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This report introduces a procedure that can be used to analyze the quantifiable aspects of commercial credit requests The procedure incorporates a systematic interpretation of basic financial data and focuses on issues that typically arise when determining creditworthiness Cash flow information is equally important when evaluating a firms prospects Reported earnings and EPS can be manipulated by management debts are repaid out of cash flow not earnings The basic objective of credit analysis is to assess the risk involved in credit extension to banks customers Risk refers to the volatility in earnings Lenders are concerned with net income or the cash flow that hinders a borrower ability to service a loan Credit analysis assigns some probability to default Some risks can be measured with historical and projected financial dataThe key issues include the following1 For what are the loan proceeds going to be used2 How much does the customer need to borrow3 What is the primary source of repayment and when will the loan be repaidVirtually every business has a credit relationship with a financial institution But regardless of the type of loan all credit request mandate a systematic analysis of the borrowers ability to repayWhen evaluating a loan a bank can make two types of errors1 Extending credit to a consumer who ultimately would repay the debt2 Denying a loan request to a customer who ultimately would repay the debtIn both cases the bank loses a customer and its profit decreases For this reason the purpose of credit analysis is to identify the meaningful and probable circumstances under which the bank might lose So a credit analyst should analyze the following itemsCharacter The foremost issue in assessing credit risk is determining a borrowers commitment and ability to repay debts in accordance with the terms of a loan agreement An individuals honesty integrity and work ethic typically evidence commitment Whenever there is deception or a lack of credibility a bank should not do business with
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