Building a strong foundation with the Five Cs of Credit 

A thorough credit investigation is a hallmark of a strong approach to extending credit. Learning the ins and outs of a company’s operations, their financials and their ability to pay in a timely manner informs the credit manager on how to best extend credit without putting their company at risk.

Why it matters: As credit managers integrate technology and artificial intelligence (AI) when evaluating a customer’s creditworthiness, it is critical that they don’t lose sight of the fundamentals of a credit investigation. Building an in-depth understanding of the Five Cs of Credit ensures that credit professionals are fully aware of the risk incurred when working with a customer, further allowing them to sell on terms that best protect their company’s interest.  

Whether you’ve heard of the Five Cs or not, the concepts are integral to a thorough credit investigation and open your company up to risk if overlooked. The Five Cs are: 

• Character: The willingness of a debtor to pay its obligations. 
• Capacity: The inclination or propensity of a business to operate profitably and its ability to pay debts.  
• Capital: The value of a customer’s business in excess of all liabilities and claims, referred to as its equity or net worth, that represents its overall financial strength.  
• Collateral: When a business’s cash flow is not adequate, a second source of repayment, or collateral, can be pledged as security for a debt. 
• Conditions: External events, occurrences and any factors that may interrupt the normal flow of business.  

“The Five Cs are foundational to every decision credit managers make,” said Ryan Steiner, corporate credit manager at Olympic Steel (Bedford Heights, OH). “You have to take all these elements into account, and the real art of credit management is knowing when one factor outweighs the other. You can’t always say that collateral is the most important thing, because sometimes you’ll deal with businesses that are light on assets and don’t have much collateral to borrow against.” 

When a credit manager has a strong understanding of the Five Cs, they can easily weigh the different qualities against one another to understand a business’s unique circumstances. “Each one of the Five Cs has different bearings to me,” said Kevin Stinner, CCE, CCRA, credit manager for J.R. Simplot Company (Boise, ID). “When I’m doing a credit write-up, I am trying to build a story by assessing each of these factors to determine whether or not I think a customer has the ability to repay the debt.” 

Those who are new to credit management are entering the field with more technology and automation at their disposal than previous generations. While ever-advancing technology has become ubiquitous in the credit department, the need for strong credit judgment rooted in decades-old foundations persists.  

“Using credit scoring, financials and AI gets you up to a certain point in evaluating a customer at a mathematical level, but the rest relies on the other questions you won’t get from tech,” said Heidi Lindgren-Boyce, CCE, senior credit manager for Star Rentals (Kent, WA). “For example, what is the customer trying to order? Is this order reasonable within your company’s footprint, as in, is this something your company regularly sells or do you have to purchase to resell to this customer?” 

While credit scoring models and other automations might make the task of evaluating a customer less daunting, there are certain elements of a credit investigation that require a human touch. “I’ve yet to see an AI model that can assess the character of a business because character is something you have to experience,” said Stinner. “You have to gain experience in determining what a person is actually willing to pay. You can come up with some basic ideas of the customer’s creditworthiness by looking at the numbers, but you need to look past that information to get a full understanding of whether or not that customer has the capacity to repay a debt.”  

One way for credit managers to brush up on their understanding of the Five Cs is to manually write up credit assessments. “Those in leadership positions should have their new credit managers start with the basics,” Stinner said. “If they’re just looking at an automated credit score, they’re never going to learn what that score or that information means. For me, I have my credit analysts do write-ups by hand to work through the Five Cs.” 

Furthermore, education is an invaluable resource for newer credit managers looking to build a strong foundation. “For those new to credit, I highly recommend that you take the Business Credit Principles course from either your NACM Affiliate or NACM National and continue with the accreditation roadmap in obtaining your credentials,” said Lindgren-Boyce. “Join NACM National’s Virtual Community Mentor Match as well as one of the many thought leader forums that best match your company.” 

The bottom line: Any seasoned credit manager can tell you, the goal of every credit investigation is to find a way to bring on a customer without introducing too much risk. In short, credit managers want to get to “yes.” A thorough understanding of a customer’s business will allow credit professionals to find creative ways to get to that “yes,” but it is only made possible by a thorough understanding of the Five Cs of Credit.