How Credit Decisions are Made

Get in control. Understand the credit process, what factors influence your credit rating and how to shape up credit that may be less than perfect.

From Personal Loans, to Auto Financing to Home Loans-applying for a loan can be an intimidating experience, particularly if you have credit problems or a troubled credit history. Put yourself in control. Understanding the loan process, related costs, and your options is a good place to start.


When lenders review a credit application, they look at these three factors:

  • Credit history:-How well you’ve paid debts in the past.
  • Current obligations:-How much you currently owe each month.
  • Income and assets:-How much you currently earn and own.

Most lenders use computerized scoring systems to rate you on each factor. Your credit score can determine if you will be offered credit, the amount of credit you may be offered, and may even determine how much you will pay for credit (your interest rate and fees). Keep in mind that different lenders have different scoring systems, so if you’re turned down by one lender, you might be approved by another.


Federal law is very specific about what lenders cannot do. Credit practices are prohibited if they discriminate on the basis of the following factors:

  • Race
  • Religion
  • Sex
  • Marital status
  • National origin
  • Color
  • Age (provided the applicant has the understanding and ability to enter into a contract)


Extending credit -- it's the careful balance of limiting risk and maximizing profitability while maintaining a competitive edge in a complex, global marketplace. How can you do this effectively for your business? Many financial managers use the "Four C's of Credit" as their guide. We've listed the "Four C's" below and added some additional guidelines to help you make more profitable business credit decisions.

Apply the "Four C's of Credit" in Your Non-Financial Analysis

The "Four C's of Credit" include character, capacity, capital and conditions of the times. The significance of each factor may vary from case to case. The credit executive must measure the account against each factor before giving a final opinion.

  • Character

    The history of the business and experience of its management are critical factors in assessing a business ability to satisfy its financial obligations. Look at how long the business has been under the same control, and check for any previous litigation or bankruptcy information. Also, get a clear understanding of who owns the business, and who is ultimately liable if a problem arises. Always get a list of the business's officers with their ages and backgrounds. Research the financial worth of principals for proprietorships and partnerships. Identify the exact business name and legal form of the organisation. What products does it sell? On what terms? Is it a seasonal business? What are its margins? Get a sense of the character of the owners and the business's ability to compete in its markets.
  • Capacity

    Make sure to assess the capacity of the business to operate as an ongoing concern in every credit decision. Principals in small businesses are often forced to wear many hats. Businesses must be able to allocate resources evenly to the various functions of the organisation such as marketing and sales, production and finance. If the production manager has to put production work aside to make collection calls, or if finance is asked to telemarket, efficiency within the business could deteriorate. Keep an eye on management. Assess their experience and their ability to manage all aspects of the business without compromising efficiency. Does the organisation have the facilities to handle your business needs?
  • Capital

    Analyse the financial capacity of the organisation in order to determine its ability to meet financial obligations in a timely fashion. Above we discussed the willingness of a business to pay its obligations, however, its ability to pay may be much more important. It is critical to understand the difference. For example, you may conduct business with customers unable to pay quite differently than with those unwilling to pay. Terms could be worked out for customers unable to pay immediately, but customers unwilling to pay on time could be priced for the inherent risk or denied altogether.

    Watching customer payment habits over time is an excellent indication of cash flow. Also, check, as well as any pending litigation or contingent liabilities. Check for a parent business relationship. A parent business's guarantee may be available. Inter-business loans might affect financial solvency. Check agency ratings that predict slow payment or default to complete your investigation.
  • Conditions of the times

    General economic conditions in the nation, in the community, and in the industry will exert a modifying influence on the financial analysis of an account. What industries are growing or shrinking? Is your prospect in a dying industry? During prosperous times, risk of credit loss is generally less than during a depressed period. Watch for any news items or special events that could affect the firm's ability to continue as an ongoing concern.


When entering into a relationship with a new customer, consider these two very important questions. Will I be paid slowly? And, will I be paid at all? Some businesses are willing to accept some level of slow pay based on their goals and objectives and how much risk they are willing to take. Few firms are willing to accept no payment at all. Financial analysis will help you determine a prospect's financial capacity to pay obligations in a timely fashion as well as their ability to maintain an ongoing relationship. Your decision to conduct business with this firm will vary based on whether they appear to be a one-time purchase or a long term account.

When trying to understand the financial capacity of a prospect, a financial ratio analysis is a good place to start. Ratios can be grouped into three main categories:

  • Solvency Ratios -To determine the cash available to pay obligations and the amount of debt of the prospect
  • Efficiency Ratios - To determine how efficiently the firm runs its operations such as the collection period and inventory turnover
  • Profitability - To determine the firm's reinvestment in the business for future growth

     Other areas of interest: