Checking Creditworthiness and Evaluation PDF

“Drawing on Credit”
This day’s readings:

Galatians 3:1-14
Creditworthiness & Evaluation
School of Business | Credit & Collection | 2nd Semester 2022-2023 | Jimuel Faigao | February 14, 2023
How to Check the Creditworthiness of a New Customer?
One of the primary reasons for poor cash flow
management is extending credit to customers without
assessing their creditworthiness. Small and mid-sized
businesses need to have a strong credit check policy
before onboarding new customers to avoid cash woes.
What is meant by Creditworthiness?
Creditworthiness is the ability of your customer
to pay you, which is why it’s important to
understand how to determine creditworthiness
before you extend trade credit.
To determine the creditworthiness of a customer, you

need to understand their reputation for paying on time
and their capacity to continue to do so.
Five Cs of Creditworthiness
1.
Character assesses how dependable and

trustworthy a customer is. To establish a
customer’s character, one must analyze their
credibility and background. Credit history is
one of the main factors to consider while
evaluating a customer’s character.
2.
You want to make sure the prospect or client can

pay your invoices. Understanding the business’
cash flow situation will provide this insight. You
should examine cash flow statements, analyze its
debt-to-income ratio, and compare that to historic
revenue.
3.
Capital signifies the total funds and assets (both

financial and non-financial) owned by a company.
Before extending credit to a new customer,
evaluate the worth of the customer’s business in
terms of their investment in fixed assets and
other instruments.
4.
Collaterals are assets that a customer

commits to back a line of credit. These
are fixed assets like inventories,
corporate bonds, or real estate.
5.
Conditions are terms established by a company in light

of its policies or due to economic conditions or
regulations prevalent in the customer’s region of
operations. Geographic location, industry type,
currency fluctuations, and political environment are
some of the factors that influence a company’s
payment terms and conditions.
How to Check the Creditworthiness of a New Customer
1 Collection relevant details to extend credit
Collecting relevant information about the client

is the first step to assessing creditworthiness.
The customers should fill out a business credit
application form consisting of general business
information, bank references, credit references,
and more.
Good questions to ask these references include:
✓ How long the business or supplier has

extended credit to the customer;
✓ The credit or purchasing limit the business or
supplier has extended the customer;
✓ When the customer’s last purchase was and
the amount;
✓ How many times the account has been late
2 Check credit reports

Analyzing credit reports is an ideal method to evaluate a
customer’s creditworthiness. A credit report contains
information on the company and its financials, enabling
you to generate credit scores. It depicts a company’s
capacity to pay by tracking its payment history and public
records.
3 Assess financial reports
The financial report of a company provides
insights into its cash position. Financial reports
include the cash flow statement, income
statement, and the balance sheet of the
company. The financial health of a new
customer should be examined thoroughly by
reviewing their public financial statements.
4 Evaluate the debt-to-income ratio
Analyze the DTI ratio of a customer to
better understand their cash flow
statement. DTI ratio indicates how much of
a company’s monthly income is spent on
repaying debts. It helps determine the risk
associated with the customer account.
To calculate the DTI ratio, divide the company’s monthly debt
payments by gross monthly income.
A low DTI ratio indicates a healthy balance between debt and

income, whereas a high DTI ratio shows that a client has
more obligations than the monthly income.
5 Conduct credit investigation
You must use multiple sources to

conduct further investigations to
evaluate the creditworthiness of a
customer.
These investigations should contain:
✓ Customer background and history

✓ Credit policies
✓ Accounts receivable aging report
✓ Economic and political climate analysis
✓ Future business probability
6 Perform credit analysis
After gathering all necessary information

about the new customer, conduct a
comprehensive account analysis. Evaluate
trade references, scrutinize financial
statements, and apply credit analysis to
predict the probability of default.
A trade reference is a detailed report
of the customer’s payment history
with its vendors and suppliers.
Using Alternative data to Evaluate Creditworthiness
In the consumer financial marketplace, alternative data

refers to information used to evaluate creditworthiness
that is not usually part of a credit report.
Some examples include:
✓ Rent payments
✓ Mobile phone payments
✓ Cable TV payments
✓ Bank account information, such as deposits,
withdrawals or transfers
Pros and Cons using Alternative data
✓Improved assessments of
creditworthiness.
✓More timely information
✓Better service and convenience
✓Lower costs
Pitfalls using Alternative data
✓Inaccurate or incomplete information

✓Difficulties in achieving good standing
✓Unintended side effects
✓The potential for discrimination

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“Drawing on Credit”

This day’s readings:

To determine the creditworthiness of a customer, you

Character assesses how dependable and

You want to make sure the prospect or client can

Capital signifies the total funds and assets (both

Collaterals are assets that a customer

Conditions are terms established by a company in light

Collecting relevant information about the client

✓ How long the business or supplier has

2 Check credit reports

A low DTI ratio indicates a healthy balance between debt and

5 Conduct credit investigation

You must use multiple sources to

✓ Customer background and history

6 Perform credit analysis

After gathering all necessary information

In the consumer financial marketplace, alternative data

✓Inaccurate or incomplete information

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