If you don’t know what credit analysis is, don’t worry! It’s not complicated. At least it doesn’t have to be.
Credit analysis is just like any other research.
Whether it’s learning something new, doing a report, or looking up reviews. That’s how I think about research in general and I like to categorize credit analysis in this category.
The only difference with credit analysis than other research is it’s about risk assessment and potential losses or recovery if there is a distressed situation.
What this means is, if you lend a person or company money and they run into financial troubles to pay lenders back and keep their business going because they are not making enough money, you may take losses in what you have lent (you can also call it what you are owed).
Doing credit analysis is about understanding that company or person so you can get an idea of whether you can take the risk of lending or them borrowing and how likely you will be paid back or whether you will be able to recover your money if they had to liquidate or sell their assets.
Nothing is ever guaranteed…
but credit analysis is about research and making an assessment based on that research.
Sometimes a company or person is higher risk, so you want to charge more interest for taking on that risk of lending. That’s what credit rating agencies are for (giving a grade on the borrower) and what credit scores are intended to do. Better grades and better scores usually mean safer. Lower grades and lower scores usually mean it’s riskier.
So to get started with credit analysis
You want to understand who or what is asking to borrow from you.
- Understand the business.
- How they make money.
- What they do.
- How much money they make.
- What their expesnses look like.
- How much debt they already have.
- What type of assets and liabilities do they have.
- What the industry they operate in looks like.
- What are the strengths and weaknesses.
- Do they have any obligations that are coming up that may impact them negatively.
- How is their current debt structured and are there any negative covenants.
- Look at historical track records.
- Look at how they use their cash.
- Look at how they operate their business.
- What is their strategy going forward.
- Do they continue to grow and expand or are they slowly declining.
- Are they managing the business well.
- Do they keep up with trends.
All these little things matter when you are investing or lending in a business because you want to make sure wherever you are risking your own capital, that it’s being wisely deployed to companies that will do well in the future. This is particularly important on the lending and borrowing side because as a credit analyst, you want to get paid back in full.
This is what you need to consider when you get started with credit analysis.