Before granting credit to a prospective consumer the firm must ask the question: How creditworthy is the consumer? In judging the creditworthiness of an applicant the three basic factors; the three C’s; are character, capacity and collateral.Character refers to the willingness of the consumer to honor his obligations. It reflects integrity, a moral attribute that is considered to be very important by credit managers. Capacity refers to the ability of the consumer to pay on time. It depends on the financial situation, particularly the working capital position and profitability, and the general business conditions affecting the performance of the consumer.
There are several ways in which you can find out whether a consumer is likely to pay his debts: Analysis of financial statements, obtaining bank reference, analysis of firms experience and numerical credit scoring. Financial statements contain a wealth of information about the consumer’s financial condition and performance. A searching analysis of these statements can provide useful insights into the creditworthiness of the consumers. The following financial ratios are helpful in this respect: current ratios, acid test ratio, debt equity ratio, total assets ratio and return on equity.
The banker of the prospective client may be another source of information about his financial condition. This information may be obtained indirectly through the bank of the credit-granting firm to ensure a higher degree of candidness. Consulting one’s own experience is very important. If the firm has had previous dealings with the consumer, then it is worth asking how prompt the customer has been in making payments. How well has the customer honored his word in the past? Where the customer is being approached/ considered for the first time the impression of the company’s salesman about the integrity of the consumer is important.
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