Case

Ms Krishna Idnani has recently joined the credit division of Axis bank. As a finance professional advise her about the various techniques used for evaluating the credit-worthiness of a customer.

What is Creditworthiness?
Creditworthiness refers to a lender's assessment of an applicant's ability to handle his or her financial responsibilities. Whether or not an applicant is deemed to be creditworthy will often determine whether or not he or she will be granted a loan or a line of credit.

If an applicant is not considered to be creditworthy, then a lender may not grant him or her a loan.

How is it determined?
Creditworthiness is generally determined by reviewing an applicant's credit history. When an individual applies for a loan, a creditor will analyze his or her credit report in order to determine whether he or she is a highrisk investment. An individual's credit report will display information regarding his or her financial obligations and success handling them.

The report will detail the debtor's payment history and verify whether or not he or she has regularly met bill deadlines, as well as paid off his or her debt to mortgage companies, credit unions, and businesses.

 Any payments that were late or missed will be reflected on this credit report. If a credit report displays data that suggests that an applicant is financially irresponsible, this will undermine his or her creditworthiness and the lender will most likely deny the loan. If a consumer does not understand the proper way to utilize credit, there is a good chance that he or she will accrue more debt than he or she is able to manage. This may eventually lead to bankruptcy.

Individual
The stages of the credit analysis are as follows: 1. Collecting and analyzing information about the company applying for a loan and formulating indicators about its financial situation; 2. Collecting and analyzing information about the credit event; 3. Assessing the credit risk; 4. Checking the reliability of the information, provided by the company applying for a loan; 5. Preparing an analysis of the credit risk; 6. Taking a decision; 7. Setting the credit terms.

Documentation
Identity proof 3 to 6 months Bank statements Residence proof Salary slip Guarantors & their same set of documents

1) Latest 3 months Bank Statement (where salary/income is credited) 2) 3 Latest salary slips 3) Proof of Continuity current job (Form 16 / Company appointment letter ) 4) Proof of Identity (any one)Passport / Driving License / Voters ID / PAN card / Photo Credit Card / Employee ID card 5) Proof of Residence (any one) Ration Card / Utility bill / LIC Policy Receipt 6) Proof of Qualification Highest Degree (for Professionals / Govt employees)

How does the Cibil Score affect your loan application? This a norm wherein the banks before giving Personal Loan checks the database of all loan borrowers in the country by the Credit Information Bureau of India (CIBIL) which is called the Cibil Score. If there has been a default in your loan payment; your loan application would certainly be rejected. Your Cibil score ranges from 100 to 999, for instance if your credit score is 100 then your loan application might be out rightly rejected. On other hand if it is higher say 800, then your loan application would be processed faster & will be rewarded with lower interest rates & discounts in processing fee & other charges. You can improve your credit score by repaying your loan EMIs on time and always pay the minimum payment on your credit card to avert from the bad credit score. you can apply for your own Credit Information Report (CIR) from CIBIL at a minimial cos

Enterprise
Liquidity their ability to pay their bills on time and in full Efficiency how well they run their business Profitability & Growth what direction is the business travelling

Power of C
Capacity- to generate sufficient cash flows to service the loan Collateral- to secure the loan in case the borrower defaults

Capital- that shareholders have invested in the business

Conditions- prevailing in the borrowers industry and broader economy Character- track record of the borrower and the borrowers management

Ratios
Acid test ratio=

Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore, if the acid-test ratio is much lower than the working capital ratio, it means current assets are highly dependent on inventory. Retail stores are examples of this type of business.

 Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore, if the acid-test ratio is much lower than the working capital ratio, it means current assets are highly dependent on inventory. Retail stores are examples of this type of business. The term comes from the way gold miners would test whether their findings were real gold nuggets. Unlike other metals, gold does not corrode in acid; if the nugget didn't dissolve when submerged in acid, it was said to have passed the acid test. If a company's financial statements pass the figurative acid test, this indicates its financial integrity

To establish liquidity
Current Ratio = Current Assets Current Liabilities This ratio tells you about the customers solvency, and their ability to pay their bills as they fall due. There are three possible answers 1, >1, < 1.

To measure efficiency
Stock Turnover Stock X 365 Sales Efficiency would be measured by how little stock they hold. Every efficient businessholds a minimum of stock consistent with meeting the demands of their customers

Measure efficency
To measure efficiency Collection Period= Debtors X 365 Sales

DEBT EQUITY RATIO

A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.

If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing. The debt/equity ratio also depends on the industry in which the company operates. For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5.

REFERENCE
http://www.icmt.ie/dynamic/attack_9_49898 2332.pdf http://www.investopedia.com/terms/d/debte quityratio.asp#axzz1q46d8PW0 CREDIT MANAGEMENT BOOOK