Effects of Late or Non-payments/The 5 "C's" (Domestic and International)
The 5 “C’s” (Domestic and International)
Character, capacity, capital, condition, and collateral are as follows:
- 1. Character refers to a buyer’s willingness to pay obligations.
- 2. Capacity is a buyer’s ability to pay.
- 3. Capital refers to a buyer’s equity and signifies the financial strength.
- 4. Condition reflects a buyer’s economic situations.
- 5. Collateral refers to a buyer’s access to additional resources to use for payment.
A buyer’s willingness to pay obligations is assessed by considering a buyer’s morality, integrity, trustworthiness, and quality of management. Character is also assessed by considering a buyer’s success, payment record, and information from current suppliers. Examples of information for such assessments should be intangibles (family background, employment record, personal credit history) that are used to form a tentative opinion. The range of findings could include favorable payment records or, on the negative side, a record of bankruptcies or litigation. For many credit mangers, bankers, and risk managers, the trait of “character” is often considered the most important.
A buyer’s ability to pay or a buyer’s ability to generate cash flow and pay when a debt is due can be determined when assessing capacity. Assessing capacity involves considering prior business experience with related operations, particularly large volume orders, exacting specifications, or tight delivery schedules. The outcome of the assessment should show positive evidence of successful operations and on-time bill payments.
A buyer’s equity or net worth signifies the financial strength of a buyer and may demonstrate an ability to pay obligations. A positive capital assessment reveals a business that shows increasing sales, profits, and net worth as well as favorable operational trends.
The market’s current and expected general economic situations may affect the applicant's business. When assessing condition, consider past and current political history, recent economic events, and currency issues. During the assessment, also consider analyzing industry cycles and consolidations and whether the industry is subject to favorable or unfavorable trends. Credit managers should analyze the business cycle of credit applicants.
A buyer’s ability to access additional resources (equities or other assets) to use for payment if that buyer’s capacity or character fails is important. Specific assets, such as receivables or inventories, can be pledged via liens against these assets, based on international laws that regulate these types of transactions. Other forms of collateral are letters of credit, standby letters of credit from the applicant's bank, guarantees by the firm or its parent, personal guarantees from the principals, and pledges of investment holdings such as stocks or bonds, or other investments. It is important to determine whether potential collateral is free and clear and has not already been pledged to other creditors.