using interest calculations based on EBIT and EBITDA are not sufficient. The cash flow forecasts must be part of a 3-way financial forecast model ie projections based on interlinked Profit & Loss, Cash Flow and Balance Sheet.

The projections should reflect your business plan and be capable of stress-testing. Ideally, you should have considered a number of “What if.?” scenarios and developed a High Case, Base (or Most Likely) Case and a Low Case.

Collateral

The quality and adequacy of security must be addressed as part of the proposal. What are the key components of security being provided for the loan? What is the quality of each of these? How readily can they be turned into cash? How well will they hold their values?

Capability

Quality of management and the presence of a balanced mix of management skills are vital to the on-going success of a business. No one person can have all the skills required.

For example, the owner or CEO of the business may be a marketing and sales whiz but may barely be able to read a set of accounts. Does he/she have capable finance and accounting support in the form of a full-time employee or consultant to the business?

There should also be depth of management. This ensures that the business will continue to function smoothly in the event that a member of the management team leaves or is ill or (heaven forbid) falls under a bus.

If you are unsure as to how to prepare a financing proposal which is framed through the 4 Cs of credit, contact me. It could make the difference between a “yes” and a “no” from your financier.

[Note: Capital is sometimes added as a 5th C. However, it is probably superfluous as Capital issues are effectively covered under Cash Flow and Collateral.]