Credit Analysis

Credit analysis is the study of a borrower to judge whether it can and will repay a loan. The analyst looks at past results, current debts, future cash flow, collateral and the people behind the business. US bank examiners stress that the key question is the strength of the primary source of repayment, usually cash flow from the business or property.

A typical credit analysis follows these steps:

1. Gather. Collect tax returns, financial statements, bank statements, a credit report and details on collateral and guarantors.
2. Spread. Enter the financials into a standard format through financial spreading.
3. Measure. Calculate ratios such as the debt service coverage ratio (DSCR), leverage and liquidity.
4. Test. Ask "what if" questions: what if sales drop 20% or rates rise?
5. Judge. Weigh the numbers against the borrower's track record, industry and the lender's policy.
6. Write it up. Summarize findings, risks and a recommendation in a credit memo.

Worked example. A bakery asks for a loan with $40,000 a year in payments. Its cash flow available for debt service is $56,000. DSCR = $56,000 ÷ $40,000 = 1.40. If sales fall and cash flow drops to $44,000, DSCR is still 1.10, so the loan holds up under stress.

Credit analysis vs. underwriting vs. the five Cs. These terms overlap, but they are not the same.

• Credit analysis is the research and math: what the numbers and facts say about the borrower.
• Underwriting is the broader decision process. It uses the credit analysis, checks it against policy, sets the loan's terms and structure, and ends in approval or decline.
• The five Cs of credit (character, capacity, capital, collateral and conditions) are a checklist. Analysts use them to organize what they review, so nothing important is skipped.

Why it matters for lenders

Good analysis catches weak deals before they close and helps strong deals get approved with fitting terms. It also creates the paper trail that examiners, investors and credit committees review. Thin or inconsistent analysis is a common cause of later losses and exam findings.

How it works in practice

An analyst at a loan fund receives a request from a daycare owner. She pulls three years of returns and six months of bank statements, spreads them and finds that last year's profit included a one-time grant. Removing it lowers coverage to 1.15. She adds the owner's personal cash flow and recommends a smaller loan with a longer term.

When documents arrive by email and spreads live in personal workbooks, analysts redo work and reviewers can't see how numbers were adjusted. A shared loan file keeps each figure tied to its source.