Credit analysis definition
/What is Credit Analysis?
Credit analysis is a review conducted by an outside party on a business or individual to judge the subject’s ability to repay debt. This analysis typically involves a review of credit scores, cash flows, income, and the presence of sufficient collateral to pay back debt. The outcome of the analysis is a determination of whether to extend credit or loan money to the subject and if so, the amount to be committed. This analysis can also be used to estimate whether the credit rating of a bond issuer is about to change, which could present an opportunity to profit from speculating in ownership of the bonds.
A credit analysis usually involves a scoring system that is unique to the reviewing party, and which is designed to maximize its returns while minimizing bad debt losses. The analysis may involve various ratios for the analysis of debt loads, earnings volatility, and the adequacy of cash flows.
Related AccountingTools Courses
Credit and Collection Guidebook
Credit Analysis Best Practices
Here are several best practices related to the use of credit analysis within a business:
Use an analysis threshold. Some businesses choose not to spend any time on credit analysis when a customer order is quite small, on the grounds that the cost to conduct the analysis is greater than the potential loss from a bad debt. There is usually a specific threshold for customer orders, below which this policy is used.
Use rules wherever possible. It is much more efficient to set up rules for the level of credit that will be granted, and to stick to those rules to the greatest extent possible. By doing so, you can avoid situations in which the same types of customers are granted different credit amounts.
Assign accounts based on experience. Always assign your most difficult analysis chores to your most experienced analysts, since they are in the best position to make credit decisions in cases where it is not clear whether to grant credit, and if so, how much.