Introduction to Credit: What is Credit?

Summary

This course introduces the fundamentals of credit, covering essential topics such as different types of credit, loans, and credit analysis techniques. The content explores the roles of both lenders and borrowers, with a focus on how companies and individuals use credit for operations, growth, and investments. Key concepts such as the five C's of credit are discussed, along with the various ways credit impacts financial decisions. The course provides a foundation for future, more advanced topics in credit analysis, preparing learners for certification as credit analysts.

Takeaways

• 😀 Credit is the provision of resources by one party to another without immediate payment, typically in the form of loans or business-to-customer credit.
• 😀 Companies use credit to finance short-term working capital needs, such as buying inventory, and for long-term investments like building factories or expanding operations.
• 😀 Individuals also use credit for major purchases like buying a car or paying for education, typically through loans or credit cards.
• 😀 The course covers both the perspective of borrowers (companies and individuals) and lenders (banks, credit providers).
• 😀 The five C's of credit are introduced, which are key concepts for credit analysis and evaluation in the lending process.
• 😀 Companies rely on three primary funding sources: cash, equity, and debt, each with its own advantages and drawbacks.
• 😀 Cash is a liquid and cost-free source of funding but may not be sufficient for large projects or emergencies.
• 😀 Issuing equity involves selling shares of the company to investors, offering no repayment requirement but diluting ownership and control.
• 😀 Debt, or credit, is cheaper than equity, provides funding without diluting ownership, but requires careful management of cash flow for interest and principal repayments.
• 😀 Debt financing can be a risk if the company is unable to meet its obligations, as it may lead to insolvency, while equity does not carry the same risk.
• 😀 Companies must carefully balance the use of cash, equity, and debt based on their financial needs and long-term strategy.

Q & A

What is the definition of credit as introduced in the course?

Credit is created when one party receives resources from another without immediate payment, where the receiver promises to pay later.

What are the two main types of counterparties involved in credit transactions?

The two main types of counterparties are lenders, who provide money in loans, and sellers of products or services, who extend credit to the buyer.

How do companies typically use credit?

Companies use credit to fund short-term working capital, such as inventory purchases, and to finance long-term investments like building factories or making acquisitions.

What role do individuals play in the credit system?

Individuals use credit to manage day-to-day expenses (e.g., through credit cards) or to make large purchases (e.g., cars or houses) that they can't afford upfront but can pay for over time.

What are the three main ways companies can fund their operations or investments?

Companies can fund their operations through cash on hand, issuing equity (selling new shares), or issuing credit/debt (borrowing money).

What are the advantages of using cash to fund projects?

Cash is highly liquid and readily accessible with no cost for obtaining it, other than opportunity costs. However, companies usually don't keep large cash balances due to the need for reserves and emergency funds.

What are the benefits and trade-offs of issuing equity?

Issuing equity can be beneficial for companies that can't access debt, as it doesn't require repayment like loans. However, it's more expensive due to higher expected returns for investors, and it dilutes ownership and control of the business.

Why is debt considered cheaper than equity?

Debt is generally cheaper than equity because it involves lower risk for investors, and the interest payments are tax-deductible, reducing the effective cost of borrowing.

What are the potential risks of using debt for funding?

Debt adds financial risk to the business, as it must be repaid with interest. Failure to manage cash flow and meet debt obligations can lead to insolvency, especially for companies with high credit risk.

How does a company's mix of funding sources impact its financial health?

A company's financial health depends on balancing cash, equity, and debt. Each source of funding has its pros and cons, and choosing the right mix is essential for minimizing risk while securing the necessary capital for growth and operations.