When extending high credits for a small business company it is important to assess the credit worthiness of the debtor.
Certain guidelines like how banks follow the KYC and proper documentation becomes imperative before loans are sanctioned. Sometimes collateral may also be necessary to ensure the loans are honored.
When extending credit to customers, firms are essentially providing them a loan equal to the amount of their purchases.
A thorough study and investigation on the character, culture and financial health of the company plays an important role.
Integrity – This refers to the borrower’s character and willingness to repay the financial obligation. Does the borrower have a bad credit rating? Has the borrower declared bankruptcy in the past? Did the borrower have any failed enterprise in the past? Has the borrower failed to meet family obligations? These questions about the character of the borrower need to be answered to ensure a clean history.
Solvency – This addresses the borrower’s cash flow and ability to repay the debt from ongoing business operations. Unforeseen business difficulties will always arise. Accordingly, the use of the borrowed funds must generate sufficient funds during the period of the loan to cover these contingencies, and still have a generous amount left over in order to service any remaining debts.
Capital – This is the borrower’s financial net worth. A significantly positive net worth has the potential to offset insufficient cash flows, because financiers perceive the borrower still has more than adequate means to repay the loan. This also helps in establishing a clients credit worthiness.
Collateral -This refers to any property owned by the borrower that can be pledged for security. If the property has been previously pledged against another loan, financiers would probably not consider it available to be pledged again until the previous loan has been paid off.
Influencers – to check if the company promoted by the borrower has any influencers or brand ambassadors. What is the impact on the market? Are there any feedbacks? How is it affecting the image of the company? Is it boosting the sales and growth?
Inventories – to be able to explore the raw material stocks and inventories held by the company of borrower. Whether these can convert as collateral and can be readily pledged against a default loan.
Excess inventory can also portray a negative impression and impact the cash flow. It may indicate poor sales.
A creditor also needs to assess a borrower’s credit worthiness based on the ability to withstand changes in the economic and political scenario especially during the loan period. The capability to handle rising raw material prices, inflation, change in tax norms, increasing interest rates, the probability of an employee strike need to be ensured.
Careful attention needs to be paid to above guidelines before funds are handed out.
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