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

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

The 5 Cs of credit framework is one that is 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 owners 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 gives a reliable picture of the credit worthiness of a buyer from a qualitative and quantitative standpoint.

Key takeaways:

  • Method to determine the credit worthiness of borrowers
  • 5 factors of interest: character, capacity, capital, collateral, conditions
  • Occasionally used during case interviews, more specialized framework for financial cases

Quiz

1
2
3
4
5
Finish Summary

The selected solution is not correct.

The selected solution is correct.

Question 1

Question 2

Question 3

Question 4

Question 5

Retake Quiz
Be the first to comment on this!