Previous article
Next article

The 5 Cs of Credit is a method to determine the creditworthiness of borrowers

With 5 characteristics – Character, Capacity, Capital, Collateral, Conditions – the worthiness and the potential risk of credit is approximated

The 5 Cs of the credit framework are used to estimate the potential risk of a credit to a certain borrower. The 5 Cs of credit concept does not have to be applied very often in consulting interviews in its pure-play form. Even if it is not one of the "must-have" skills, it is still worth looking at this concept. Especially if you are from a finance background or if you're applying at a consultancy with a strong financial services focus.

We will now go over these 5 factors in more detail – while you probably won’t need to learn all the factors by heart, knowing just the names of the 5 factors is probably the 80/20 way to go here.

Character:

Character is a subjective judgment about the potential borrower. Factors that are taken into account can include:

  • First impression
  • Reputation of the borrower
  • Know-how and experience
  • References and background

Capacity:

Capacity might objectively be the most important factor because it refers to the ability of a potential borrower to pay the loan back.

Factors include:

  • Cash position/expected cash flows
  • Revenue and expenses
  • Credit history

Capital:

In this context, capital is the amount the potential borrower has invested in the business/company. It is normally an indicator of how much the borrower is involved in the company and how much he/she has to lose if the investment fails. A higher (relative) capital investment of a potential borrower usually means more alignment with the incentives of the lender and the borrower.

Collateral:

Guarantees or other forms of security the potential borrowers can offer are known as collateral. These forms of security can include:

  • Buildings
  • Equipment
  • The owner's private properties

Conditions:

Conditions are two-folded and include the overall economic environment and the intended purpose of the loan. As a rule of thumb, the economic circumstances, in general, are less favorable for a potential borrower if the economy is in a downturn/recession.

Taken together, these five factors usually give a reliable picture of the creditworthiness of a buyer from a qualitative and quantitative point of view.

Key takeaways:

  • Method to determine the creditworthiness of borrowers.
  • 5 factors of interest: character, capacity, capital, collateral, conditions.
  • Occasionally used during case interviews, more specialized framework for financial cases.
Previous article
Next article
Do you have questions on this article?
Contribute to our Q&A forum and ask the community your question!
How likely are you to recommend us to a friend or fellow student?
0
1
2
3
4
5
6
7
8
9
10
0 = Not likely
10 = Very likely